<PAGE>
As filed with the Securities and Exchange Commission on June 29, 1999
Registration No. 333-76103
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
PRE-EFFECTIVE AMENDMENT NO. 3
TO
Form S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Wave Systems Corp.
(Exact name of registrant as specified in its charter)
Delaware 7379 13-3477246
(State or other jurisdiction of (Primary standard industrial (I.R.S. Employer
Incorporation or organization) classification code number) Identification No.)
480 Pleasant Street
Lee, Massachusetts 01238
(413) 243-1600
(Address, including zip
code, and telephone
number, including area
code, of registrant's
principal executive
offices)
Steven Sprague
President and Chief Operating Officer
Wave Systems Corp.
480 Pleasant Street
Lee, Massachusetts 01238
(413) 243-1600 (Name,
address, including zip
code, and telephone
number, including area
code, of agent for
service)
Copy to:
Neil W. Townsend, Esq.
Bingham Dana LLP
399 Park Avenue
New York, New York 10022-4689
(212) 318 7700
Approximate date of commencement of proposed sale to public: At such
time or times after the Registration Statement becomes effective as the Selling
Holders may determine.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. /X/
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. /_/
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. /_/
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. /_/
If the delivery of the prospectus is expected to be made pursuant to
Rule 434 under the Securities Act, check the following box. /_/
The Registrant hereby amends this Registration Statement on such date
or dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
The Registrant is hereby amending this Registration Statement on Form S-1
(Registration No. 333-76103) solely to revise the subsection entitled "Recent
Developments" included in the "Business" section, on page 33 of the Prospectus,
immediately before the "Employees" subsection.
<PAGE>
SUBJECT TO COMPLETION, DATED JUNE 10, 1999
PROSPECTUS
The information in this prospectus is not complete and may be changed. The
selling stockholders may not sell these securities until the Registration
Statement filed with the Securities and Exchange Commission is effective. This
prospectus is not an offer to sell these securities and it is not soliciting an
offer to buy these securities in any state where the offer or sale is not
permitted.
4,738,703 Shares
WAVE SYSTEMS CORP.
Class A Common Stock
This prospectus relates to 4,738,703 shares of Class A Common Stock, par value
$.01 per share, of Wave Systems Corp. We are registering these shares on behalf
of certain stockholders, to be offered and sold by them from time to time. We
are not selling any of these shares and will not receive any proceeds from the
sale of these shares. Our Class A common stock trades on the Nasdaq National
Market under the symbol "WAVX". The last reported sales price of our Stock on
June 4, 1999 was $17.69 per share.
------------------------
Investing in our Class A Common Stock involves a high degree of risk.
See "Risk Factors" beginning on page 7
------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved of these securities or determined if this prospectus is
accurate or complete. It is illegal for anyone to tell you otherwise.
-------------------------
The date of this prospectus is June 10, 1999.
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Table Of Contents
<TABLE>
<S> <C>
Prospectus Summary.................................................................................. 3
Risk Factors........................................................................................ 7
Price Range of Common Stock......................................................................... 16
Use of Proceeds..................................................................................... 16
Selected Consolidated Financial Data................................................................ 16
Management's Discussion and Analysis of Financial Condition and Results of Operations............... 19
Business............................................................................................ 25
Management............................................................................................ 35
Security Ownership of Certain Beneficial Owners and Management...................................... 38
Certain Relationships and Related Transactions...................................................... 39
Description of Securities........................................................................... 41
Selling Security Holders............................................................................ 45
Plan of Distribution................................................................................ 48
Legal Matters....................................................................................... 49
Experts............................................................................................. 49
Financial Statements................................................................................ F-1
</TABLE>
You should rely only upon the information contained in this document or
that to which we have referred you. We have not authorized anyone to provide you
with additional information or information that is different. This prospectus is
not an offer to sell or an invitation of an offer to buy any of the securities
offered hereby to any person in any jurisdiction in which it is unlawful to do
so. The information contained in this prospectus is accurate as of its date,
regardless of the time of the delivery of this prospectus or of any sale of the
Class A common stock; changes may have occurred since.
We own or have rights to trademarks or tradenames that we use in
conjunction with the sale of our products. Embassy(TM), WaveMeter(R),
WaveNet(R), Great Stuff Network(TM), Second Shift(TM) (the Wave juggler logo),
WaveCommerce(TM), Wave Interactive Network(TM), WINPublish(TM), WINPurchase(TM)
and CablePC(TM) are trademarks or registered trademarks used by us. All other
trademarks and tradenames referred to in this prospectus are the property of
their respective owners.
<PAGE>
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PROSPECTUS SUMMARY
The following is a summary, and should be read as such. This summary is
qualified in its entirety by, and should be read in conjunction with, the more
detailed information and financial information and statements incorporated by
reference in this prospectus. You should carefully consider the factors set
forth under the caption "Risk Factors".
Our Business....... Wave Systems Corp. offers powerful, next-generation
solutions for electronic commerce , making the process
easier, versatile, and more secure for consumers as well as
business-to-business applications. We are involved in the
research, development, and market testing of the Wave
System, which performs the buying transactions in a range of
consumer electronic devices, including computers, personal
digital assistants, and interactive televisions, for the use
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,
as well as access to services such as broadcast or
telecommunications services. Examples include archived
newspaper and magazine articles, on-line books, music
selections, clip-art, photographs and video games. Under our
model, electronic content and service providers use the Wave
System to allow consumers to purchase one-time, multiple or
permanent use of their content or service, using a wide
range of payment models including rental, pay-for-use , or
outright purchase, 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 de-centralized distribution 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 computer or other
interactive device. This means that content and services can
be consumed with more efficient and flexible pricing,
broader distribution opportunities, greater protection
against unauthorized usage and with better privacy
protection of the consumer's sensitive information.
Our Market......... Our long-term strategy is to achieve broad market acceptance
of the Wave System as a standard platform for the delivery
of electronic content and services and to build a network of
services for this platform. 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. The business world is creating new customer and
supplier value chains which require new approaches to the
protection of information and content which flows over
public, shared networks. 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. Our creation of the trusted client
model allows important new approaches to addressing issues
regarding the authentication of identities, the protection
of content and services, and the distribution of electronic
commerce transactions. These three capabilities are key to
building a network of end-users and conducting e-commerce
transactions.
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Our Product........ The Wave System consists of an EMBedded Application Security
SYstem in consumer devices that provides a core hardware and
software foundation for consumers to purchase electronic
content and access services on a flexible purchase basis.
The EMBASSY platform is a programmable, low cost "system
within a system" that can perform independent transactions
such as meter pay-per-use of electronic 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 platform is an
open model based on security hardware originally designed
for use with "smart cards" that can be integrated into
personal computers and peripherals, interactive televisions
or used as independent components. The WaveMeter application
running in the EMBASSY platform 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. The WaveMeter server enables electronic content
owners to securely sell usage of their intellectual property
from a Web site. This secure electronic content delivery
service, offered through the WaveMeter 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
WaveNet central transaction processing center periodically.
The WaveNet application manages electronic codes for
scrambling and unscrambling electronic content, processes
credit and usage charges, automatically obtains credit
authorization, calculates royalty distributions, and provide
user and usage data to electronic content owners. The Wave
System is designed to be compatible with existing content
delivery systems, such as CD- ROMs and the Internet. Using
these Wave-enabled distribution systems, electronic content
providers can distribute their products in a secure format
and offer them for sale through the EMBASSY platform, which
in turn allows consumers to purchase and access the
electronic content when desired .
Our Partners........We are pursuing strategic relationships to build new ways of
distributing electronic content and services with electronic
content providers, network companies, and hardware
manufacturers . 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 partners. During 1998
and early 1999, we established relationships with RSA Data
Security, NEC Technologies, Pollex Technology,
Hewlett-Packard's VerSecure division, Sun Microsystems,
SMSC, ITE, IGST, Sarnoff Corp., 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.
We are incorporated in Delaware, and we were known previously as Indata
Corp. and Cryptologics International, Inc. 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.
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THE OFFERING
<TABLE>
<S> <C>
Issuer........................................................... Wave Systems Corp.
Shares of Class A common stock
offered by the selling stockholders............................ 4,738,703
Class A common stock outstanding
as of March 31, 1999........................................... 32,030,921
Voting Rights.................................................... One vote per share
Use of Proceeds.................................................. Wave will not receive any proceeds
from sales made hereunder
Listing.......................................................... Nasdaq National Market
Trading Symbol................................................... WAVX
</TABLE>
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Summary Consolidated Financial Information
Statement of operations data:
<TABLE>
<CAPTION>
Three Months Year Ended December 31
Ended --------------------------------------------------------------------------
March 31,
1999 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net revenues $ 2,398 $ 10,193 $ 10,712 $ 1,458 $ -- $ --
Operating expenses: 3,487,456 13,383,134 14,788,164 8,869,642 7,404,920 4,193,649
License Fee 625,000 2,750,000 1,000,000 -- -- --
License Warrant Cost
-- (1,100,000) -- -- -- --
Net loss (3,673,911) (11,895,944) (13,897,794) (8,683,815) (6,832,866) (4,271,501)
Accrued dividends on
preferred stock 5,400 858,863 2,482,982 870,579 40,600 39,484
(including accretion of
assured incremental
yield on preferred
stock of $0 in 1999,
$750,000 in 1998,
$1,673,000 in 1997 and
$670,965 in 1996 and
$3,093,965 since
inception)
Net loss to common
stockholders $(3,679,311) $(12,754,807) $(16,380,776) $(9,554,394) $(6,873,466) $(4,310,985)
----------- ------------ ------------ ----------- ----------- -----------
----------- ------------ ------------ ----------- ----------- -----------
Weighted average number
of common shares
outstanding during the
period 32,148,271 29,299,844 20,943,748 14,956,584 13,794,373 10,503,621
Loss per common share $ (.11) $ (.44) $ (.78) $ (.64) $ (.50) $ (.41)
----------- ------------ ------------ ----------- ----------- -----------
----------- ------------ ------------ ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
Period from
February 12,
1988 (inception)
through
March 31
1999
----
(unaudited)
-----------
<S> <C>
Net revenues $ 24,761
Operating expenses: 63,711,795
License Fee 4,375,000
License Warrant Cost
(1,100,000)
Net loss (60,894,318)
------------
Accrued dividends on
preferred stock 4,342,758
(including accretion of
assured incremental
yield on preferred
stock of $0 in 1999,
$750,000 in 1998,
$1,673,000 in 1997 and
$670,965 in 1996 and
$3,093,965 since
inception)
Net loss to common
stockholders $(65,237,076)
------------
------------
Weighted average number
of common shares
outstanding during the
period 12,024,013
Loss per common share $ (5.43)
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------------
</TABLE>
<TABLE>
<CAPTION>
Balance sheet data: March 31, 1999
--------------
(unaudited)
-----------
<S> <C>
Working Capital $ 18,246,984
Total Assets $ 22,719,922
Series A Cumulative Redeemable Preferred Stock $498,601
Deficit Accumulated During Development $(60,894,318)
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Total Stockholders' Equity $ 18,961,888
------------
------------
</TABLE>
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Risk Factors
We have a history of net losses and expect net losses to continue. If we
continue to lose money, our operations will not be financially viable.
We have experienced significant losses and negative cash flow from
operations since our inception. We have not realized a net operating profit in
any quarter since we began our operations. As of March 31, 1999, we had a
deficit accumulated during the development stage of approximately $61 million
and working capital of approximately $18.3 million. Our limited operating
history offers little information to serve as a basis for evaluating us and our
long-term prospects. You should consider our prospects in light of the risks,
expenses and difficulties that companies in their earlier stage of development
encounter, particularly companies in new and rapidly evolving markets, such as
online commerce.
To achieve profitability we must, among other things:
- - Convince personal computer manufacturers and distributors of movies,
games, financial information and other digital data and electronic
content over the Internet to modify their offerings to be used with our
products and services;
- - Convince consumers to choose to order, purchase and accept products
using our products and services;
- - Assemble and maintain the necessary resources, especially talented
software programmers;
- - Develop partnerships to maximize acceptance of our products and
services; and
- - Raise additional capital if necessary to support our operations.
If we do not succeed in these objectives, our business likely will be
materially and adversely affected. We may never achieve, or be able to sustain,
profitability.
We may not be able to fund our operations.
Since we began our operations, we have incurred net losses and
experienced significant negative cash flow from operations. Based on our current
operating plan, we believe we have adequate cash to fund our operations through
at least September 2000. However, our actual cash requirements may exceed what
we have anticipated and we may run out of money. We do not know if additional
financing will be available or that, if available, it will be available on
favorable terms. If we issue additional shares of our stock, our stockholders'
ownership may be diluted, or the shares issued may have rights, preferences or
privileges senior to those of our common stock. If we do not have enough money,
we may be unable to continue our operations, develop or enhance our products,
take advantage of future opportunities or respond to competitive pressures.
If we are unable to develop a market for our products and services,
our business will suffer.
The market for our services is still immature and is evolving rapidly.
Our business will suffer if the market does not accept our products and
services. Demand for our products and serviced could drop if:
<PAGE>
-8-
- - providers of products or information in electronic form over the
Internet or personal computer manufacturers refuse to modify their
offerings so that they may be used with our products and service;
- - providers of products or information in electronic form over the
Internet refuse to change their business model to allow end-users to
use our technology;
- - consumers don't choose to use our technology; or
- - competitors develop superior products or services.
To be successful, we must, among other things, prove that our
technology works and complete its development, respond to any competitive
developments, continue to attract, retain and motivate qualified personnel, and
market our technology effectively. We have only recently begun introducing our
technology to the market.
Our technologies have not been accepted as standards. To be
successful, we must obtain widespread acceptance of our technologies, or modify
our products and services to meet whatever industry standards ultimately
develop. If we fail to do either, our business will suffer.
An increasing number of market entrants have introduced or are
developing competing products and services to for delivering and receiving
payment for products or information in electronic form over the Internet.
Critical issues concerning the Internet remain unresolved and may limit the
growth of this type of commerce. Delays in the deployment of improvements to the
infrastructure for Internet access, including higher speed modems and other
access devices, also could hinder the development of the Internet.
For all of these reasons, it remains uncertain whether commerce over
the Internet will continue to grow, our technologies will be generally accepted
as a standard model of this type of commerce, or a significant market for our
products and services will emerge.
Our business will not grow if we do not keep pace with rapidly changing
technologies.
Because the market in which we operate is characterized by rapidly
changing technology and frequent new product introductions, our success will
depend, among other things, upon our ability to improve our products, to develop
and introduce new products and services that keep pace with technological
developments, to respond to evolving customer requirements and to achieve market
acceptance. If we do not identify, develop, manufacture, market and support new
products and deploy new services successfully, our business will not grow and
our financial results will suffer.
Our business will suffer if our technologies are not compatible with
popular modes of delivery of products and information in electronic form.
We believe that our system is adaptable to most present modes for the
delivery of products and information in electronic form, such as on CD-ROMs,
over the Internet and through telecommunications devices. However, these modes
of delivery of products and information in electronic form may be replaced by
other distribution technologies that are not compatible with our technology.
The Internet, and online commerce over the Internet, are at an early
stage of development and are rapidly evolving. While the Internet is expected to
experience substantial growth in the number of users and amount of traffic,
Internet infrastructure may not continue to support the increasing demands
<PAGE>
-9-
placed on it by this growth. Break-downs and slow-downs in Internet traffic may
slow expansion of its use. Further, the costs of use of the Internet could
increase to a degree that reduces its attraction as a platform for electronic
commerce.
Adequate Internet infrastructure and increased online commerce are
necessary for us to succeed. If the Internet infrastructure and complementary
services are unable to support growth, our business will not grow.
Problems relating to security, system disruptions and computer
infrastructure could negatively affect our business and the business of our
customers.
Although we have implemented in our products various security
mechanisms, our products and services may nevertheless be vulnerable to
break-ins, piracy and similar disruptive problems caused by Internet users. Any
of these disruptions would harm our business. Advances in computer capabilities,
new discoveries in the field of security, or other developments may result in a
compromise or breach of the technology we use to protect products and
information in electronic form. Computer break-ins and other disruptions would
jeopardize the security of information stored in and transmitted through the
computer systems of users of our products, which may result in significant
liability to us and may also deter potential customers.
The security, piracy and privacy concerns of existing and potential
customers and electronic content providers, as well as concerns related to
computer viruses, may inhibit the growth of the Internet marketplace generally,
and our customer base and revenues in particular. A party who is able to
circumvent our security measures could misappropriate proprietary electronic
content or cause interruptions in our operations and those of our strategic
partners. We may be required to expend significant capital and other resources
to protect against security breaches or to alleviate problems caused by
breaches. Our attempts to implement contracts which limit our liability to our
customers, including liability arising from a failure of security features
contained in our products and services, may not be enforceable. We currently do
not have product liability insurance to protect against these risks.
Competition could reduce our market share and harm our business.
Our competitors may be able to develop products and services that are
more attractive to customers than our products and services . Many of our
competitors and potential competitors have substantially greater financial and
technical resources, greater name recognition and more extensive customer bases
that could be used to gain market share or product acceptance .
The Wave System competes with conventional information delivery
systems, such as on-line services, subscription services on CD-ROM, and services
on the Internet. We are also aware of other metering systems which compete
directly with the Wave System, and other current and evolving technologies that
provide some of its functionality. The Wave System is subject to competition
from producers of hardware-based controllers . We compete with producers of
software unlocking systems such as Rainbow Technologies, Inc. and Portland
Software. In addition to small companies dedicated to specific solutions, many
large information industry players are forming alliances and attempting to take
advantage of the information delivery options offered by the Internet. The Wave
System also competes with electronic commerce payment technologies developed and
offered by IBM infoMarket Service, Broadvision Inc., Connect, Inc., CyberCash,
Inc., DigiCash and Open Market, Inc.
Other companies have developed or are developing technologies that are,
or may become, the basis for competitive products in the field of electronic
content distribution. Some of those technologies may have an approach or means
of processing that is entirely different from ours. Existing or new
<PAGE>
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competitors may develop products that are superior to ours or that otherwise
achieve greater market acceptance than ours.
If we do not successfully develop and maintain our relationships with
strategic partners, our revenues could grow more slowly than expected.
We depend upon strategic partners in our efforts to establish an
installed base of WaveMeters sufficient to convince content providers to use the
Wave System for delivery of their content. We are dependent upon semiconductor
companies to manufacture functioning WaveMeters in sufficient numbers and at a
low enough cost to enable us to convince manufacturers of personal computers to
incorporate WaveMeters . We are dependent upon electronic content owners to
modify their products to be used with the WaveMeters . These partners may choose
not to use our technology and could develop or market products or technologies
that compete directly with us. We cannot predict whether these third parties
will commit the resources necessary to achieve broad-based commercial acceptance
of our technology. Any delay in the use of our technology by these partners
could have a material adverse impact on the commercial acceptance of our
systems. We have no binding commitments from many of our strategic partners, and
there can be no assurance that we will enter into definitive agreements or that
the terms of such agreements will be satisfactory.
Software defects or development delays may harm our business.
We may experience delays in the development of our software products or
the software and computing systems underlying our services. In addition, despite
testing by us and potential customers, it is possible that our software may
nevertheless contain errors. These development delays or errors could have a
material adverse effect on our business.
If we lose our key personnel, or fail to attract and retain additional
personnel, our business and growth may suffer.
We believe that our future success depends upon the continued service
of our key technical and management personnel and on our ability to attract and
retain highly skilled technical, management, sales and marketing personnel. We
are particularly dependent on the skills and contributions of several key
individuals, including Peter J. Sprague and Steven Sprague, each of whom may
voluntarily terminate their employment with Wave at any time and whose departure
would have a material adverse effect on our business. We do not have "key
person" life insurance policies on any of our employees. Our industry is
characterized by a high level of employee mobility and aggressive recruiting of
skilled personnel. There can be no assurance that our current employees will
continue to work for us or that we will be able to hire any additional personnel
necessary for our growth. Our future success also depends on our continuing
ability to identify, hire, train and retain other highly qualified technical and
managerial personnel. Competition for these employees is intense and increasing.
We may not be able to attract, assimilate or retain qualified technical and
managerial personnel in the future, and the failure of us to do so would have a
material adverse effect on our business.
We have a limited ability to protect our intellectual property rights
and others could infringe on or misappropriate our proprietary rights.
Our success depends, in part, on our ability to enjoy or obtain
protection for our products and technologies under United States and foreign
patent laws, copyright laws and other intellectual property laws and to preserve
our trade secrets . We cannot assure you that issued patent owned or licensed by
us will provide us with adequate protection or will not be challenged,
invalidated, infringed or circumvented.
<PAGE>
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We rely on trade secrets and proprietary know-how, which we protect, in
part, by confidentiality agreements with our employees and contract partners.
However, our confidentiality agreements may be breached and we may not have
adequate remedies for these breaches. Our trade secrets may also otherwise
become known or be independently discovered by competitors. We also rely on
copyright to prevent the unauthorized duplication of our software and hardware
products. While we have and will continue to protect our software and our
copyright interests, copyright laws may not adequately protect our technology.
We have submitted three trademark registrations and intend to apply for
additional name and logo marks in the United States and foreign jurisdictions,
as appropriate, but we cannot assure you that federal registration of any of
these trademarks will be granted.
Claims that our technology may infringe proprietary rights of third
parties could have a material adverse effect on our business.
We are aware of four United States patents, each of which has some
claim that is similar to some of the claims we have licensed under the patent
discussed above. Based upon what we currently know, some of the claims of each
of these patents cover certain material aspects of our technology. Therefore,
the commercialization of our technology is subject to the rights of the holder
of these patents unless we are able to invalidate or license such claims. Also,
the holder of these patents or its licensees could seek to invalidate the claims
of the patent which we have licensed and therefore be able to commercialize a
technology similar to our technology. We can give no assurance that we would be
successful in invalidating such claims or, in turn, avoid having our claims
invalidated. Any proceeding involving the validity of these patents would be
protracted and costly. If these other four patents are not invalid insofar as
their claims relate to our technology, then we would require a license from the
holder of these patents to commercialize our technology. Due to the uncertainty
as to whether these other patents could be proved to be invalid, we have engaged
in preliminary negotiations with the patents holder to obtain a license
thereunder. The negotiations have so far not produced any agreement and we
cannot assure you that we will be able to obtain a license on acceptable terms,
if at all. Our inability to obtain a license, if needed, on commercially
reasonable terms or to invalidate the claims would have a material adverse
effect on our business and our future operations.
In January 1996, we received notice from a third party that claimed
that our technology infringes upon U.S. and foreign patents it owned. These
patents are also currently being litigated by third parties. We are not involved
in these proceedings. This company offered to license its patents to us. We are
currently obtaining information needed to investigate the merits of this claim.
While we believe that there is a viable argument for non-infringement, if we are
not able to show non-infringement, then we would require a license from this
company to commercialize our technology. We cannot assure you that we would be
able to obtain a license on acceptable terms, if at all. Our inability to obtain
a license, if needed, on commercially reasonable terms would have a material
adverse effect on our business and our future operations.
Regulation of international transactions may adversely affect our
business overseas.
A variety of U.S. export control laws apply to our technology. We
will require export licenses to export certain of our technology outside
North America. We cannot assure you that we will be able to obtain licenses
for our products. In addition, the regulation of electronic monitoring,
transmitting payment instructions or audited usage and financial information
varies from country to country. We may be subject to different statutory or
regulatory controls in different foreign jurisdictions. Our technology may
not be permitted in foreign jurisdictions. Violations of foreign regulations
or regulation of international transactions could hurt our business.
Our stock price is volatile.
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-12-
The price of our Class A common stock has been and likely will continue
to be subject to wide fluctuations in response to a number of events and
factors, such as:
- - quarterly variations in operating results;
- - variances of our quarterly results of operations from securities
analyst estimates;
- - announcements of technological innovations, new products, acquisitions,
capital commitments or strategic alliances by us or our competitors;
- - changes in financial estimates and recommendations by securities
analysts;
- - the operating and stock price performance of other companies that
investors may deem comparable to us; and
- - news reports relating to trends in our markets.
In addition, the stock market in general, and the market prices for
Internet-related companies in particular, have experienced significant price and
volume fluctuations that often have been unrelated to the operating performance
of the companies affected by these fluctuations. These broad market fluctuations
may adversely affect the market price of our Class A common stock, regardless of
our operating performance. Securities class action litigation has often been
instituted against companies that have experienced periods of volatility in the
market price for their securities. If we were to become the target of this kind
of litigation, the cost in dollars and management attention could be
substantial, and the diversion of management's attention and resources could
have a material adverse affect on our business.
We May Be Subject to Conflicts of Interest.
Our Board of Directors has included, and is likely to include in the
future, representatives of our strategic partners. It is possible that those
corporations may be competing against us or each other, directly or indirectly.
A director who also represents another company may voluntarily abstain from
voting on matters where there could be conflicts of interest. Even if such a
director does abstain, his presence on the Board could affect the process or the
results of the Board's deliberations. We have adopted no policies or procedures
to reduce or avoid such conflicts. If such conflicts of interest arise, they may
have a materially adverse effect on our business.
Disproportionate voting rights may affect our stock price.
Our common stock is divided into two classes, Class A common stock and
Class B common stock. Each class has different voting rights. Voting rights of
Class B common stock permit the holders of Class B common stock to block mergers
or similar transactions that are not approved by our Board of Directors and
other transactions submitted to stockholders if any person has acquired more
than 20% of our outstanding Series A common stock. The disproportionate voting
power enjoyed by the Class B common stock holders when voting on questions of
control may dissuade a potential merger partner or acquirer, even if the
majority of the Class A common stock holders wanted the merger or acquisition to
occur, and could depress the market price of the Common Stock.
Governmental regulation may slow our growth and decrease our
profitability.
<PAGE>
-13-
There are currently few laws or regulations that apply directly to the
Internet. Because our business is dependent in significant respect on the
Internet the adoption of new local, state, national or international laws or
regulations may decrease the growth of Internet usage or the acceptance of
Internet commerce which could, in turn, decrease the demand for our products and
services and increase our costs or otherwise have a material adverse effect on
our business.
Tax authorities in a number of states are currently reviewing the
appropriate tax treatment of companies engaged in Internet commerce. New state
tax regulations may subject us to additional state sales, use and income taxes.
Our anti-takeover provisions may discourage future acquisitions and
depress our stock price.
In addition to the anti-takeover effect of the voting rights granted to
the holders of Class B common stock, a change of control may be delayed,
deferred or prevented by certain provisions of our charter documents, as well as
the Board's ability to issue shares of preferred stock without further vote or
action by the stockholders. In addition, Delaware law restricts certain business
combinations with any "interested stockholder", as defined. This statute may
delay, defer, or prevent a change in control of our company. These provisions
are intended to encourage any person interested in acquiring us to negotiate
with and obtain the approval of our Board of Directors. Certain of these
provisions may discourage a future acquisition not approved by our Board in
which you might receive an attractive value for your shares or that a
substantial number or even a majority of our stockholders might believe to be in
their best interest. As a result, stockholders who desire to participate in such
a transaction may not have the opportunity to do so. All of these factors may
depress the market price of our Class A common stock.
Our dividend policies may depress our stock price.
We have never declared or paid any cash dividends on our common stock.
We currently anticipate retaining all future cash earnings, if any, to fund the
development and growth of our business and we do not anticipate paying dividends
on our common stock for the foreseeable future.
Year 2000 problems may disrupt our business.
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. Any failure of our products or systems to
operate properly due to Year 2000 problems could require us to incur
unanticipated expenses to address associated problems, which could have a
material adverse effect on our business.
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. 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.
<PAGE>
-14-
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.
We will develop contingency plans if we identify instances of noncompliance, and
we expect such noncompliance 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 its
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, no assurance can be given that Year 2000
compliance can be achieved without significant additional costs.
<PAGE>
-15-
Where you can find more information
We are subject to the periodic filing requirements of the Securities
Exchange Act of 1934. Further to our obligations under the Exchange Act, we file
reports, proxy and information statements and other information with the
Securities and Exchange Commission. These reports, proxy and information
statements and other information may be inspected and copied at the public
reference facilities of the Securities and Exchange Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
Regional Offices of the Securities and Exchange Commission located at Seven
World Trade Center, 13th Floor, New York, New York 10048 and at 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of these materials also can
be obtained from the Public Reference Section of the Securities and Exchange
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of
prescribed fees. The Securities and Exchange Commission also maintains a site on
the World Wide Web that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Securities and Exchange Commission (including Wave systems). The address of this
site is http://www.sec.gov.
We have filed a registration statement on Form S-1 with the Securities
and Exchange Commission to register under the Securities Act of 1933 the
securities that this prospectus offers. In accordance with the rules and
regulations of the Securities and Exchange Commission, portions of the
registration statement have been omitted from this prospectus. Therefore, this
prospectus contains only some of the information in the registration statement.
If you would like more information about Wave Systems and the securities this
prospectus offers, please refer to the registration statement, which is on file
at the offices of the Commission. You may obtain copies of these documents upon
payment of the fee, or you may examine them without charge at the offices or via
the Web site. When we discuss other documents in this prospectus, we may not
provide all of the information about or contained in those other documents. You
should not rely upon this prospectus to provide a complete discussion of the
contents of other documents. You should refer to those other documents yourself.
Whenever we discuss the contents of other documents, we qualify our statements
in all respects by reference to the applicable documents on file with the
Commission.
In addition to historical information, this prospectus and the
registration statement contain forward-looking statements within the meaning of
the Securities Litigation Reform Act of 1995. These statements and projections
about the future involve risks and uncertainties. As a result, we may not be
able to accurately predict the future and our actual results may turn out to be
materially different from what we anticipate and discuss in this prospectus. In
addition, we operate in an industry segment where securities prices may
fluctuate dramatically and may be influenced by regulatory and other factors
beyond our control. We discuss some of the factors which we believe to be
important in the cautionary statements that accompany the forward-looking
statements and in the risk factors section of this prospectus, as well as in the
risk factors detailed in the other filings we have made with the Securities and
Exchange Commission during the past 12 months. Whenever you assess a
forward-looking statement in this prospectus, we urge you to read carefully all
of the risk factors and cautionary statements in this prospectus, as well as
those in our other filings with the Securities and Exchange Commission.
<PAGE>
-16-
Price Range of Common Stock
The Class A common stock trades on the Nasdaq National Market under the
symbol "WAVX". The following table sets forth, for the periods indicated, the
high and low closing sales prices per share for the Class A common stock. There
is no established trading market for our Class B common stock.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Three Months Ended March 31, 1999
First Quarter (January 1, 1999-March 31, 1999) $27.50 $3.72
HIGH LOW
---- ---
Year Ended December 31, 1998
First Quarter (January 1, 1998-March 31, 1998) $1.68 $0.97
Second Quarter (April 1, 1998-June 30, 1998) 4.75 1.56
Third Quarter (July 1, 1998-September 30, 1998) 4.56 2.25
Fourth Quarter (October 1, 1998-December 31, 1998) 5.63 2.44
HIGH LOW
---- ---
Year Ended December 31, 1997
First Quarter (January 1, 1997-March 31, 1997) $3.00 1.56
Second Quarter (April 1, 1997-June 30, 1997) 1.81 1.25
Third Quarter (July 1, 1997-September 30, 1997) 2.00 0.94
Fourth Quarter (October 1, 1997-October 23, 1997) 1.94 1.06
Fourth Quarter (October 24, 1997-December 31, 1997) 2.00 0.63
</TABLE>
As of June 8, 1999, there were approximately 602 holders of our Class A
common stock. As of such date, there were 40 holders of our Class B common
stock.
On June 4, 1999, the last sale price reported on the Nasdaq National
Market for the Class A common stock was $17.69.
We have never declared or paid any cash dividends on our capital stock.
We currently anticipate that we will retain all future earnings, if any, to fund
the development and growth of our business and do not anticipate paying any cash
dividends on our capital stock in the foreseeable future.
Use Of Proceeds
The selling stockholders will receive all of the net proceeds from
sales of the Class A common stock sold pursuant to this prospectus.
Selected Consolidated Financial Data
The following table sets forth our selected consolidated financial data
for the three months ended March 31,1999 and as of the end of, and for each of
the years in the five-year period ended December 31, 1998, and for the period
from February 12, 1988 (inception) through March 31, 1999. The selected
consolidated financial data as of December 31, 1998 and 1997 and for each of the
years in the three-year period ended December 31, 1998 have been derived from
and should be read in conjunction with the consolidated financial statements of
the Company which have been audited by KPMG LLP, independent certified public
accountants, whose report appears elsewhere in this prospectus.
<PAGE>
-17-
Statement of operations data
<TABLE>
<CAPTION>
Three months
ended Year Ended December 31
March 31 ---------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
------------- ------------ ------------ ------------ ------------ -----------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net revenues $ 2,398 $ 10,193 $ 10,712 $ 1,458 $ -- $ --
Operating expenses:
Selling, general and
administrative 2,401,046 9,874,166 7,983,151 5,560,620 4,080,185 2,432,283
Write-off of Goodwill -- -- 769,886 -- -- --
Aladdin Technology
License Expense -- -- 3,889,000 -- -- --
Research and
development 1,086,410 3,508,968 2,146,127 3,309,022 3,324,735 1,761,366
------------ ------------ ------------ ------------ ----------- ------------
3,487,456 13,383,134 14,788,164 8,869,642 7,404,920 4,193,649
------------ ------------ ------------ ------------ ----------- ------------
Other income (expense):
License Fee 625,000 2,750,000 1,000,000 -- -- --
License Warrant Cost
(1,100,000) -- -- -- --
Net interest and other
income (expense) (813,853) (173,003) (120,342) 184,369 572,054 (77,852)
------------ ------------ ------------ ------------ ----------- ------------
Net loss (3,673,911) (11,895,944) (13,897,794) (8,683,815) (6,832,866) (4,271,501)
Accrued dividends on
preferred stock 5,400 108,863 809,982 199,614 40,600 39,484
------------ ------------ ------------ ------------ ----------- ------------
Assured incremental
yield -- 750,000 1,673,000 670,965 -- --
------------ ------------ ------------ ------------ ----------- ------------
Net loss to common
stockholders $ (3,679,311) $(12,754,807) $(16,380,776) $ (9,554,394) $ (6,873,466) $ (4,310,985)
------------ ------------ ------------ ------------ ----------- ------------
------------ ------------ ------------ ------------ ----------- ------------
Weighted average
number of common
shares outstanding
during the period 32,148,271 29,299,844 20,943,748 14,956,584 13,794,373 10,503,621
Loss per common share $ (.11) $ (.44) $ (.78) $ (.64) $ (.50) $ (.41)
------------ ------------ ------------ ------------ ----------- ------------
------------ ------------ ------------ ------------ ----------- ------------
</TABLE>
<TABLE>
<CAPTION>
Period from
February 12,
1988
(inception)
through
March 31
1999
(unaudited)
<S> <C>
Net revenues $ 24,761
Operating expenses:
Selling, general and
administrative 39,711,718
Write-off of Goodwill 769,886
Aladdin Technology
License Expense 3,889,000
Research and
development 19,341,191
------------
63,711,795
------------
Other income (expense):
License Fee 4,375,000
License Warrant Cost (1,100,000)
Net interest and other
income (expense) (482,284)
------------
Net loss 60,894,318)
Accrued dividends on
preferred stock 1,248,793
------------
Assured incremental
yield 3,093,965
------------
Net loss to common
stockholders $(65,237,076)
------------
------------
Weighted average
number of common
shares outstanding
during the period 12,024,013
Loss per common share $ (5.43)
------------
------------
</TABLE>
<PAGE>
-18-
<TABLE>
<CAPTION>
Balance sheet data
March 31 December 31
-------- ---------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Working capital (deficiency) $ 18,246,984 $ (3,778,895) $ (669,041) $ 3,197,519 $ 5,458,512 $ 12,463,502
Total assets 22,719,922 2,057,812 1,678,213 6,237,219 7,754,042 13,766,864
Current liabilities 3,259,433 4,840,989 1,949,886 937,163 1,210,778 867,145
Long-term liabilities -- -- 522,124 465,500 -- --
Series A Cumulative
Redeemable Preferred
Stock 498,601 493,201 471,601 432,334 390,534 349,934
Series B Cumulative
Convertible Preferred
Stock -- -- -- 195,520 -- --
Series C Cumulative
Convertible Preferred
Stock -- -- -- 2,647,742 -- --
Deficit accumulated during
the development stage (60,894,318) (57,220,407) (45,324,463) (31,426,669) (22,742,854) (15,909,988)
Total stockholders' equity
(deficiency) $ 18,961,888 $ (3,276,378) $ (743,274) $ 1,558,960 $ 6,152,730 $ 12,549,785
</TABLE>
<PAGE>
-19-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
Wave is creating a new electronic commerce model for digital
information and services based on client-side security, transactions and trust.
Since our inception in February of 1988, we have devoted substantially all of
our efforts and resources to research, feasibility studies, design, development,
and market testing of a distributed trust system that enables client based
transactions, including the metered usage of electronic content and services
(the "Wave System"). Electronic content and services refers to any data, graphic
software, video or audio sequence that can be digitally transmitted and/or
stored. As our research and development activities matured, we were able to
devote increased resources to the creation of content distribution services,
market development and the application of the Wave System to end-user services.
During 1998 we established relationships with RSA Data Security, NEC
Technologies, Pollex Technology, Hewlett-Packard's VerSecure division, Sun
Microsystems, SMSC, ITE, IGST, Sarnoff, Hauppauge Computer Systems and
WavePhore. We received payments of $1 million and $4 million pursuant to a joint
venture agreement with Internet Technology Group, PLC ("ITG"), a United Kingdom
company, and have recognized $3.75 million to date as license fees. We also
recorded a net cost of $1.1 million for an exchange of warrants between us and
ITG for 1,000,000 shares of common stock in each of the companies, which is to
occur upon attainment of the final milestones and payment of the final
installment of the license fee. From inception through March 31, 1999, we have
realized only minimal operating revenues, and do not anticipate significant
revenues in the near future. There are numerous risks that could adversely
affect our efforts to achieve profitability.
Results of operations
Three Months Ended March 31, 1999 and 1998
For the three months ended March 31, 1999, we had only minimal
operating revenues.
Research and development expenses for the three months ended March 31,
1999 were $1,086,410, as compared to $538,821 for the comparable period of 1998,
an increase of 102%. This increase is primarily attributable to an increase in
headcount and consulting-related expenses during the first three months of 1999.
Selling, general and administrative expense for the three months ended
March 31, 1999 were $2,401,046, as compared to $1,420,875 for the comparable
period of 1998, an increase of 69%. This substantial increase is primarily
attributable to an increase in personnel, trade shows, equipment and other
related costs associated with the development and marketing of new applications
and new markets for our technology.
Interest expense for the three months ended March 31, 1999 was
$830,465, as compared to interest expense of $11,400 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
<PAGE>
-20-
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. For the three months ended March
31, 1999, approximately $151,000 of the value of the reduced conversion rate was
recorded as interest expense.
We recognized $625,000 of license fees from the Internet Technology
Group, PLC, pursuant to a licensing technology agreement executed in 1997.
Due to the reasons set forth above, our net loss for the three months
ended March 31, 1999 was $3,673,911. We did not receive any cash license fee
payments in the three months ended March 31, 1999 and the net loss for this
period to common stockholders was $3,679,311.
Years ended December 31, 1998 and 1997
For the years ended December 31, 1998 and December 31, 1997 we had only
minimal operating revenues.
Selling, general and administrative expenses for the year ended
December 31, 1998 were $9,874,166 as compared with $7,983,151 for 1997. The
increase in selling, general and administrative expenses was primarily
attributable to increased headcount, as well as trade-show related expenses.
In the third quarter of 1997 we wrote off approximately $770,000 of
Goodwill recorded for the Win acquisition because we were uncertain as to
whether the anticipated future operations of the business would be sufficient to
justify the carrying value.
Research and development expenses for the year ended December 31, 1998
were $3,508,968 as compared with $2,146,127 for 1997. The increase in research
and development expenses is attributable to increased headcount and
consulting-related expenses.
License fee income for the year ended December 31, 1998 was $2,750,000,
as compared with $1,000,000 for 1997. The $2,750,000 for the year ended December
31, 1998 is before a charge of $1.1 million related to our net cost of a warrant
we are obligated to issue to ITG as part of the technology licensing agreement.
The $1.1 million charge includes the estimated fair value of the ITG warrant
that we will receive as part of the warrant exchange. The license fee for both
1998 and 1997 were portions of a $5 million fee paid by ITG to us as part of a
joint venture agreement under which ITG receives the right to market the Wave
technology in European and Middle Eastern markets.
Net interest expense for the year ended December 31, 1998 was $173,003
as compared with net interest expense of $120,342 for 1997. The increase in
interest expense for the year ended December 31, 1998 was primarily attributable
to the restated and amended note for Southeast Interactive Technologies Fund I
(see Note 5), offset by an increase in interest-bearing assets. Interest income
of $55,282 for the year ended December 31, 1997 was attributable to the interest
earned on marketable securities purchased with proceeds from the issuance our
convertible preferred stock in May 1996. We held no marketable securities at
December 31, 1998.
Due to the reasons set forth above, our net loss was $11,895,944 for
the year ended December 31, 1998, as compared with $13,897,794 for 1997.
Years ended December 31, 1997 and 1996
<PAGE>
-21-
For the years ended December 31, 1997 and December 31, 1996 we had only
minimal operating revenues.
Selling, general and administrative expenses for the year ended December
31, 1997 were $7,983,151 as compared with $5,560,620 for 1996. The increase in
selling, general and administrative expenses was primarily attributable to
development and marketing of new applications of our technology as well as
accrued expenses related to the ITG Joint Venture Agreement, and bonuses and
salary increases.
In the third quarter of 1997 we wrote off approximately $770,000 of
Goodwill recorded for the Win acquisition because we were uncertain as to
whether the anticipated future operations of the business would be sufficient to
justify the carrying value.
Research and development expenses for the year ended December 31, 1997
were $2,146,127 as compared with $3,309,022 for 1996. The decrease in research
and development expenses is attributable in part to a license agreement with
Aladdin Knowledge System, whereby we licensed Aladdin's Hasp technology for a
share in content revenues as well as cash and warrants totaling $3,889,600. More
generally, the decrease in research and development is attributable to the shift
in our focus from research and development to commercialization and marketing
and personnel adjustments consequent thereto.
In July of 1997, we entered into a joint-venture with Internet
Technology Group, PLC (ITG), a United Kingdom Internet service provider.
Pursuant to the joint venture agreement, we will receive a license fee of up to
$5 million in exchange for the joint venture's right to market our technology in
European and Middle Eastern markets. During the third quarter of 1997, we
received $1.0 million from the joint-venture representing partial payment of the
license fee, with the remaining payment to be made upon our attaining certain
milestones related to the number of Wave Meters distributed. The amount received
was recorded as deferred license fee income in the third quarter as it was
uncertain whether we had met the contractual requirements required in order to
have earned the first payment. During the fourth quarter of 1997, we met these
requirements and recorded the $1 million as a license fee. Also, we accrued
$490,000 in the fourth quarter for expenses related to our obligation to assist
the joint-venture in setting up the Wave system in the designated markets. These
costs are included in selling, general and administrative expense. Additionally,
upon attainment of the final milestones and final cash payment by ITG, we and
ITG will exchange warrants for 1 million shares of the other company.
Net interest expense for the year ended December 31, 1997 was $120,342
as compared with net interest income of $184,369 for 1996. Interest income of
$55,282 for the year ended December 31, 1997 was attributable to the interest
earned on proceeds from the issuance of our convertible preferred stock in May
of 1996. Interest income of $194,766 for the year ended December 31, 1996 was
attributable to the interest earned on proceeds from the issuance of our
convertible preferred stock in May of 1996. We held no marketable securities at
December 31, 1997.
Due to the reasons set forth above, our net loss was $13,897,794 for the
year ended December 31, 1997, as compared with $8,683,815 for 1996.
Liquidity and capital resources
We have experienced net losses and negative cash flow from operations
since our inception, and, as of March 31, 1999, had a $60,894,318 deficit
accumulated during the development stage, and
<PAGE>
-22-
stockholders' equity of $18,961,888. We have financed our operations through
March 31, 1999 principally through:
- - the private placement of Class A and B Common Stock for an aggregate
amount of $31,201,931 before expenses ;
- - 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);
- - 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;
- - the private placement of 800,000 shares of Class A Common Stock raising
$800,000 before expenses ; and
- - the private placements of convertible preferred stock for an aggregate
amount of $13,350,000 before expenses .
At March 31, 1999, we had $21,354,954 in cash and cash equivalents. At
December 31, 1998, we had $1,057,094 in cash and cash equivalents. We did not
hold any marketable securities at March 31, 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 for a total
amount of $468,000, for which demand for redemption has been made.
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 March 31, 1999, we had working capital of $18,246,984. 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 into the third quarter of 2000. In
order to continue operations beyond the third quarter of 2000, 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.
<PAGE>
-23-
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Under this concept, all revenues, expenses, gains and losses recognized during
the period are included in income, regardless of whether they are considered to
be results of operations of the period. SFAS 130, which we adopted effective
January 1, 1998, did not impact our consolidated financial statements.
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report selected information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS 131,
which we adopted effective January 1, 1998, did not impact our consolidated
financial statements and footnote disclosures, as we operate in one segment.
The Financial Accounting Standards Board ("FASB") recently issued
Statement of Financial Standards Number 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and hedging,
requiring recognition of all derivatives as either assets or liabilities in the
statement of financial position measured at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
We do not expect the effects of adopting SFAS 133 to have a material impact on
our financial condition, results of operations or cash flows.
The AICPA Accounting Standards Executive Committee recently issued
Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement requires that
certain costs related to the development or purchase of internal-use software be
capitalized and amortized over the estimated useful life of the software, and is
effective for fiscal years beginning after December 15, 1998. The statement also
requires that costs related to the preliminary project stage and post
implementation/operations stage in an internal-use computer software development
project can be expensed as incurred. We will comply with the provisions of SOP
98-1 in fiscal 1999. We do not expect that the adoption of this SOP to have a
material impact on our financial position or results of operations.
The AICPA Accounting Standards Executive Committee recently issued SOP
98-5, Reporting on the Costs of Start-Up Activities. This Statement requires
that costs incurred during start-up activities, including organization costs, be
expensed as incurred, and is effective for fiscal years beginning after December
15, 1998. We will comply with the provisions of SOP 98-5 in fiscal 1999. We do
not expect the adoption of this SOP to have an impact on our financial position
or results of operations.
Impact of Year 2000 issue
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
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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 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.
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.
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Business
Wave Systems Corp. offers powerful, next-generation solutions for
electronic commerce , making the process easier, versatile, and more secure for
consumers as well as business-to-business applications. We are involved in the
research, development, and market testing of the Wave System, which performs the
buying transactions in a range of consumer electronic devices, including
computers, personal digital assistants, and interactive televisions, for the use
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, as well as access to services such as broadcast or
telecommunications services. Examples include archived newspaper and magazine
articles, on-line books, music selections, clip-art, photographs and video
games. Under our model, electronic content and service providers use the Wave
System to allow consumers to purchase one-time, multiple or permanent use of
their content or service, using a wide range of payment models including rental,
pay-for-use, or outright purchase, 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 de-centralized distribution 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 computer or other interactive device. This means that content and
services can be consumed with more efficient and flexible pricing, broader
distribution opportunities, greater protection against unauthorized usage and
with better privacy protection of the consumer's sensitive information.
We believe that the Wave System can fundamentally change today's
centralized e-commerce model by creating a distributed trust and security
system, where transactions are executed and recorded in the consumer's devices,
at the consumer's location. This means that electronic content and services can
be consumed with more efficient and flexible pricing, broader distribution
opportunities, greater protection against unauthorized usage and secure,
low-cost, and accurate data on the usage of the products and services.
The Wave System consists of an EMBedded Application Security SYstem in
consumer devices that provides a core hardware and software foundation for
consumers to purchase electronic content and access services on a flexible
purchase basis. The EMBASSY platform is a programmable, low cost "system within
a system" that can perform independent transactions such as meter pay-per-use of
electronic 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 platform is an open model based on security
hardware originally designed for use with "smart cards" that can be integrated
into personal computers and peripherals, interactive televisions or used as
independent components. The WaveMeter application running in the EMBASSY
platform allows e-commerce transactions to occur without the expense of a
real-time network connection for every transaction.
The EMBASSY securely stores electronic funds and transaction
information about the usage of electronic content to be transmitted securely to
a WaveNet central transaction processing center periodically. The WaveNet
application manages electronic codes for scrambling and unscrambling electronic
content, processes credit and usage charges, automatically obtains credit
authorization, calculates royalty distributions, and provide user and usage data
to electronic content owners. The Wave System is designed to be compatible with
existing content delivery system, such as CD- ROMs and the Internet. Using these
Wave-enabled distribution systems, electronic content providers can distribute
their products in a secure format and offered them for sale through the EMBASSY
platform, which in turn allows consumers to purchase and access the electronic
content on an as-desired basis.
In order to achieve broad market acceptance of the Wave System, we
pursue strategic relationships with major computer manufacturers and technology
suppliers, and promote the use of the
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EMBASSY platform to electronic content owners, particularly developers and
distributors of entertainment, audio, broadcast and educational software. We
believe that the EMBASSY platform can manage subscribers and usage of electronic
content independent of the type of content or network on which it is delivered.
This means that electronic content can be delivered on CD-ROM, high-speed wired
and wireless broadcasting, and other forms of transmission.
We believe that the Wave System provides a powerful merchandising
interface for electronic content and services at the point of purchase. This is
an enticement to consumers to sample electronic content that they are
considering purchasing. The Wave System provides the consumer with enhanced
control of their individual privacy and secure storage of sensitive information.
The Wave System facilitates the payment of royalties to content providers and
service partners while allowing both customized and broad, inexpensive
distribution to customers.
We recently enhanced the Wave System to make it acceptable as an open
industry standard for a broad range of security and e-commerce functions in end
user-devices. We have been successful in attracting other companies to port
their applications and services to the Wave System and our EMBASSY platform,
which we believe will increase the value of the system to potential deployment
partners. These strategic relationships have generated what we believe to be
significant joint marketing benefits in our efforts to promote the Wave System
to manufacturers of computers and electronic consumer goods and the electronic
content industry.
During 1998, we established relationships with RSA Data Security, NEC
Technologies, Pollex Technology, Hewlett-Packard's VerSecure division, Sun
Microsystems, SMSC, ITE, IGST, Sarnoff, Hauppauge Computer Systems and
WavePhore. We also received a payment of $4 million pursuant to a joint venture
agreement with Internet Technology Group, PLC ("ITG"), a United Kingdom company.
In 1999, we will seek to continue to expand our commitments from
additional hardware manufacturers, including personal computer manufacturers,
peripheral companies and companies involved in the commerce of electronic
content and services, both in North America and overseas.
Additionally, we have also developed the WaveMeter server, a production
software version of the WaveMeter application that offers some of the features
of the hardware version and has been implemented as part of our Internet
commerce server. The WaveMeter server enables content owners to secure and sell
their intellectual property from a web site. The e-commerce services offered
through the Wave Meter server do not require the consumer or publisher to
install any additional hardware or software.
Significant uncertainty currently exists with respect to the adequacy
of current funds to support our activities. This uncertainty will continue until
a positive cash flow from operations can be achieved. Additionally, we are
uncertain as to the availability of financing from other sources to fund any
cash deficiencies.
In order to reduce these uncertainties, we are currently evaluating
additional financing options and may therefore elect to raise capital, from time
to time, through equity or debt financings in order to capitalize on business
opportunities and market conditions and to insure the continued development of
our technology, products and services. In January, 1999, we issued a convertible
promissory note in aggregate principal amount of $2 million, which was
subsequently converted into Class A Common Stock in March, 1999, in addition to
and following our completion of an additional $23 million private placement with
institutional, strategic and accredited investors. We cannot assure you,
however, that we can raise additional financing in the future.
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As of October 19, 1997, we became obligated to redeem for approximately
$465,000 all of the outstanding shares of the Series A Redeemable Preferred
Stock issued to a certain individual pursuant to the terms of the Restated
Certificate of Incorporation. As of March 31, 1999, our total obligation
(principal plus interest) under the Series A redemption was $498,601 and it
continues to accrue dividends and interest. We have not redeemed such shares as
of March 31, 1999, but as of April 28, 1999, a demand for redemption has been
made.
We presently have no material commitments for capital expenditures.
However, in order to bring the Wave System to market, we anticipate spending
additional amounts on contracting for software development, licensing key
technologies, and inventory items such as computer chips and boards, additional
hardware, and related materials. Such spending will vary based on our
performance.
Our Class A common stock was traded on the Nasdaq National Market from
the inception of public trading until October 3, 1997, when we became listed on
the Nasdaq SmallCap Market, due to our inability to meet certain listing
criteria. Later that month we were delisted from the Nasdaq SmallCap Market, and
our stock was traded on the Over-the-Counter Bulletin Board until May 27, 1999,
when it was again listed on the Nasdaq National Market . We cannot assure you,
however, that we will not in the future be unable again to satisfy Nasdaq's
listing criteria. In order for us to maintain a listing on the Nasdaq National
Market , we must continue to meet the Nasdaq continuing listing criteria on an
ongoing basis. The future removal of our Class A common stock from listing on
the Nasdaq National Market may have a negative effect on the market price of our
common stock and on the ability of stockholders and investors to buy and sell
shares of the Class A common stock in the public markets, and consequently our
ability to raise capital in the future.
We were incorporated in Delaware under the name Indata Corp. on August
12, 1988. We changed our name to Cryptologics International, Inc. on December 4,
1989. We changed our name again to Wave Systems Corp. on January 22, 1993. Our
principal executive offices are located at 480 Pleasant Street, Lee,
Massachusetts 01238 and our telephone number are (413) 243-1600.
We are a development stage company and have realized minimal operating
revenues since our inception. At December 31, 1998 we had an accumulated deficit
of approximately $57.2 million. There can be no assurance that we will be
successful in achieving commercial acceptance of the Wave System.
The Wave System
The Wave System is designed to create new revenue streams for owners of
electronic content by improving upon existing distribution systems for
electronic content. Using existing distribution systems such as CD-ROM and the
Internet, electronic content owners distribute their products to customers in
the encrypted Wave-enabled form so it can be offered for sale through the
EMBASSY E-Commerce System. Customers are then able to purchase and access the
electronic content on an as-desired basis. We believe that the Wave System
allows electronic content owners to deliver their products to a larger market
because the efficient and secure metering technology facilitates greater
flexibility in content distribution and pricing. We believe that greater
flexibility in electronic distribution and pricing makes the Wave System
particularly attractive to developers, distributors and consumers of
entertainment and educational software. Currently, the two primary mechanisms of
delivery of electronic content to the end user are the Internet and CD-ROM. The
Wave System, however, will work with point-to-multi-point data broadcasting via
satellite, broadcast TV, FM radio, floppy disc, DVD and cable modem and similar
high-speed networking.
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In addition, the programmable EMBASSY platform is capable of supporting
multiple secure applications from a range of service providers, applications
vendors, and security companies. We believe that our expansion of the EMBASSY
platform has provided a source of increased interest in Wave's technology as a
general-purpose solution for adoption by a wide range of companies in their
platforms and as a mechanism for the secure delivery of electronic content.
The Wave System consists of the EMBASSY E-Commerce System, the
WaveMeter application, a subsystem that records and communicates the usage of
electronic content, and WaveNet, a central transaction processing network. The
EMBASSY platform controls the simultaneous loading and execution of multiple
applications, all on a secure basis. The WaveMeter controls and monitors the
customer's access to encrypted electronic information and software. The Wave
System is well suited to low-cost processing of very-low-priced, rental and
rent-to-own electronic content transactions. We have completed a prototype
incorporating the rental and rent-to-own functionality into the Wave System
using Wave's current chip technology. This is currently being integrated into a
WinTV tuner card from Hauppauge Computer Systems. This product is planned for
introduction into the market in 1999. With this version of the WaveMeter,
application transactions are executed within the electronic device itself,
against a source of funds stored in the WaveMeter secure memory. The WaveMeter
retains this pricing and licensing information, downloaded from WaveNet, for use
in the execution of these transactions. Transactions are securely stored in the
usage log of the WaveMeter for eventual uploading and reporting to WaveNet. The
WaveMeters and WaveNet communicate using Wave's secure communications protocol.
WaveNet consists of the WaveNet Transaction Processing System ("TXP")
and the WaveNet Information Clearing House ("ICH"). TXP acts as the principal
interface with the EMBASSY. Every EMBASSY-equipped device will contact TXP on a
periodic basis. During this secure communication, all stored event information,
such as purchase logs, are uploaded to TXP, additional credit may be requested,
pending events are delivered to the device, and a routine audit check is
performed. There may be a number of TXP systems to distribute access around the
globe. TXP routes all event logs to ICH where they are processed against Wave's
royalty contracts. ICH calculates royalties due to each partner and handles the
billing and reporting services, ensuring that all Wave partners are properly
compensated. WaveNet is presently in operation.
The Wave System is installed into the customer's computer or integrated
into an attached peripheral device. It is based on a semiconductor device that
uses secure certified integrated circuit technology to unscramble data and to
store credit and usage data. At present, the WaveMeter, based on our own silicon
chip, is packaged on an accessory board to be installed in a personal computer.
In 1999 , we plan to deliver a new version of the EMBASSY hardware with a USB
interface, which should easily integrate into a broad range of products,
including separate attachments for portable interactive devices. We also offer a
production software version of the WaveMeter application , which is compatible
with the use of the hardware version .
We believe that the hardware version of the Wave System with EMBASSY is
the most secure form of content licensing management and metering technology
available today. The EMBASSY hardware and software contain a wide range of
security features . Tampering results in the device automatically locking out
users, and is readily detected . The codes used to unscramble data are loaded at
the time we manufacture the EMBASSY device, and are unique and specific to each
device. Every piece of electronic content is protected using a unique code key.
Services are controlled by secure applications running in the EMBASSY platform.
We believe we have designed a security architecture where the value of breaking
into an individual computer system to ascertain the code keys is low, since
there are no common keys that allow the use of such code keys on other systems.
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Markets and Business Strategy
Our long-term strategy is to achieve broad market acceptance of the
Wave System as a distributed trust platform for commerce performed in user
devices. To achieve this goal, we pursue strategic relationships with hardware
manufacturers and companies involved in the development of commerce in
electronic content and services. In addition, we believe that, since the Wave
System permits greater flexibility in pricing and distribution of electronic
content, it is particularly well-suited for merchandising consumer content,
entertainment and educational software. Therefore we are vigorously targeting
this market segment as a means of rapidly achieving the broad installed base of
the Wave System. We believe that once there is a broad installed base of the
Wave System and EMBASSY, electronic content owners from other market segments
are likely to be attracted to the Wave System. However, we cannot assure you
that the Wave System will achieve any significant market acceptance.
We have focused on forming agreements with strategic partners that will
help us promote the broad-based acceptance of the Wave System as a platform for
commerce in electronic content. We are currently in discussion with original
equipment manufacturers regarding the incorporation of the Wave System and
EMBASSY into their products. We have also focused on pursuing strategic
relationships with companies seeking to distribute electronic content via the
Internet. The compatibility of the Wave System with the Web has provided us with
a product that has already attracted the attention of leaders in the development
of electronic commerce solutions and particularly commerce in electronic
content. We will continue to focus on developing other strategic relationships
to seek to achieve the broad acceptance of the Wave System as a platform for
electronic commerce.
We have focused on promoting the acceptance of the Wave System by
electronic content owners. The initial target market is entertainment and
educational software developers and distributors. We believe that the Wave
System will provide the home consumer with a new way of acquiring interactive
content and can offer electronic content developers and distributors benefits
similar to those provided by video rental in the film industry. We have invested
heavily in developing relationships with entertainment and educational software
providers. Today, we have over 50 titles functional for demonstration and are
actively preparing others to be launched in 1999.
Competition
We operate in a highly competitive and fragmented environment that is
characterized by rapidly evolving technology. Many of our competitors and
potential competitors have substantially greater financial and technical
resources than us. Also, many current and potential competitors have greater
name recognition and more extensive customer bases that could be leveraged,
thereby gaining market share or product acceptance to our detriment. The Wave
System competes with conventional information delivery systems, such as on-line
services like AOL, subscription services on CD-ROM, and services on the
Internet. However, we believe that its metering capability is competitive with
other electronic content delivery systems in a number of applications due to its
superior protection against unauthorized usage, accurate and detailed
information on content usage, and transparent operation. Further, we believe
that it will be competitive with existing distribution systems, including
traditional retail outlets for entertainment and educational software, due to
its ability to offer these innovative merchandising mechanisms.
We are aware of other metering systems that compete directly with the
Wave System, and other current and evolving technologies that provide some of
the functionality of the Wave System. There are other companies that have
developed or are in the process of developing technologies that are, or in the
future may be, the basis for competitive products in the field of electronic
content distribution. Some
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of those technologies may have an entirely different approach or means of
accomplishing the desired effects of the products being developed by us. We
cannot assure you that either existing or new competitors will not develop
products that are superior to or that otherwise achieve greater market
acceptance than our products.
The Wave System is subject to competition from producers of
hardware-based controllers such as hardware-based key systems and software
unlocking systems. We will compete with well-established producers of
hardware-based unlocking systems such as Rainbow Technologies, Inc. We also
compete with developers of software unlocking systems such as Portland Software.
We also provides basic security services that compete with companies such as
QPass and PrivaSeek in providing electronic wallets and certain e-commerce
capabilities. We believe that the Wave System is superior to existing
hardware-based and software unlocking systems in several ways. These systems
primarily operate as "on/off switches" to control the use of electronic content
and services, but are very limited in their ability to measure and record usage
information. We believe that the Wave System offers superior protection from
unauthorized usage, low operating costs (because it does not require constant
communication with and authorization from a centralized processor), and fast
operation that is convenient and essentially transparent to the end user. Both
hardware controllers and software unlocking systems offer only part of the
functionality of the Wave System. Our products also provides a superior solution
for the broadcasting and multicasting of data. Distinct from the existing
software unlocking systems, WaveNet provides centralized back-office support to
owners of electronic content.
Many large information industry players are forming alliances and
attempting to capitalize on the information delivery options offered by the
Internet. In electronic content delivery via the Internet, the Wave System
competes with electronic commerce payment technologies developed and offered by
IBM Micropayment Service, Broadvision, Connect, CyberCash, and Open Market.
However, we believe that many of the electronic commerce payment technologies
may be used as acceptable currency through the Wave System and may be
complementary to, rather than competitive with, the Wave System. We are also
aware of other companies, such as TestDrive, Release Software and InterTrust
that provide electronic content encryption and license management functionality
for transmission of electronic content over the Internet. We believe that the
Wave System is superior to currently available electronic content encryption
technologies due to the high level of persistent security and usage reporting
capabilities of the WaveMeter.
We believe that the interoperability of the Wave System with currently
available and developing distribution media makes the Wave System attractive to
both distributors and consumers of electronic content. A consumer with an
installed EMBASSY platform will be able to purchase Wave-enabled electronic
content from sources on CD-ROM and/or the Internet, as well as from sources
distributing electronic content via other developing media. In addition, with
the incorporation of the rental and rent-to-own functionality, the Wave System
will offer greater merchandising flexibility than is possible using currently
available electronic commerce solutions. We caution you, however, that the Wave
System may never achieve the broad-based acceptance necessary to make it a
viable competitor with existing and developing electronic commerce solutions.
International Market
Our technologies are controlled under various United States export
control laws and regulations and will require export licenses for certain
exports outside of the United States and Canada. We have received full export
license from the U.S. Department of Commerce for the sale and export of our
single-key DES products. We have also received an export license for our
triple-key data encryption standard products under the provisions of a License
Exception KMI, granted by the Bureau of Export Administration of the U.S.
Department of Commerce. We cannot assure you that that we will have
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patent protection or that it will not infringe patents of third parties in
foreign jurisdictions. Because electronic monitoring and the transmission of
audited usage and financial information on end users or payment instructions may
be subject to varying statutory or regulatory controls in foreign jurisdictions,
the use of all portions of the Wave System may not be permitted in any
particular foreign jurisdiction.
Wave Systems formed a strategic alliance in 1998 with HP VerSecure in
the development of the underlying architecture of the EMBASSY platform. HP
VerSecure provides a security management framework for EMBASSY that controls
security functions in the device . The primary function of the VerSecure system
is to provide a management system that enables the EMBASSY hardware to have
strong security features that can be selectively enabled or disabled in order to
comply with the regulations of various countries. This capability is intended to
allow computer manufacturers to build a single, consistent product which can be
shipped worldwide, regardless of local restrictions.
Proprietary Rights and Licenses and Intellectual Property
Our success depends, in part, on our ability to enjoy or obtain
protection for our products and technologies under United States and foreign
patent laws, copyright laws and other intellectual property laws, to preserve
our trade secrets and to operate without infringing the proprietary rights of
third parties. Any issued patent owned or licensed by us may not, however,
afford adequate protection to us and may be challenged, invalidated, infringed
or circumvented. Furthermore, you should understand that our activities may
infringe patents owned by others.
In addition, we may be required to obtain licenses to patents or other
proprietary rights of third parties. Licenses required under any such patents or
proprietary rights may not be made available on terms acceptable to us, if at
all. If we are required to and do not obtain such licenses, we would be
prevented from, or encounter delays in the development and marketing of, our
products and technologies while we attempted to design around such patents or
other rights. Such attempts may not be successful. Failure to obtain such
licenses or to design around such patents or other rights would have a material
adverse effect on us.
We hold non-exclusive patent rights relating to the metered use of
encrypted data in local memory under a limited license from Titan Corporation to
a patent jointly held by Titan and a third party. This license agreement
restricts us from metering information produced and used solely by a government
entity or producing products that meter this information. In addition, this
license agreement is subject to the rights of the joint owner of this patent,
who has the right to exploit, or to license to third parties, this patent,
including in a manner competitive with us. The joint owner of this patent may
compete with us or license this patent to a competitor of ours, and our business
may exceed the scope of this license agreement. Pursuant to this license
agreement, we are obligated to pay certain royalties to Titan. Pursuant to this
license agreement, we have granted to Titan the exclusive right to use our
patents for products distributed to government entities. On February 28, 1997 we
and Titan executed an addendum to this license agreement whereby we received a
sole license to this patent to develop and distribute products to the in-home
consumer microcomputer market segment. Under this addendum to this license
agreement, Titan waived any and all defaults by us under this license agreement
occurring prior to February 28, 1997.
We are aware of four United States patents (the "Third Party Patents")
each having some claims that are similar to some of the claims in the Licensed
Patent. Based upon information currently known to us, some of the claims of both
the Licensed Patent and the Third Party Patents cover certain material aspects
of our technology. Therefore, the commercialization of our technology would be
subject to the rights of the holder of the Third Party Patents unless we are
able to invalidate or license such claims. Also, the holder of the Third Party
Patents or a licensee of the Third Party Patents could seek to
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invalidate such claims of the Licensed Patent and therefore be able to
commercialize a technology similar to our technology. In either case, in order
to invalidate the other party's patent rights, the party claiming invalidity
might need to prove that it invented the claimed subject matter prior to the
other party. We cannot assure you that we would be successful in invalidating
such claims of the Third Party Patents or that the holder of the Third Party
Patents or a licensee of the Third Party Patents would not be successful in
invalidating the claims of the Licensed Patent. Furthermore, we cannot assure
you that the Third Party Patents could be proven to be invalid on any other
basis. Any proceeding involving the validity of the Licensed Patent and the
Third Party Patents would be protracted and costly. In any suit contesting the
validity of a patent, the patent being contested would be entitled to a
presumption of validity and the contesting party would be required to
demonstrate invalidity of such patent by clear and convincing evidence.
If the Third Party Patents are not invalid insofar as their claims
relate to our technology, then we would require a license from the holder of the
Third Party Patents to commercialize our technology and make, use, or sell
products or practice methods, or license others to sell products or use methods,
utilizing this technology in the United States. Due to the uncertainty as to
whether the Third Party Patents could be proved to be invalid, we have engaged
in preliminary negotiations with the holder of the Third Party Patents to obtain
a license under the Third Party Patents. The negotiations have so far not
produced any agreement and a license may not be obtainable on acceptable terms,
if at all. The inability to obtain a license, if needed, on commercially
reasonable terms would have a material adverse effect on our business and our
future operations.
We have been issued three United States patents relating to encryption
and to our proprietary WaveMeter and WaveNet technology. We also have one patent
pending before the United States Patent Office and three corresponding foreign
patent applications pending before the European Patent Office. Our patents are
material to protecting some of our technology. Our patent rights derive from a
license from Mr. Peter J. Sprague, our Chairman and Chief Executive Officer, of
his rights in these patents, and several agreements with former officers
regarding their rights in these patents. The license agreement with Mr. Sprague
requires us to make royalty payments to him and Dr. John R. Michener, a former
officer, in a total amount equal to two percent of gross revenues less certain
adjustments. This royalty payment is apportioned 75 percent to Mr. Sprague and
25 percent to Dr. Michener. The payment of royalties is secured by a security
interest in and to our patents. We believe that these agreements as a whole
provide us with exclusive rights under our patents. We cannot assure you,
however, that we will enjoy exclusive rights to these patents under such
agreements.
On January 26, 1996, we received notice from E-Data Corporation
(formerly Interactive Gift Express, Inc.), claiming that our practice of our
technology infringes U.S. and foreign patents owned by E-Data Corporation, and
offering to license such patents to us. We are currently obtaining information
needed to investigate the merits of this claim. We believe that there is a
viable argument for non-infringement. The patents owned by E-Data Corporation
are currently being litigated by third parties. We are not involved in these
proceedings.
We rely on trade secrets and proprietary know-how, which we protect, in
part, by confidentiality agreements with our employees and contract partners.
However, we caution you that our confidentiality agreements may be breached and
we may not have adequate remedies is such a breach occurs. Furthermore, we
cannot assure you that our trade secrets will not otherwise become known or be
independently discovered by competitors.
We also rely on copyright to prevent the unauthorized duplication of
our software and hardware products. We have and will continue to protect our
software and our copyright interest therein through
<PAGE>
-33-
agreements with our consultants. We cannot assure you that copyright laws will
adequately protect our technology.
We have registered trademark and service mark registrations with the
United States Patent and Trademark Office for the marks WaveMeter and WaveNet,
Great Stuff Network, Second Shift (the Wave juggler logo), WaveCommerce, Wave
Interactive Network, WINPublish, WINPurchase and CablePC. We have submitted
trademark registrations for EMBASSY, EMBASSY System and EMBASSY E-Commerce
System and intend to apply for additional name and logo marks in the United
States and foreign jurisdictions as appropriate. No assurance can be given that
federal registration of any of these trademarks in the United States will be
granted. We have abandoned our prior applications for DataWave, InfoWave, and
WaveTrac.
Research and Development
The Wave System incorporates semiconductor, encryption/decryption,
software transaction processing and other technologies in which we have made a
substantial investment in research and development. We expect that we will be
required to continue to make substantial investments in the design of the Wave
System, including EMBASSY, the WaveMeter, WaveNet and software interfaces. For
the three months ended March 31, 1999 and the years ended December 31, 1998,
1997, and 1996, we expended approximately $1.1 million, $3.5 million, $2.1
million and $3.3 million respectively, on research and development activities
(which amounts include the value of stock issued). In addition to our ongoing
research and development activities, in July 1997 we licensed technology and
in-process research and development from Aladdin Knowledge Systems for cash and
warrants valued at $3.9 million. From our inception in February 1988 through
March 1999, we expended approximately $19.3 million on research and development
activities.
The success of the Wave System depends to a large extent on our ability
to adapt the Wave System for use with various methods for the distribution of
electronic content, the ability of the Wave technology to interface with various
platform environments, and the ability of the Wave System to work in many
application environments. Incorporation of Aladdin's Hasp technology furthered
these efforts and illustrates the adaptive capabilities of the Wave System. We
believe that a significant portion of our future research and development
expenditures will be used to adapt the Wave System accordingly.
We will also continue to expend a significant amount of resources on
the development of new iterations of the EMBASSY and the WaveMeter application.
We believe that by providing various means of linking the EMBASSY to the
customer's computer or network, we will be more likely to achieve broad
acceptance of the Wave System. We are currently developing other forms of the
EMBASSY to target other market needs.
We are now focusing increased resources on developing our operational
infrastructure. We are placing greater emphasis on developing internal
production and fulfillment systems and marketing infrastructure to distribute
the Wave System. We will also increase the resources available to WaveNet to
adapt to changing market requirements. We plan to expand WaveNet to handle more
end users, to implement more sophisticated pricing methodologies and to add
greater financial system flexibility.
RECENT DEVELOPMENT
As part of our strategy to accelerate the widespread use of a flexible
and comprehensive security solution for personal computers and other consumer
electronic devices, we announced on June 14, 1999 that we signed a preliminary,
non-binding letter of intent to acquire N*Able Technologies Incorporated. N*Able
is a developer of hardware security solutions based in Danvers, Massachusetts.
Under the terms of the letter of intent, we would acquire N*Able in a tax-free
pooling of interests transaction by merging N*Able with one of our subsidiaries.
Based on our current stock price, we would issue, or reserve for issuance,
approximately 2,500,000 shares of our Class A common stock (which would
represent an increase of approximately 7.2% in the number of shares of Class A
common stock outstanding) in exchange for, or for issuance upon conversion of,
outstanding shares of N*Able capital stock and convertible securities.
This proposed transaction is subject to a variety of conditions,
including:
o definitive documentation satisfactory to both us and N*Able
(only preliminary drafts of which have been distributed
between the parties, as of the date of this Prospectus);
o qualification of the proposed transaction as a tax-free
pooling of interests transaction(as of the date of this
Prospectus, our legal and accounting experts are unable to
provide us with any assurance that this qualification is
possible, much less probable);
o satisfactory results from our legal, accounting and business
due diligence (as of the date of this Prospectus, we have not
undertaken or completed substantial portions of our due
diligence);
o the execution of arrangements with employees satisfactory to
us; and
o approval by the boards of directors of both parties, and
shareholder approval by N*Able. Because price negotiations are
continuing, we are unable to evaluate whether the Board or
stockholders of N*Able will approve this transaction. Our own
Board of Directors is also continuing to evaluate the
information provided by our legal and accounting experts with
regard to the risks and benefits of this transaction. No
meetings to seek such board or shareholder approval have been
scheduled.
In addition, the preliminary letter does not have any provisions
requiring the payment of a fee by either party thereto, should this proposed
transaction not occur. After a thorough review of the facts and conditions
surrounding this proposed transaction, and because of the significant amount of
additional due diligence, legal and accounting analysis, and document and price
negotiation that must be completed prior to entering into any commitments to
complete this transaction, we have reached the conclusion that the financial
statements of N*Able are not necessary at this time for an investor to make an
investment decision with respect to Wave common stock. The importance of our due
diligence review of materials provided by N*Able is especially highlighted, as
we have not had any commercial dealing with N*Able prior to May 1999, and
because N*Able is a development stage company with no historical track record of
significant revenues or earnings. We have reviewed the facts regarding the
proposed transaction, and we do not deem this transaction to be "probable"
within the meaning of applicable rules of the Securities and Exchange
Commission, again for the reasons stated above.
Employees
As of March 31, 1999, we employed 83 full-time employees, 44 of whom
were involved in sales, marketing and administration and 39 of whom were
involved in research and development. As of March 31, 1999, we employed 9
full-time consultants, who are reflected in the foregoing figures. We believe
our employee relations are satisfactory.
<PAGE>
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Properties
We lease a 10,748 square foot facility for our executive offices and to
house the WaveNet installation, administration, and customer support operations
in Lee, Massachusetts at a monthly rent of $5,598, with a monthly charge of
$2,123 for common costs. The Lee, Massachusetts lease will expire during
February 2001. We lease offices in New York, New York, at a monthly rent of
$12,000, which is scheduled to expire in May 2001. We lease a 6,400 square foot
facility in Princeton, New Jersey at a monthly base rent of $4,214 with a
monthly payment for taxes, insurance and maintenance reimbursements and
improvements which currently totals approximately $1,653 per month. This lease
is scheduled to expire during January 2001. Our principal research and
development activities are conducted at the Princeton facility. We lease a 2,728
square foot facility in San Jose, California for $6,138 per month, which is
scheduled to expire in December 2001.
Legal Proceedings
From time to time, we are party to litigation arising in the ordinary
course of business. We believe that no pending legal proceeding will have a
material adverse effect on our business, financial condition or results of
operations.
<PAGE>
-35-
Management
<TABLE>
<CAPTION>
Directors
Business Experience and Principal Occupation or Employment During Past 5 Director
Name Age Years; Positions held with Wave Systems; Other Directorships Since
- ---- --- ------------------------------------------------------------ -----
<S> <C> <C> <C>
Peter J. Sprague(1)(4) 59 Chairman of since 1988 and Chief Executive Officer Company since July 1988
1991; Chairman of National Semiconductor Corporation from 1965 until May
1995; Director of EnLighten Software, Inc. and Imagek, Inc.; Trustee of
the Strang Clinic; Member of Academy of Distinguished Entrepreneurs,
Babson College.
John E. Bagalay, Jr., 65 Senior Advisor to Chancellor, Boston University from January 1998; 1993
Ph.D.(1)(2)(4) Managing Director of Community Technology Fund, a venture capital
affiliate of Boston University, from September 1989 until
January 1, 1998; Chief Operating Officer, Chief Financial
Officer and Director of Eurus Technologies, inc. since January
15, 1999; General Counsel of Lower Colorado River Authority from
October 1984 to September 1988; former General Counsel of Texas
Commerce Bancshares, Inc. and Houston First Financial Group;
Director of Seragen, Inc., Cytogen, Inc., AES, Inc. and several
privately-held corporations; President and CEO of Cytogen
Corporation from January 1998, CFO since October 1997; Managing
Director of Boston University Venture Capital Fund from
1989-1997.
Philippe Bertin(3) 49 Manager of Financiere Wagram Poncelet (direct marketing; media) since 1993
December 1991; Manager of Midial S.A. (consumer goods) from 1984 until
1991; Manager of FINOVELEC since October 1997.
George Gilder(4) 59 Chairman of the Executive Committee since 1996; Senior Fellow at the 1993
Discovery Institute in Seattle, Washington; author of nine books,
including LIFE AFTER TELEVISION, MICROCOSM, THE SPIRIT OF ENTERPRISE AND
WEALTH AND POVERTY; contributing editor to Forbes Magazine; Director and
President of Gilder Technology Group, Inc. (publisher of monthly
technology reports); former chairman of the Lehrman Institute Economic
Roundtable; former Program Director for the Manhattan Institute; recipient
of White House award for Entrepreneurial Excellence from President Reagan.
John E. McConnaughy, 69 Chairman and Chief Executive Officer of JEMC Corporation (private 1988
Jr. (1)(2)(3)(4) investments); Chairman and Chief Executive Officer of Peabody
International Corporation (an environmental services company) from 1969
through 1985; Chairman and Chief Executive Officer of GEO International
Corporation (a nondestructive testing, screen printing and oil field
services company which was spun off from Peabody) from February 1981 to
October 1992; Director of Riddell Sports Inc., Levcor International, Inc.,
Transact International, Inc., De-Vlieg Bullard, Inc. and Mego Financial
Corp. Mr. McConnaughy is also a member of the Board of Trustees of the
Strang Clinic and the Chairman of the Board of the Harlem School of the
Arts.
Steven Sprague 34 President and Chief Operating Officer since May 1996; President of Wave 1997
Interactive Network from June 1995 to December 30, 1996; Vice President of
Operations from April 1994 to June 1995; Wave employee in the areas of
operations and strategic planning from November 1992 to April 1994;
consultant to us from March 1992 to November 1992; President of Tech
Support, Incorporated (hardware technical support information on CD-ROM)
from June 1992 to November 1992; sole proprietor of SKS Environmental
Sales (manufacturers' representative for water treatment companies) from
June 1991 to November 1992.
</TABLE>
(1) Member of Nominating Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.
(4) Member of Executive Committee.
<PAGE>
-36-
Involvement in certain legal proceedings
Mr. McConnaughy is the Chairman of the Board of the Excellence Group,
LLC, which filed a petition for bankruptcy under Chapter 11 on January 13, 1999.
The Excellence Group's subsidiaries produced labels for a variety of customers.
Executive officers of the registrant
Our executive officers are Mr. Peter J. Sprague, Chairman and Chief
Executive Officer, Mr. Steven Sprague, President and Chief Operating Officer and
Mr. Gerard T. Feeney, Senior Vice President of Finance and Administration, Chief
Financial Officer and Secretary. Prior to joining us in June 1998, Mr. Feeney,
40, served for five years as the Vice President of Finance, Chief Financial
Officer and Treasurer of Xionics Document Technologies, Inc.
All officers are elected annually at the first meeting of the Board of
Directors following the annual meeting of the stockholders, and are subject to
removal at any time by the Board of Directors.
Executive compensation
Summary Compensation Table
The following table sets forth information with respect to the
compensation we paid or awarded to the Chief Executive Officer and the other
executive officers whose cash compensation exceeded $100,000 (collectively, the
"Named Executive Officers") for services rendered in all capacities during 1998,
1997 and 1996.
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
Annual Compensation Number of Shares
Name and Principal Position Underlying
Year Salary($) Bonus($) Options(#)
<S> <C> <C> <C> <C>
Peter J. Sprague(1) 1998 $ 182,917 $ 150,000 895,395
Chairman and Chief 1997 $ 160,000 $ 100,000 10,000
Executive Officer 1996 $ 160,000 $ 50,000 -0-
Steven Sprague(2) 1998 $ 177,500 $ 150,000 954,505
President and 1997 $ 150,000 $ 117,500 -0-
Chief Operating Officer 1996 $ 131,666 $ -0- 150,000
Gerard T. Feeney(3) 1998 $ 90,359 $ 65,000 450,000
Senior Vice President, Chief
Financial Officer and
Secretary
</TABLE>
(1) Mr. Peter Sprague received a bonus of $150,000 for 1998; $75,000 was
received in cash and $75,000 was applied to reduce his debt to Wave
(see Item 13).
(2) Mr. Steven Sprague was elected President and Chief Operating Officer on
May 23, 1996 and was not previously an executive officer during 1996.
Prior to that, Mr. Steven Sprague was Vice President of Operations from
April 1994 to June 1995 and a Wave employee in the areas of operations
and strategic planning from November 1992 to April 1994.
(3) Mr. Gerard T. Feeney was hired as Senior Vice President, Finance and
Administration and Chief Financial Officer on June 8, 1998 and was
elected Secretary on February 25, 1999.
<PAGE>
-37-
Option Grants Table
The following table sets forth certain information regarding options we
granted during the fiscal year ended December 31, 1998 to the Named Executive
Officers. The potential realizable values of the options reported in this table
were calculated by assuming 5% and 10% compounded annual rates of appreciation
from the date of grant until expiration, based upon the market price on the date
of grant. These assumed annual rates of appreciation were used in compliance
with the rules of the Securities and Exchange Commission and are not intended to
forecast future price appreciation of the common stock.
<TABLE>
<CAPTION>
Number of % of Total Potential Realizable Value
Shares Options at Assumed Annual Rates of
Underlying Granted to Exercise Stock Price Appreciation for
Options Employees Price Expiration Option Term
Name Granted (#) Fiscal Year ($/Share) Date 5% ($) 10% ($)
- ---- ----------- ----------- --------- ------------ ------ -------
<S> <C> <C> <C> <C> <C> <C>
Peter J. Sprague (1) 300,000 5.7% $ 1.15 2/6/08 216,900 548,400
50,005 0.1 1.10 3/11/08 37,854 74,657
545,500 10.4 3.66 5/20/08 1,990,529 4,347,090
Steven Sprague (2) 193,200 3.7 1.15 2/6/08 139,684 353,170
250,005 4.8 1.10 3/11/08 189,254 373,257
511,300 9.7 3.66 5/20/08 1,865,734 4,074,550
Gerard T. Feeney 450,000 8.6 3.50 6/8/08 1,265,400 2,941,200
</TABLE>
(1) Includes an aggregate of 300,000 options repriced on February 6, 1998.
(2) Includes an aggregate of 193,200 options repriced on February 6, 1998.
Fiscal Year End Option Value Table
The following table sets forth information regarding the aggregate
number and value of options held by the Named Executive Officers as at December
31, 1998, and the aggregate number and value of options exercised by the Named
Executive Officers during 1998. The last reported bid price for our Class A
common stock on the OTC Bulletin Board on December 31, 1998 was $3.719 per
share. Value is calculated on the basis of the difference between the respective
option exercise prices and $3.719, multiplied by the number of shares of common
stock underlying the respective options.
<TABLE>
<CAPTION>
Number of Shares Value of Unexercised
Shares Underlying Unexercised Options In-The-Money Options
Acquired on Value at December 31, 1998(#) at December 31, 1998($)
Name Exercise Received Exercisable Unexercisable Exercisable Unexercisable
- ---- -------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Peter J. Sprague - 0 - - 0 - 31,995 895,505 $ 67 ,715 $ 933,848
Steven Sprague - 0 - - 0 - 1,995 954,505 5,245 1,181,261
Gerard T. Feeney - 0 - - 0 - - 0 - 450,000 - 0 - 98,550
</TABLE>
<PAGE>
-38-
Compensation of Directors
Directors presently receive no cash compensation for serving on the
Board of Directors. Under our Non-Employee Directors Stock Option Plan, each
director who is one of our employees receives an annual grant of options to
purchase 20,000 shares of Class A common stock at fair market value. The options
are granted upon re-election after the annual meeting of the stockholders and
vest the day following the grant. Options terminate upon the earliest to occur
of (i) subject to (ii) below, three months after the optionee ceases to be a
director, (ii) one year after the death or disability of the optionee, and (iii)
ten years after the date of grant. If there is a change of control of Wave, all
outstanding stock options will become immediately exercisable.
Security Ownership Of Certain Beneficial Owners And Management
The following table sets forth certain information concerning the
beneficial ownership of our Class A and Class B common stock as of March 31,
1999 (except as otherwise noted) by
- - each stockholder who is known by us to own beneficially more than five
percent of the outstanding Class A or Class B common stock;
- - each of our directors;
- - each of the executive officers named in the Summary Compensation Table
above, and
- - all of our directors and executive officers as a group.
Each individual or entity listed below has sole voting and investment
power, except as otherwise indicated. Holders of Class A common stock are
entitled to one vote per share on all matters submitted to a vote of the
stockholders. The number of shares of our Class A common stock shown in the
table below does not include the number of shares of our Class A common stock
issuable upon conversion of our Class B common stock.
Holders of Class B common stock are entitled to one vote per share on
all matters submitted to a vote of the stockholders, except that holders of
Class B common stock will have five votes per share in cases where one or more
directors are nominated for election by persons other than our Board of
Directors and where there is a vote on any merger, consolidation or other
similar transaction which is not recommended by our Board of Directors. In
addition, holders of Class B common stock will have five votes per share on all
matters submitted to a vote of the stockholders in the event that any person or
group of persons acquires beneficial ownership of 20% or more of our outstanding
voting securities. Shares of Class B common stock are convertible into shares of
Class A common stock on a one-for-one basis at the option of the holder. In
circumstances where our Class B common stock has five votes per share, the
percentages of total voting power reflected in the table below would be as
follows: Peter J. Sprague, 16.8%; Steven Sprague, 3.0%; John E. Bagalay, Jr.
less than 1%; Phillipe Bertin, less than 1%; George Gilder, less than 1%; John
E. McConnaughy, Jr., 4.0%; Aladdin Knowledge Systems, 5.9%; and all Executive
officers and directors as a group, 24.1%.
<PAGE>
-39-
<TABLE>
<CAPTION>
Number of Number of Percent
shares shares of all
of Class A Percent of Class B Percent outstanding
common of common of common
Beneficial Owner stock owned class stock owned class stock
<S> <C> <C> <C> <C> <C>
Peter J. Sprague(1) 364,486 1.2 1,372,899 49.5 5.4
Steven Sprague(2) 332,163 1.1 189,659 6.8 1.6
John E. Bagalay, Jr.(3) 38,000 * 0 * *
Philippe Bertin(4) 38,000 * 0 * *
George Gilder(5) 67,333 * 2,000 * *
John E. McConnaughy, Jr.(6) 38,000 * 335,000 12.1 1.5
Aladdin Knowledge Sys. (7) 2,531,307 8.0 0 * 7.3
Gerard T. Feeney 0 * 0 * *
All executive officers and
directors as a group
(7 persons)(8) 877,982 2.9 1,899,558 68.6 8.5
</TABLE>
*Less than one percent.
(1) Includes 330,496 shares which are subject to options presently
exercisable or exercisable within 60 days. Also includes 320,000 shares
held in trust for the benefit of Mr. Sprague's adult children, and for
which Mr. Sprague is a trustee.
(2) Includes 320,163 shares which are subject to options presently
exercisable or exercisable within 60 days. Also includes 37,102 shares
held in trust for the benefit of Mr. Sprague's family, and for which
Mr. Sprague is a trustee.
(3) Includes 34,000 shares which are subject to options presently
exercisable or exercisable within 60 days.
(4) Includes 34,000 shares which are subject to options presently
exercisable or exercisable within 60 days.
(5) Includes 67,333 shares which are subject to options presently
exercisable or exercisable within 60 days.
(6) Includes 34,000 shares which are subject to options presently
exercisable or exercisable within 60 days.
(7) Includes 2,531,307 shares which are subject to warrants presently
exercisable or exercisable within 60 days.
(8) Includes 681,043 shares which are subject to options presently
exercisable or exercisable within 60 days.
Certain Relationships And Related Transactions
Note receivable from director/officer
On November 16, 1992, we made a personal loan to Mr. Peter J. Sprague,
our Chairman and Chief Executive Officer, as evidenced by a note for $150,000,
which sum was due and payable to us on January 16, 1993 and which bore interest
at the rate of ten percent per annum. On the due date, the note was canceled and
the total amount owed was "rolled-over" into a new note, dated May 12, 1993 for
$150,000, plus accrued interest. The note is due on demand by us and accrues
interest at the rate of ten percent per annum. On April 22, 1993, we made an
additional loan to Mr. Peter Sprague for $23,175 as evidenced by a promissory
note, which is due on demand by us and which bears interest at a rate of ten
percent per annum. All of these loans were made to Mr. Sprague for personal
reasons. As part of Mr. Sprague's $150,000 bonus for 1998, $75,000 was applied
against his indebtedness to us.
<PAGE>
-40-
As of March 31, 1999, Mr. Sprague's aggregate indebtedness (including accrued
interest) to us under the notes totaled $ 150,546. No demand for payment has
been made as of the date hereof. The notes are secured by a pledge of 67,000
shares of Class B common stock.
Compensation to Steven Sprague
Steven Sprague received aggregate compensation of $327,500, $267,500
and $131,666 for services rendered to us in 1998, 1997 and 1996, respectively.
Steven Sprague is the son of Mr. Peter J. Sprague, our Chairman and Chief
Executive Officer.
Compensation to Michael Sprague
Michael Sprague received aggregate compensation of $112,500 and $27,500
for services rendered to us in 1998 and 1997, respectively. Michael Sprague is
the son of Mr. Peter J. Sprague, our Chairman and Chief Executive Officer.
Amended and restated license agreement and assignment
Pursuant to an Amended and Restated License Agreement, dated February
14, 1994, and related Patent Assignment and Security Agreement, Mr. Peter J.
Sprague assigned his interest in a patent for the metering and usage of serial
data information to us in exchange for a non-terminable royalty interest. We
have agreed to pay royalties to Mr. Sprague in an amount equal to 2% of the
gross revenues (less actual amounts paid to information, database and content
providers, hardware manufacturers and suppliers, search and retrieval software
suppliers, consolidators of information and network providers) derived from our
technology based on the patent. The royalty payments are allocated 75% to Mr.
Sprague and 25% to one of our former officers, and are secured by a security
interest in the patent.
License and cross-license agreement
On May 1, 1992, we entered into a Joint Technology Development
Agreement and License and Cross-License Agreement with The Titan Corporation
whereby Titan granted to us license rights to the use of certain patents which
are co-owned by Titan. Dr. Gene W. Ray, one of our directors, is a director,
President and Chief Executive Officer of Titan. We 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 patents held by
us. 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 that information. On February 28,
1997 we and Titan executed an addendum to the License and Cross-License
Agreement whereby we received a sole license to the licensed patent to develop
and distribute products to the in-home consumer microcomputer market segment.
Under this addendum to the License and Cross-License Agreement, Titan waived any
and all defaults by us under the License and Cross-License Agreement occurring
prior to February 28, 1997.
<PAGE>
-41-
Description Of Securities
Our authorized capital stock consists of 75,000,000 shares of Class A
common stock, $.01 par value per share; 13,000,000 shares of Class B common
stock, $.01 par value per share; and 2,000,000 shares of preferred stock, $.01
par value.
The following summary description of our capital stock is a summary
only and is not intended to be complete. You should refer to our Restated
Certificate of Incorporation, which is filed as an exhibit to the registration
statement of which this prospectus forms a part, and the Delaware General
Corporation Law. For a more detailed description of the provisions highlighted
below, please refer to that exhibit and the Delaware General Corporation Law.
Common stock
Our Class A common stock and Class B common stock are equal in all
respects except for voting rights, conversion rights and restrictions on
transferability, as discussed more fully below.
Voting rights
The voting powers, preferences and relative rights of the Class A
common stock and the Class B common stock are identical in all respects, subject
to the following provisions. Holders of Class A common stock have one vote per
share on all matters submitted to a vote of our stockholders. Holders of Class B
common stock have one vote per share on all matters submitted to a vote of our
stockholders, except that holders of Class B common stock will have five votes
per share on the following matters:
- - Any election of directors where one or more directors has been
nominated by any person or persons other than our Board of Directors or
in the event of any solicitation of proxies or consents by or on behalf
of any person or persons other than our Board of Directors for the
purpose of electing directors;
- - Any vote on a merger, consolidation or reorganization of Wave or
similar business combination or transaction, or any sale, lease,
exchange or other disposition of all or substantially all of the assets
of Wave Systems, if the particular business combination or other
transaction has not been recommended by our Board of Directors; and
- - All matters submitted to a vote of our stockholders in the event that
any person or group acquires beneficial ownership of 20% or more of our
outstanding voting securities. This provision will not apply to any
person or group who beneficially owns 3% or more of our outstanding
voting securities at the time of the closing of this offering or any
group including any such person.
No class of outstanding common stock alone is entitled to elect any
directors. There is no cumulative voting with respect to the election of
directors. Under our Restated Certificate of Incorporation and the Delaware
General Corporation Law, the holders of Class A common stock and Class B common
stock are entitled to vote as separate classes with respect to any amendment to
our Restated Certificate of Incorporation that would increase or decrease the
aggregate number of authorized shares of any class, increase or decrease the par
value of the shares of any class, or modify
<PAGE>
-42-
or change the powers, preferences or special rights of the shares of any class
so as to affect that class adversely.
Dividends
Holders of the Class A common stock and the Class B common stock are
entitled to receive ratably any dividends that are declared by our Board of
Directors out of funds legally available for that purpose. However, dividends
paid shares of Class A common stock will be paid only to holders of Class A
common stock , and dividends paid in shares of Class B common stock will be paid
only to holders of Class B common stock. Our Restated Certificate of
Incorporation provides that if there is any dividend, subdivision, combination
or reclassification of either class of common stock, a proportionate dividend,
subdivision, combination or reclassification of the other class of common stock
shall simultaneously be made.
Conversion; limitation on transferability of Class B common stock
The Class A common stock has no conversion rights. At the option of the
holder, each share of Class B common stock is convertible at any time, and from
time to time, into one share of Class A common stock. In the event of the
transfer or attempted transfer of shares of Class B common stock, except to
related persons and other permitted transferees, the shares of Class B common
stock will automatically convert into an equal number of shares of Class A
common stock.
Other rights
Our stockholders have no preemptive or other rights to subscribe for
additional shares. In the event of our liquidation, dissolution or winding up,
holders of Class A common stock and Class B common stock are entitled to share
ratably in all assets available for distribution to holders of common stock
after payment in full of creditors. No shares of any class of common stock are
subject to a redemption or a sinking fund. All outstanding shares are, and all
shares offered by this prospectus will be, validly issued, fully paid and
nonassessable.
Transfer agent and registrar
American Stock Transfer & Trust Company is our transfer agent and
registrar for the Class A common stock.
Preferred stock
We are authorized to issue 2,000,000 shares of preferred stock. The
Board of Directors is authorized, without any further action by the
stockholders, to determine the voting rights, dividend rights, dividend rates,
liquidation preferences, redemption provisions, sinking fund terms, conversion
or exchange rights and other rights, preferences, privileges and restrictions of
any wholly unissued series of preferred stock and the number of shares
constituting any such series. In addition, shares of preferred stock could have
other rights, including economic rights, senior to the Class A common stock, so
that the issuance of shares of preferred stock could adversely effect the market
value of the Class A common stock. The issuance of preferred stock may also have
the effect of delaying, deferring or preventing a change in control of Wave
Systems.
We have issued and outstanding 360 shares of preferred stock designated
as Series A Cumulative Redeemable Preferred Stock, par value $.01 per share, all
of which is held by one person. The holder of the Series A preferred stock is
entitled to a cumulative annual dividend of $60 per share.
<PAGE>
-43-
Dividends on the Series A preferred stock must be declared and paid prior to any
dividend being declared or paid upon our common stock or any other stock of Wave
Systems ranking junior to, or on a parity with, the Series A preferred stock as
to dividends or liquidation rights. In the event of any liquidation, dissolution
or winding up of Wave Systems, whether voluntary or involuntary, the holder of
the Series A preferred stock is entitled to receive a liquidation preference of
$1,000 per share plus accrued dividends . The Series A preferred stock is
redeemable, in whole or in part, at any time at our option , at a price of
$1,000 per share and is subject to mandatory redemption five years from the date
of issuance. The holder of these shares made demand for redemption as of April
28, 1999. We plan to redeem these shares prior to June 30, 1999.
Certain Provisions of our Restated Certificate of Incorporation and Bylaws
Certain provisions of our Restated Certificate of Incorporation and
Bylaws summarized below may have an anti-takeover effect and may delay, defer or
prevent a tender offer or takeover attempt that a stockholder may consider in
its best interest, including attempts that might result in a premium over the
market price for the shares held by stockholders.
No stockholder action by written consent; special meetings
Our Restated Certificate of Incorporation generally provides that
stockholder action may be taken only at an annual or special meeting of
stockholders and cannot be taken by written consent in lieu of a meeting. Our
Restated Certificate of Incorporation and Bylaws also provide that, subject to
the rights of the holders of any class or series of preferred stock, special
meetings of the stockholders may only be called pursuant to a resolution adopted
by a majority our the board of directors. Stockholders are not permitted to call
a special meeting or to require the board of directors to call a special meeting
of stockholders. Any call for a meeting must specify the matters to be acted
upon at the meeting. Stockholders are not permitted to submit additional matters
or proposals for consideration at any special meeting.
Stockholder proposals
Our Bylaws establish an advance notice procedure for nominations
(other than by or at the direction of our board of directors) of candidates for
election as directors at, and for proposals to be brought before, an annual
meeting of stockholders . Subject to any other applicable requirements, business
may be conducted at an annual meeting only if it has been brought before the
meeting by, or at the direction of, our board of directors or by a stockholder
who has given to the Secretary of Wave Systems timely written notice, in proper
form, of the stockholder's intention to bring that business before the meeting.
In addition, only persons who are nominated by, or at the direction of, our
board of directors, or who are nominated by a stockholder who has given timely
written notice, in proper form, to the Secretary prior to a meeting at which
directors are to be elected, will be eligible for election to our board of
directors .
Amendment of provisions of restated certificate of incorporation
Our Restated Certificate of Incorporation requires the affirmative
vote of the holders of at least 80% of the outstanding shares of our common
stock generally entitled to vote to amend the provisions of the Restated
Certificate of Incorporation and the Bylaws described in the preceding two
paragraphs.
<PAGE>
-44-
Section 203 of the Delaware General Corporation Law
We are subject to Section 203 of the Delaware General Corporation Law,
which generally prohibits a publicly held corporation organized under the laws
of Delaware from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless
- - prior to such date our board of directors approved either the business
combination or the transaction in which the person became an interested
stockholder;
- - upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of our outstanding voting stock, excluding shares owned by
our directors who are also officers of Wave Systems and by certain
employee stock plans; or
- - the business combination is approved by our board of directors and by
the affirmative vote of holders of at least 662/3% of our outstanding
voting stock that is not owned by the interested stockholder. A
"business combination" generally includes mergers, asset sales and
similar transactions between Wave Systems and the interested
stockholder, and other transactions resulting in a financial benefit to
the stockholder. An "interested stockholder" is a person who, together
with affiliates and associates, owns 15% or more of our voting stock or
who is an affiliate or associate of Wave Systems and, together with his
affiliates and associates, has owned 15% or more of our voting stock
within three years.
<PAGE>
-45-
Selling Security Holders
An aggregate of 4,738,703 shares of Class A common stock are being
registered in this offering for the account of the selling stockholders. Of
these shares, 2,090,954 shares were originally issued in a private placement
completed in March 1999. We granted registration rights with respect to these
shares. We agreed to bear expenses, other than fees and expenses of counsel to
the selling stockholders, in connection with the registration and sale of these
shares. See "Plan of Distribution."
The following table sets forth the names of the selling stockholders,
the number of shares of Class A common stock each of the selling stockholders
beneficially owns, the number of shares which may be offered for resale pursuant
to this prospectus, and the number of shares that will be owned by each selling
stockholders after the completion of this offering.
As of March 31, 1999, there were 32,030,921 shares of Class A common
stock outstanding. The shares offered by this prospectus may be offered from
time to time, in whole or in part, by the selling stockholders or their
transferees. No selling stockholders has held any position nor had any material
relationship with us or our affiliates during the past three years, except where
noted.
The information included below is based upon information provided by
the selling stockholders. Because the selling stockholders may offer all, some
or none of their shares, we cannot provide a definitive estimate as to the
number of shares that the selling stockholders will hold after the offering.
Beneficial ownership is calculated in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person, and the percentage ownership of that person,
shares of common stock subject to options held by that person that are currently
exercisable or become exercisable within 60 days following April 30, 1999 are
deemed outstanding. However, these shares are not deemed outstanding for the
purpose of computing the percentage ownership of any other person. Unless
otherwise indicated, the persons and entities named in the table have sole
voting and investment power with respect to all shares beneficially owned,
subject to community property laws where applicable.
<TABLE>
<CAPTION>
Shares Beneficially
Owned After the
Offering
------------------
Shares Beneficially
Owned Prior to Shares Being
Selling Security Holder the Offering Offered Number Percent
<S> <C> <C> <C> <C>
Aladdin Knowledge Systems, Ltd. (1)........................... 2,531,307 1,216,136 1,315,171 4.2%
Carriage Partners LLC (2)..................................... 456,818 456,818 - -
Craig Mudge (3)............................................... 3,093 3,093 - -
Bruce Schneier (4)............................................ 1,031 1,031 - -
Lora Lee Professional Recruiters, Inc. (5).................... 15,000 15,000 - -
Jaffoni & Collins Incorporated (6)............................ 17,500 17,500 - -
William Morris Agency, Inc. (7)............................... 150,000 150,000 - -
Carl A. Artopoeus/Artopoeus Capital Management (8)............ 56,667 56,667 - -
Barry Eskanos (9)............................................. 28,333 28,333 - -
Combination, Inc. (10)........................................ 150,000 150,000 - -
Southeast Interactive Technology Fund, LLC (11)............... 330,671 330,671 - -
Barrant V. Merrill (12)....................................... 3,000 3,000 - -
Balestra Capital Partners LP (12) (13)........................ 655,000 20,000 635,000 2.0
Endeavor Asset Management, LP (12)............................ 15,000 15,000 - -
Clarion Capital Corporation (12) (14)......................... 31,818 31,818 - -
Clarion Offshore Fund Ltd. (12) (14).......................... 13,000 13,000 - -
Clarion Partners, L.P. (12) (14).............................. 46,091 46,091 - -
Fidelity National Title Insurance Company Of New York (12).... 125,000 125,000 - -
</TABLE>
<PAGE>
-46-
<TABLE>
<S> <C> <C> <C> <C>
Bogner Regis, Inc. (12)....................................... 10,000 10,000 - -
Stuart G. Gauld (12).......................................... 11,000 11,000 - -
Cascade Capital Partners, L.P. (12)........................... 165,200 165,200 - -
Job & Co. (12)................................................ 12,800 12,800 - -
Gryphon Offshore Fund (12).................................... 22,000 22,000 - -
Anthony Kamin (12)............................................ 5,000 5,000 - -
Lancaster Investment Partners, L.P. (12)...................... 50,000 50,000 - -
Loy D. Martin (12)............................................ 10,000 10,000 - -
Gary Rosenbach (12)........................................... 65,000 65,000 - -
Gary W. Ross (12)............................................. 9,000 9,000 - -
Trellus Partners, L.P. (12)................................... 100,000 100,000 - -
V/F Skagen Global (12)........................................ 50,000 50,000 - -
The Brooks Revocable Trust, Evan Brooks & Violet Brooks, - -
Trustees (12)............................................... 25,000 25,000
David C. Brown (12)........................................... 100,000 100,000 - -
M. Jay Walkingshaw (12)....................................... 10,000 10,000 - -
Whitney Partners, LP (12)..................................... 150,000 150,000 - -
Huey Lewis SSB Keogh Custodian AKA Hugh Cregg (12)............ 3,500 3,500 - -
Cregg Conroy Revocable Trust, Hugh Cregg and - -
Sidney Conroy, Trustees (12)................................ 500 500
Security Trust Co FBO: Paul Dragul, MD (12) (15)............. 15,000 13,000 2,000 *
Security Trust Co FBO: J. Glen McLeod (12) (16).............. 10,000 7,000 3,000 *
Todd Kenck (12) (17).......................................... 2,000 2,000 - -
K.C. Stone (12) (17).......................................... 3,000 3,000 - -
John C. Coleman, Jr. (12) (17)................................ 10,000 10,000 - -
Donald Padou (12) (17)........................................ 10,000 10,000 - -
Richard H. Osgood (12) (17)................................... 10,000 10,000 - -
Stephen J. Massocca (12) (17)................................. 70,000 70,000 - -
Stephen Olson (12) (17)....................................... 3,500 3,500 - -
Apodaca Investment Group (12) (18)............................ 50,000 50,000 - -
Special Situations Private Equity Fund, LP (12)............... 50,000 50,000 - -
Commerzbank AG (12)........................................... 454,545 454,545 - -
Marcuard Cook & Cie S.A. (12)................................. 50,000 50,000 - -
Paul Burrowes (12)............................................ 25,000 25,000 - -
Security Trend Partners (12).................................. 25,000 25,000 - -
Veritas SG Investment Trust GMBH (12)......................... 100,000 100,000 - -
Gruber & Mcbaine International (12)........................... 11,000 11,000 - -
Jon D. Gruber (12)............................................ 6,500 6,500 - -
Donaghy Inc. (12)............................................. 2,000 2,000 - -
Hare & Co. for Trustees of Hamilton College (12).............. 2,000 2,000 - -
Karl Matthies & Deborah Matthies Community Properties (12).... 1,500 1,500 - -
Lagunitas Partners, LP (12)................................... 27,000 27,000 - -
Edgar L. Ball (12)............................................ 20,000 20,000 - -
Thomas J. Niedermeyer, Jr. (12)............................... 5,000 5,000 - -
Hollis Capital (12)........................................... 50,000 50,000 - -
Porter Partners, LP (12)...................................... 30,000 30,000 - -
Internet Technology Group PLC (19)........................... 200,000 200,000 - -
Weeden Brothers (20) 22,500 22,500 - -
TOTAL.................................................... 6,693,874 4,738,703 1,955,171
</TABLE>
- --------------
* less than 1%
(1) Includes shares held and (i) 1,216,136 shares issuable, at an exercise
price of $1.70 per share, upon exercise of a warrant issued to Aladdin
on July 18, 1997 in connection with a technology license agreement; and
(ii) shares issuable upon exercise of a warrant granted to Aladdin on
July 18, 1997 in connection with a technology license agreement. The
second warrant provides Aladdin with the right to acquire 7% of the
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
<PAGE>
-47-
purchase 1,000,000 shares and still has the right to acquire shares
approximating 3.45% of the Class A common stock. During the third
quarter of 1997, we entered into a license agreement with 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, we are prohibited from
using any other encryption technology for the first five years of the
license.
(2) Includes (i) 181,818 shares held and (ii) 275,000 shares issued upon
exercise of a warrant sold to Carriage Partners, LLC as full payment
for a $2,000,000 promissory note.
(3) Includes 3,093 shares issued to Dr Mudge as partial payment for
consulting services rendered during 1998, the balance of which was paid
in cash.
(4) Includes 1,031 shares issued to Mr. Schneier as partial payment for
consulting services rendered during 1998, the balance of which was paid
in cash.
(5) Includes 15,000 shares issued to Lora Lee Professional Recruiters, Inc.
as payment for professional placement and consulting services rendered
during 1998.
(6) Includes 17,500 shares issued to Jaffoni & Collins Incorporated as
payment for investor relations and consulting services rendered during
1998.
(7) Includes 150,000 shares issued to William Morris Agency, Inc. as
payment for investor relations and consulting services rendered during
1998.
(8) Includes 56,667 shares issued to Carl A. Artopoeus and Artopoeus
Capital Management as payment on January 25, 1999 for a legal
settlement.
(9) Includes 28,333 shares issued to Barry Eskanos as payment on January
25, 1999 for a legal settlement.
(10) Includes 150,000 shares issued upon exercise of warrants at $1.38 per
share, granted to Combination, Inc., associated with the placement of
our Series G Preferred Stock on March 6, 1998.
(11) Includes 278,947 shares issued upon conversion of a warrant issued on
October 18, 1998 to Southeast Interactive Technology Fund, LLC pursuant
to a convertible note.
(12) These selling stockholders received all of these shares (except where
otherwise indicated) from a private sale of a total of 2,090,954 shares
on March 30, 1999, at a price of $11.00 per share, for the aggregate
purchase price of $23,000,494. These shares were sold to a group of
accredited investors pursuant to Regulation D promulgated under the
Act.
(13) Of the 655,000 shares reported, Balestra Capital Partners LP
beneficially owns 60,000 shares, including 20,000 shares purchased in
the offering referenced in note 13 above. Also includes 595,000 shares
over which Balestra Capital Partners LP has investment power.
(14) Morton A. Cohen has sole voting and investment power for each of
Clarion Capital Corporation, Clarion Offshore Fund Ltd. and Clarion
Partners, L.P. Mr. Cohen is Chairman of Clarion Capital Corporation and
the investment manager for Clarion Offshore Fund Ltd. and Clarion
Partners, L.P.
(15) Of the 15,000 shares reported, Dr. Dragul acquired 13,000 shares in the
offering referenced in note 12 above.
(16) Of the 10,000 shares reported, Mr. McLeod acquired 7,000 shares in the
offering referenced in note 12 above.
<PAGE>
-48-
(17) Each of Todd Kenck, K.C. Stone, John C. Coleman, Jr., Donald Padou,
Richard H. Osgood, Stephen J. Massocca and Stephen Olson are affiliates
of Pacific Growth Equities, Inc., which acted as placement agent for
the private placement referenced in note 12 above.
(18) Of the 50,000 shares reported, 28,000 shares are beneficially owned by
Apodaca Investment Partners and 22,000 shares are beneficially owned by
Apodaca Investment Offshore.
(19) Includes 200,000 shares issued upon the exercise of a warrant issued to
Internet Technology Group PLC at an exercise price of $1.75 per share
in connection with the formation of a joint venture to promote and
commercialize the Wave technology in certain European and Middle
Eastern markets.
(20) Includes 22,500 shares issued upon the exercise of a warrant issued to
Weeden Brothers in connection with a private placement transaction in
1994.
Plan Of Distribution
We are registering the shares of Class A common stock offered in this
prospectus on behalf of the selling stockholders. As used in this prospectus,
the term selling stockholder includes pledgees, donees, transferees or other
successors-in-interest selling shares received from a selling stockholder as a
gift, partnership or liquidating distribution or other non-sale related transfer
after the date of this prospectus. We will pay all expenses of registration of
the shares offered, except for taxes or underwriting fees, discounts, selling
commissions and legal fees of selling stockholders. Each selling stockholder
will pay any brokerage commissions and similar selling expenses attributable to
the sale of the shares. We will not receive any of the proceeds from the sale of
the shares by the selling stockholder.
The selling stockholders may sell the shares from time to time in one
or more types of transactions, including block transactions, on one or more
exchanges, in the over-the-counter market, in negotiated transactions, through
put or call options transactions relating to the shares, through short sales of
the shares, or a combination of these methods of sale. The selling stockholders
may sell their shares at market prices prevailing at the time of sale, or at
negotiated prices.
The selling stockholders may use brokers or dealers to sell their
shares. As of the date of this prospectus, we have not been advised by any
selling stockholders that he, she or it has made any arrangements as to the
distribution of shares covered by this prospectus.
The selling stockholders may sell their shares directly to purchasers
or to or through broker-dealers, which may act as agents or principals. These
broker- dealers may receive compensation in the form of discounts, concessions
or commissions from the selling stockholders and/or the purchasers of shares for
whom broker-dealers may act as agents or to whom they sell as principal, or
both. Compensation as to a particular broker-dealer might be in excess of
customary commissions.
The selling stockholders and any broker-dealers that act in connection
with the sale of the shares might be deemed to be "underwriters" as the term is
defined in Section 2(11) of the Securities Act of 1933. Consequently, any
commissions received by these broker-dealers and any profit on the resale of the
shares sold by them while acting as principals might be deemed to be
underwriting discounts or commissions under the Securities Act of 1933.
Because the selling stockholders may be deemed to be "underwriters" as
defined in Section 2(11) of the Securities Act of 1933, the selling stockholders
will be subject to the prospectus delivery requirements of the Securities Act of
1933, as amended.
<PAGE>
-49-
A selling stockholders also may resell all or a portion of the shares
in open market transactions in reliance upon Rule 144 under the Securities Act
of 1933, provided that he, she or it meets the criteria and conforms to the
requirements of that Rule.
Upon being notified by a selling stockholders that he, she or it has
entered into any material arrangement with a broker-dealer for the sale of the
shares through a block trade, special offering, exchange distribution or
secondary distribution or a purchase by a broker or dealer, we will file a
supplement to this prospectus, if required, pursuant to Rule 424(b) under the
Securities Act of 1933, regarding the plan of distribution.
We have agreed to indemnify certain of the selling stockholders against
certain liabilities, including liabilities arising under the Securities Act of
1933, or to contribute to payments which these selling stockholders may be
required to make in respect hereof. These selling stockholders have agreed to
indemnify us against certain liabilities, including liabilities arising under
the Securities Act of 1933, as amended.
Legal Matters
The validity of the securities offered hereby will be passed upon for Wave
Systems by Bingham Dana LLP, New York, New York.
Experts
The consolidated financial statements of Wave Systems Corp. and
Subsidiaries (a development stage corporation) as of December 31, 1998 and
1997, and for each of the years in the three-year period ended December 31,
1998 included herein and elsewhere in the Registration Statement have been
included herein and in the registration statement in reliance upon the report
of KPMG LLP, independent certified public accountants, appearing elsewhere
herein upon the authority of said firm as experts in accounting and auditing.
<PAGE>
F-1
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Page(s)
-------
<S> <C>
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
and March 31, 1999 (unaudited)
Consolidated Statements of Operations for each of the years ended F-4
December 31, 1998, 1997 and 1996 and for the period from February 12, 1988
(inception) through March 31, 1999 (unaudited), and for the three
months ended March 31, 1999 (unaudited) and 1998 (unaudited)
Consolidated Statements of Stockholders' Equity (Deficiency) for each of the F-5
years ended December 31, 1998, 1997 and 1996 and for the period from February
12, 1988 (inception) through March 31, 1999 (unaudited)
Consolidated Statements of Cash Flows for each of the years ended F-10
December 31, 1998, 1997 and 1996 and for the period from February 12, 1988
(inception) through March 31, 1999 (unaudited) , and for the three
months ended March 31, 1999 (unaudited) and 1998 (unaudited)
Notes to Consolidated Financial Statements F-13
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited the consolidated financial statements of Wave Systems Corp. and
subsidiaries (a development stage corporation) as listed in the accompanying
index and the consolidated statements of operations and cash flows for the
period from February 12, 1988 (date of inception) through December 31, 1998
(not included herein). These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Wave
Systems Corp. and subsidiaries as of December 31, 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.
KPMG LLP
Boston, Massachusetts
March 26, 1999
<PAGE>
F-3
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31
Assets March 31, ----------------------------
1999 1998 1997
------------- ------------ -------------
Current assets: (unaudited)
<S> <C> <C> <C>
Cash and cash equivalents $ 21,354,954 $ 1,057,094 $ 758,721
Prepaid expenses and other receivables 151,463 5,000 --
------------ ------------ ------------
Total current assets 21,506,417 1,062,094 758,721
Property and equipment, net 1,106,048 888,261 849,276
Other assets 107,457 107,457 70,216
------------ ------------ ------------
22,719,922 2,057,812 1,678,213
------------ ------------ ------------
------------ ------------ ------------
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Accounts payable and accrued expenses 2,058,287 3,029,158 1,427,762
Deferred license fee 625,000 1,250,000 --
Note payable 576,146 561,831 522,124
------------ ------------ ------------
Total current liabilities 3,259,433 4,840,989 1,949,886
------------ ------------ ------------
Series A Cumulative Redeemable Preferred Stock, $.01 par value
360 shares issued and outstanding in 1998 and 1997; involuntary
liquidation value, $498,601 498,601 493,201 471,601
------------ ------------ ------------
Stockholders' Equity (deficiency):
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 32,030,921 in March 31, 1999, 28,402,149 in 1998 and
22,874,639 in 1997 320,309 284,022 228,747
Common stock, $.01 par value. Authorized 13,000,000 shares as Class B; issued
and outstanding 2,545,932 in March 31, 1999, 3,140,665 in 1998 and 4,421,953
in 1997 25,460 31,407 44,220
Capital in excess of par value 79,660,983 53,430,130 44,520,246
Deficit accumulated during the development stage (60,894,318) (57,220,407) (45,324,463)
Less: Note receivable from stockholder, including accrued interest
of $102,371 in March 31, 1999, $101,167 in 1998 and $88,849 in 1997 (150,546) (149,342) (212,024)
------------ ------------ ------------
Total stockholders' deficiency 18,961,888 (3,276,378) (743,274)
------------ ------------ ------------
Commitments and contingencies $ 22,719,922 $ 2,057,812 $ 1,678,213
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Three months ended, March 31 Year Ended December 31
---------------------------- --------------------------------------------
1999 1998 1998 1997 1996
------------ ------------ ------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
Net revenue $ 2,398 $ 8,613 $ 10,193 $ 10,712 $ 1,458
------------ ------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 2,401,046 1,420,875 9,874,166 7,983,151 5,560,620
Write-off of goodwill -- -- -- 769,886 --
Aladdin license and in process
research and development expense -- -- -- 3,889,000 --
Research and development 1,086,410 538,821 3,508,968 2,146,127 3,309,022
------------ ------------ ------------ ------------ ------------
3,487,456 1,959,696 13,383,134 14,788,164 8,869,642
------------ ------------ ------------ ------------ ------------
Other income (expense):
License fee 625,000 -- 2,750,000 1,000,000 --
License warrant cost -- -- (1,100,000) -- --
Interest income 16,612 5,215 111,009 55,282 194,766
Interest expense (830,465) (11,400) (284,012) (175,624) (10,397)
Other Income -- -- -- -- --
------------ ------------ ------------ ------------ ------------
(188,853) (6,185) 1,476,997 879,658 184,369
------------ ------------ ------------ ------------ ------------
Net loss (3,673,911) (1,957,268) (11,895,944) (13,897,794) (8,683,815)
Accrued dividends on preferred stock (including
accretion of assured incremental yield on
preferred stock of $0 in 1999, $750,000 in 1998,
$1,673,000 in 1997 and $620,965 in 1996, and
$3,093,965 since inception) 5,400 137,792 858,863 2,482,982 870,579
------------ ------------ ------------ ------------ ------------
Net loss to common stockholders $ (3,679,311) $ (2,095,060) $(12,754,807) $(16,380,776) $ (9,554,394)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Weighted average number of common
shares outstanding during the period 32,148,271 27,358,558 29,299,844 20,943,748 14,956,584
Loss per common share $ (.11) $ (.08) $ (.44) $ (.78) $ (.64)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
Period from February 12, 1988
(date of inception) through
March 31,1999
-----------------------------
(unaudited)
<S> <C>
Net revenue $ 24,761
------------
Operating expenses:
Selling, general and administrative 39,711,718
Write-off of goodwill 769,886
Aladdin license and in process
research and development expense 3,889,000
Research and development 19,341,191
------------
63,711,795
------------
Other income (expense):
License fee 4,375,000
License warrant cost (1,100,000)
Interest income 1,185,953
Interest expense (1,680,957)
Other Income 12,720
------------
2,792,716
Net loss (60,894,318)
Accrued dividends on preferred stock (including
accretion of assured incremental yield on
preferred stock of $0 in 1999, $750,000 in 1998,
$1,673,000 in 1997 and $620,965 in 1996, and
$3,093,965 since inception) 4,342,758
------------
Net loss to common stockholders $(65,237,076)
------------
------------
Weighted average number of common
shares outstanding during the period 12,024,013
Loss per common share $ (5.43)
------------
------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-5
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency)
Period from February 12, 1988 (date of inception) to March 31, 1999
<TABLE>
<CAPTION>
Deficit
accumulated
Class A Class B Capital during the
common stock common stock in excess of development
Shares Amount Shares Amount Par Value Stage
------ ------ ------ ------ --------- -----
<S> <C> <C> <C> <C> <C> <C>
Shares issued to founders at $.003 per share -- $- 4,680,000 $ 46,800 $ (31,200) $ --
Shares issued at $1.25 per share, net of expenses of
$36,574 from September through November 1988 -- -- 300,000 3,000 335,426 --
Net loss for period ended December 31, 1988 -- -- -- -- -- (326,832)
-------- ---- ----------- ----------- ----------- -----------
Balance at December 31, 1988 -- -- 4,980,000 49,800 304,226 (326,832)
Shares issued at $1.25 per share, net of expenses of
$68,750, from January through December 1989 -- -- 270,000 2,700 266,050 --
Shares issued at $1.25 per share in July 1989 as
compensation for services rendered -- -- 1,920 19 2,381
Shares issued by principal stockholders at $1.25
per share in December 1989 as compensation
for services rendered -- -- -- -- 374,000 --
Net loss for year ended December 31, 1989 -- -- -- -- -- (982,186)
-------- ---- ----------- ----------- ----------- -----------
Balance at December 31, 1989 -- -- 5,251,920 52,519 946,657 (1,309,018)
Shares issued by principal stockholder at $1.25
per share in March 1990 as compensation for
services rendered -- -- -- -- 56,250 --
Shares issued by principal stockholder at $.50 per
share in March 1990 as compensation for
services rendered -- -- -- -- 60,000 --
Shares issued at $1.67 per share in May 1990 as
compensation for services rendered -- -- 6,000 60 9,940
Shares issued at $1.67 per share, net of expenses of
$5,000 in March, April, November and December 1990 -- -- 390,000 3,900 641,100 --
Net loss for year ended December 31, 1990 -- -- -- -- -- (1,178,129)
-------- ---- ----------- ----------- ----------- -----------
Balance at December 31, 1990 -- -- 5,647,920 56,479 1,713,947 (2,487,147)
Shares issued at $1.67 per share from March
through November 1991 -- -- 315,000 3,150 521,850 --
Shares issued at $1.67 per share in November
1991 as compensation for services rendered -- -- 19,800 198 32,802 --
Net loss for year ended December 31, 1991 -- -- -- -- -- (1,009,368)
-------- ---- ----------- ----------- ----------- -----------
Balance at December 31, 1991 (carried forward) -- -- 5,982,720 59,827 2,268,599 (3,496,515)
</TABLE>
<TABLE>
<CAPTION>
Note
receivable
Deferred from
Compensation Stockholder Total
------------ ----------- -----
<S> <C> <C> <C>
Shares issued to founders at $.003 per share $ -- $ -- $ 15,600
Shares issued at $1.25 per share, net of expenses of
$36,574 from September through November 1988 -- -- 338,426
Net loss for period ended December 31, 1988 -- -- (326,832)
------------ ----------- -----------
Balance at December 31, 1988 -- -- 27,194
Shares issued at $1.25 per share, net of expenses of
$68,750, from January through December 1989 -- -- 268,750
Shares issued at $1.25 per share in July 1989 as
compensation for services rendered -- -- 2,400
Shares issued by principal stockholders at $1.25
per share in December 1989 as compensation
for services rendered -- -- 374,000
Net loss for year ended December 31, 1989 -- -- (982,186)
------------ ----------- -----------
Balance at December 31, 1989 -- -- (309,842)
Shares issued by principal stockholder at $1.25
per share in March 1990 as compensation for
services rendered -- -- 56,250
Shares issued by principal stockholder at
share in March 1990 as compensation for
services rendered -- -- 60,000
Shares issued at $1.67 per share in May 1990 as
compensation for services rendered -- -- 10,000
Shares issued at $1.67 per share, net of expenses of
$5,000 in March, April, November and December 1990 -- -- 645,000
Net loss for year ended December 31, 1990 -- -- (1,178,129)
------------ ----------- -----------
Balance at December 31, 1990 -- -- (716,721)
Shares issued at $1.67 per share from March
through November 1991 -- -- 525,000
Shares issued at $1.67 per share in November
1991 as compensation for services rendered -- -- 33,000
Net loss for year ended December 31, 1991 -- -- (1,009,368)
------------ ----------- -----------
Balance at December 31, 1991 (carried forward) -- -- (1,168,089)
</TABLE>
<PAGE>
F-6
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
<TABLE>
<CAPTION>
Deficit
accumulated
Class A Class B Capital during the
common stock common stock in excess of development
Shares Amount Shares Amount Par Value Stage
------ ------ ------ ------ --------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1991 (brought forward) -- -- 5,982,720 59,827 2,268,599 (3,496,515)
Shares issued at $1.67 per share from January through
October 1992 -- -- 708,000 7,080 1,172,920 --
Shares issued at $1.67 per share in May 1992 in connection
with License and Cross-License Agreement -- -- 674,976 6,750 1,118,210 --
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered -- -- 18,000 180 29,820 --
Shares issued at $2.50 per share in May and November
1992 as compensation for services rendered -- -- 771,000 7,710 1,919,790 --
Shares issued at $2.50 per share, net of expenses
of $7,500, in November and December 1992 -- -- 323,001 3,230 796,773 --
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered -- -- -- -- 75,000
Shares canceled in October and December 1992 -- -- (75,000) (750) 750 --
Issuance of stock options at $.003 exercise price
per share in June 1992 -- -- -- -- 798,400 --
Amortization of deferred compensation -- -- -- -- -- --
Accrued dividends on preferred stock -- -- -- -- (6,383)
Note received from stockholder and accrual of
interest thereon -- -- -- -- -- --
Net loss for year ended December 31, 1992 -- -- -- -- -- (4,182,638)
------ ------ ------ ---------- --------- -----------
Balance at December 31, 1992 (carried forward) -- -- 8,402,697 84,027 8,173,879 (7,679,153)
</TABLE>
<TABLE>
<CAPTION>
Note
receivable
Deferred from
Compensation Stockholder Total
------------ ----------- -----
<S> <C> <C> <C>
Balance at December 31, 1991 (brought forward) -- -- (1,168,089)
Shares issued at $1.67 per share from January through
October 1992 -- -- 1,180,000
Shares issued at $1.67 per share in May 1992 in connection
with License and Cross-License Agreement -- -- 1,124,960
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered -- -- 30,000
Shares issued at $2.50 per share in May and November
1992 as compensation for services rendered -- -- 1,927,500
Shares issued at $2.50 per share, net of expenses
of $7,500, in November and December 1992 -- -- 800,003
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered -- -- 75,000
Shares canceled in October and December 1992 -- -- --
Issuance of stock options at $.003 exercise price
per share in June 1992 (398,660) -- 399,740
Amortization of deferred compensation 155,455 -- 155,455
Accrued dividends on preferred stock -- -- (6,383)
Note received from stockholder and accrual of
interest thereon -- (152,974) (152,974)
Net loss for year ended December 31, 1992 -- -- (4,182,638)
---------- ---------- ----------
Balance at December 31, 1992 (carried forward) (243,205) (152,974) 182,574
</TABLE>
<PAGE>
F-7
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (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) 182,574
Shares issued at $1.67 per share in February 1993 -- -- -- 50,100
Shares issued at $3.50 per share, net of expenses of
$82,427, from April through December 1993 -- -- -- 1,843,798
Shares issued at $3.50 per share from May to December
1993 as compensation for services rendered, for the
acquisition of property and equipment and as additional
interest on borrowings -- -- -- 256,617
Issuance of warrants to purchase Class B common stock
from September to December 1993 in conjunction with
the issuance of convertible debt -- -- -- 72,893
Amortization of deferred compensation -- 243,205 -- 243,205
Accrued dividends on preferred stock -- -- -- (38,467)
Note received from stockholder and accrual of
interest thereon -- -- (39,783) (39,783)
Net loss for year ended December 31, 1993 (3,959,334) -- -- (3,959,334)
----------- ----------- ----------- -----------
Balance at December 31, 1993 (11,638,487) -- (192,757) (1,388,397)
Shares issued at $3.50 per share in January and
February 1994 -- -- -- 335,003
Shares issued at $3.50 per share in February 1994
as additional interest on borrowings -- -- -- 19,950
Issuance of warrants to purchase Class B common stock
in January and February 1994 in conjunction with
the issuance of convertible debt -- -- -- 115,234
Accrued dividends on preferred stock -- -- -- (39,484)
Accrual of interest on note receivable from stockholder -- -- (17,315) (17,315)
Sale of warrants to underwriter in September 1994 -- -- -- 4
Conversion of notes payable -- -- -- 2,085,126
Shares issued at $5.00 per share in initial public offering
in September 1994, net of expenses of $2,929,835 -- -- -- 15,711,165
Net loss for year ended December 31, 1994 (4,271,501) -- -- (4,271,501)
----------- ----------- ----------- -----------
Balance at December 31, 1994 (carried forward) (15,909,988) -- (210,072) 12,549,785
</TABLE>
<PAGE>
F-8
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (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) --
Net loss for the year ended December 31, 1996 -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 11,582,086 115,821 6,208,141 62,081 33,052,432
------------ ------------ ------------ ------------ ------------
Exercise of options to purchase Class A and B common stock 70,326 703 10,330 104 139,081
Shares issued at prices ranging from $1.00 per share
to $3.00 per share as compensation for services
rendered 126,885 1,269 -- -- 304,227
Conversion of preferred stock into common stock 7,998,860 79,989 -- -- 6,703,028
Issuance of Class A common stock and warrants to
purchase Class A common stock to Aladdin 500,000 5,000 -- -- 3,834,000
Issuance of Class A common stock and warrants to
purchase Class A common stock 799,964 8,000 -- -- 792,000
Reduction in note receivable -- -- -- -- --
Accrual of interest on note receivable -- -- -- -- --
Issuance of warrants to purchase Class A common stock
in conjunction with the issuance of preferred stock -- -- -- -- 386,462
Accrued dividend on preferred stock including accretion
of assured incremental yield -- -- -- -- (1,372,984)
Assured incremental yield on issuance of Series F
convertible preferred stock and debt -- -- -- -- 682,000
Net loss -- -- -- -- --
Exchange of Class B stock for Class A stock 1,796,518 17,965 (1,796,518) (17,965) --
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 (carried forward) 22,874,639 $ 228,747 4,421,953 $ 44,220 $ 44,520,246
</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) 12,549,785
Shares issued at prices ranging from $1.00 per share to
$3.13 per share as compensation for services rendered -- -- -- 57,499
Exercise of options to purchase Class B stock -- -- -- 436,230
Accrued dividends on preferred stock -- -- -- (40,600)
Accrual of interest on note receivable from stockholder -- -- (17,318) (17,318)
Exchange of Class B stock for Class A stock -- -- -- --
Net loss for the year ended December 31, 1995 (6,832,866) -- -- (6,832,866)
------------ --- ------------ ------------
Balance at December 31, 1995 (22,742,854) -- (227,390) 6,152,730
Exercise of options to purchase Class A stock -- -- -- 422,507
Shares issued at prices ranging from $2.06 per share to
$3.44 per share as compensation for services rendered -- -- -- 123,450
Issuance of unregistered Class B common stock to acquire
Wave Interactive Network valued at approximately
$.98 per share -- -- -- 368,438
Issuance of warrants to purchase unregistered shares of
Class A common stock in conjunction with the issuance
of convertible debt and preferred stock -- -- 283,455 --
Conversion of Class B Preferred Stock -- -- -- 3,108,524
Accrual of interest on note receivable -- -- (17,315) (17,315)
Accrued dividends on preferred stock -- -- -- (199,014)
Exchange of Class B stock for Class A stock -- -- -- --
Net loss for the year ended December 31, 1996 (8,683,815) -- -- (8,683,815)
------------ --- ------------ ------------
Balance at December 31, 1996 (31,426,669) -- (244,705) 1,558,960
------------ --- ------------ ------------
Exercise of options to purchase Class A and B common stock -- -- -- 139,888
Shares issued at prices ranging from $1.00 per share
to $3.00 per share as compensation for services
rendered -- -- -- 305,496
Conversion of preferred stock into common stock -- -- -- 6,783,017
Issuance of Class A common stock and warrants to
purchase Class A common stock to Aladdin -- -- -- 3,839,000
Issuance of Class A common stock and warrants to
purchase Class A common stock -- -- -- 800,000
Reduction in note receivable -- -- 50,000 50,000
Accrual of interest on note receivable -- -- (17,319) (17,319)
Issuance of warrants to purchase Class A common stock
in conjunction with the issuance of preferred stock -- -- -- 386,462
Accrued dividend on preferred stock including accretion
of assured incremental yield -- -- -- (1,372,984)
Assured incremental yield on issuance of Series F
convertible preferred stock and debt -- -- -- 682,000
Net loss (13,897,794) -- -- (13,897,794)
Exchange of Class B stock for Class A stock -- -- -- --
------------ --- ------------ ------------
Balance at December 31, 1997 (carried forward) $(45,324,463) $-- $ (212,024) $ (743,274)
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-9
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (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 (brought forward) 22,874,639 $228,747 4,421,953 $ 44,220 $ 44,520,246
---------- -------- ---------- -------- ------------
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
Net loss -- -- -- -- --
Exchange of Class B stock for Class A stock 1,281,288 12,813 (1,281,288) (12,813) --
---------- -------- ---------- -------- ------------
Balance at December 31, 1998 (carried forward) 28,402,149 $284,022 3,140,665 $ 31,407 $ 53,430,130
---------- -------- ---------- -------- ------------
---------- -------- ---------- -------- ------------
</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 (brought forward) $(45,324,463) -- $(212,024) $ (743,274)
------------ ----------- --------- ------------
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 $222,500 -- 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 (11,895,944) -- -- (11,895,944)
Exchange of Class B stock for Class A stock -- -- -- --
------------ ----------- --------- ------------
Balance at December 31, 1998 (carried forward) $(57,220,407) $ 347,812 $(149,342) $ (3,276,378)
------------ ----------- --------- ------------
------------ ----------- --------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-10
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (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, 1998 (brought forward) 28,402,149 $284,022 3,140,665 $ 31,407 $ 53,430,130
---------- -------- --------- -------- ------------
Exercise of options to purchase Class A
common stock (unaudited) 193,400 1,934 -- -- 467,530
Shares issued at $11.00 per share,
net of expenses (unaudited) 2,304,023 23,041 -- -- 23,679,978
Exercise of warrants to purchase Class A
common stock (unaudited) 145,679 1,456 -- -- 535,482
Warrants to purchase Class A common stock
to be issued to consultants for services (unaudited) -- -- -- -- 1,075,240
Shares issued at prices ranging from $5.00 per share
to $15.00 per share as compensation for services
rendered (unaudited) 13,835 138 -- -- 133,982
Accrual of interest on note receivable (unaudited) -- -- -- -- --
Accrued dividend on preferred stock (unaudited) -- -- -- -- (5,400)
Conversion of Series G Preferred Stock (unaudited) 377,102 3,771 -- -- 344,041
Net loss (unaudited) -- -- -- -- --
Exchange of Class B stock for Class A stock (unaudited) 594,733 5,947 (594,733) (5,947) --
---------- -------- --------- -------- ------------
Balance at March 31, 1999 (unaudited) 32,030,921 $320,309 2,545,932 $ 25,460 $ 79,660,983
---------- -------- --------- -------- ------------
---------- -------- --------- -------- ------------
</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, 1998 (brought forward) $(57,220,407) $ 347,812 $(149,342) $ (3,276,378)
------------ --------- --------- ------------
Exercise of options to purchase Class A
common stock (unaudited) -- -- -- 469,464
Shares issued at $11.00 per share,
net of expenses (unaudited) -- -- -- 23,703,019
Exercise of warrants to purchase Class A
common stock (unaudited) -- -- -- 536,938
Warrants to purchase Class A common stock
to be issued to consultants for services (unaudited) -- -- -- 1,075,240
Shares issued at prices ranging from $5.00 per share
to $15.00 per share as compensation for services
rendered (unaudited) -- -- -- 134,120
Accrual of interest on note receivable (unaudited) -- -- (1,204) (1,204)
Accrued dividend on preferred stock (unaudited) -- -- -- (5,400)
Conversion of Series G Preferred Stock (unaudited) -- (347,812) -- --
Net loss (unaudited) (3,673,911) -- -- (3,673,911)
Exchange of Class B stock for Class A stock (unaudited) -- -- -- --
------------ --------- --------- ------------
Balance at March 31, 1999 (unaudited) $(60,894,318) $ -- $(150,546) $ 18,961,888
------------ --------- --------- ------------
------------ --------- --------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-11
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Three months ended,
March 31
-------------------------
1999 1998 1998
---------- ---------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(3,673,911) $(1,957,268) $(11,895,944)
Adjustments to reconcile net loss to net cash used in
operating activities:
Write-off of goodwill -- -- --
Depreciation and amortization 87,869 82,547 332,741
Reserve for note from affiliate -- -- --
Accrued interest on marketable securities -- -- --
Noncash expenses:
Accretion of assured incremental yield on
convertible debt -- -- --
Common stock issued in connection with
License and Cross-License Agreement -- -- --
Common stock issued for services rendered
and additional interest on borrowings 134,120 15,000 648,488
Warrants to be issued to ITG and warrants
issued as compensation for services 1,075,240 -- 1,546,824
Issuance of warrants to Aladdin -- -- --
Accrued interest on note payable 14,315 11,400 39,707
Preferred stock issued for services rendered -- -- --
Compensation associated with issuance of
stock options -- -- 234,723
Amortization of deferred compensation -- -- --
Amortization of discount on notes payable -- -- --
Common stock issued by principal stockholder
for services rendered -- -- --
Changes in assets and liabilities:
Increase (decrease) in deferred revenue (625,000) 797,025 1,250,000
Increase in accrued interest on note receivable (1,204) -- (12,318)
(Increase) decrease in prepaid expenses and
other receivables (146,463) -- (5,000)
(Increase) decrease in other assets -- (2,833) (37,241)
(Decrease) increase in accounts payable and
accrued expenses (970,871) (126,784) 1,601,396
---------- ---------- -------------
Net cash used in operating activities (4,105,905) (1,180,913) (6,296,624)
---------- ---------- -------------
</TABLE>
<TABLE>
<CAPTION>
Period from February 12, 1988
date of inception) through
1997 1996 March 31,1999
------------ ----------- ------------------------------
(unaudited)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(13,897,794) $(8,683,815) $(60,894,318)
Adjustments to reconcile net loss to net cash used in
operating activities:
Write-off of goodwill 769,886 -- 769,886
Depreciation and amortization 486,693 316,829 1,607,978
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 305,496 40,938 3,459,666
Warrants to be issued to ITG and warrants
issued as compensation for services -- -- 2,622,064
Issuance of warrants to Aladdin 2,939,000 -- 2,939,000
Accrued interest on note payable 56,624 9,500 120,146
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 (decrease) in deferred revenue -- -- 625,000
Increase in accrued interest on note receivable (17,319) (17,315) (102,372)
(Increase) decrease in prepaid expenses and
other receivables 70,358 64,413 (151,463)
(Increase) decrease in other assets 184,771 (53,346) (122,373)
(Decrease) increase in accounts payable and
accrued expenses 490,599 (191,103) 2,195,799
------------ ----------- ------------
Net cash used in operating activities (8,492,686) (7,460,348) (42,090,829)
------------ ----------- ------------
</TABLE>
<PAGE>
F-12
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
Three months ended,
March 31
--------------------------
1999 1998 1998
----------- ----------- ----------
(unaudited) (unaudited)
<S> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (305,656) (87,400) (371,726)
Short-term loans to affiliate -- -- --
Organizational costs -- -- --
Purchase of marketable securities-held to maturity -- -- --
Maturity of marketable securities-held to maturity -- -- --
Net cash provided by (used in) investing activities (305,656) (87,400) (371,726)
------------ ----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 22,709,421 -- 4,114,223
Net proceeds from issuance of preferred stock
and warrants -- 2,777,500 2,777,500
Sale of warrants -- -- --
Note receivable from stockholder -- -- 75,000
Proceeds from notes payable and warrants to
stockholders 2,000,000 -- --
Repayments of notes payable to stockholders -- -- --
Proceeds from notes payable and warrants -- -- --
Repayments of note payable -- -- --
Advances from stockholder -- -- --
Repayments of advances from stockholder -- -- --
Increase in deferred offering costs -- -- --
------------ ----------- -----------
Net cash provided by financing activities 24,709,421 2,777,500 6,966,723
------------ ----------- -----------
Net increase (decrease) in cash and cash equivalents 20,297,860 1,509,187 298,373
Cash and cash equivalents at beginning of period 1,057,094 758,721 758,721
------------ ----------- -----------
Cash and cash equivalents at end of period $ 21,354,954 $ 2,267,908 $ 1,057,094
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
Period from February 12, 1988
(date of inception) through
1997 1996 March 31,1999
-------- --------- ------------------------
(unaudited)
<S> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (256,306) (252,439) (2,484,500)
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 (305,656) 2,640,210 (4,065,438)
------------ ----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,837,889 422,507 51,233,115
Net proceeds from issuance of preferred stock
and warrants 3,555,500 5,950,027 12,283,027
Sale of warrants -- -- 4
Note receivable from stockholder 50,000 -- (48,175)
Proceeds from notes payable and warrants to
stockholders -- -- 4,083,972
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 5,443,389 6,372,534 67,511,221
------------ ----------- -----------
Net increase (decrease) in cash and cash equivalents (3,305,603) 1,552,396 21,354,954
Cash and cash equivalents at beginning of period 4,064,324 2,511,928 --
------------ ----------- -----------
Cash and cash equivalents at end of period $ 758,721 $ 4,064,324 $ 21,354,954
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
F-13
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements
December 31, 1998, 1997, 1996 and The Period From February 12, 1988
(Date of Inception) Through March 31, 1999
(1) Organization and Basis of Preparation
Wave Systems Corp. (the "Company" or "Wave") is engaged in the research and
development of a proprietary system (the "Wave System") for use with a
computer, that measures, controls, and records the use of electronic
content. The Company is also engaged in various research, development and
marketing efforts to commercialize the Wave System to provide more
efficient and flexible pricing (e.g., pay per use or rent-to-own) and
greater security on the usage of the electronic content. The Company is in
the development stage and, accordingly, the accompanying consolidated
financial statements are presented in a format prescribed for a development
stage enterprise.
The Company has incurred significant losses in current and prior periods.
Management intends to continue to devote resources toward the research,
development and marketing of its products in order to generate future
revenues from licensing and product sales. In addition, the Company is
actively pursuing additional short- and long-term financing sources,
including debt and equity financing 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 and Interim Financial Information
The consolidated financial statements include the financial statements of
Wave; a wholly owned subsidiary, Harvard International Medical Library,
Inc., doing business as MedWave; a majority owned inactive subsidiary,
Network News Corp. ("NNC"); and a wholly owned inactive subsidiary. All
significant intercompany balances and transactions have been eliminated
in consolidation.
The consolidated financial statements as of March 31, 1999 and for the
three months ended March 31, 1999 and 1998 are unaudited. All
adjustments and accruals (consisting only of normal recurring
adjustments) have been recorded that, in the opinion of management, are
necessary for a fair presentation. Results of operations for interim
periods are not necessarily indicative of the results for the full year.
(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.
(Continued)
<PAGE>
F-14
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements - (Continued)
(E) Goodwill
Goodwill, which represents the excess of purchase price over the fair value
of net assets acquired, is amortized on a straight-line basis over the
period expected to be benefited of five years. The Company assesses the
recoverability of this intangible asset by determining whether the
amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the related
acquired operation. The amount of goodwill impairment, if any, is
measured based on projected discounted future operating cash flows using
a discount rate reflecting the Company's average cost of funds. The
assessment of the recoverability of goodwill is impacted if estimated
future operating cash flows are not achieved. During the third quarter of
1997, the Company wrote-off goodwill related to the WIN acquisition as it
was uncertain whether the current and expected future results of
operations of WIN would be sufficient to support its carrying value.
(F) Income Taxes
The Company accounts for income taxes under the asset and liability method.
As such, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(G) Stock Option Plan
The Company accounts for its stock option plans in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As
such, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeds the exercise price.
On January 1, 1996, the Company adopted the disclosure provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting
for Stock Based Compensation and accordingly, provides pro forma net
income and pro forma earnings per share footnote disclosures for employee
stock options as if the fair value-based method defined in SFAS No. 123
had been applied.
(H) Research and Development
Research and development costs are expensed as incurred.
(Continued)
<PAGE>
F-15
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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-16
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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.
(Continued)
<PAGE>
F-17
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(4) Property and Equipment
Property and equipment as of December 31 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Equipment $1,554,001 $1,297,702
Furniture, fixtures and improvements 459,822 389,530
Computer software 171,363 128,228
--------- ---------
2,185,186 1,815,460
Less: Accumulated depreciation 1,296,925 966,184
--------- ---------
Total $ 888,261 $ 849,276
--------- ---------
--------- ---------
</TABLE>
Depreciation expense on property and equipment amounted to approximately
$333,000, $344,000, $272,000 and $1,297,000 for the years ended December
31, 1998, 1997, and 1996 and for the period from inception through December
31, 1998, respectively.
(5) Notes Payable
In connection with the acquisition of WIN, the Company issued a 10%
convertible note amounting to $456,000 and a warrant to refinance WIN's
obligation to a WIN noteholder. The note 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 755,521 298,486
Accrued consulting and professional fees 155,000 264,495
Legal Settlement (note 13) 602,000 -
Accrued payroll and related costs 816,269 318,403
Lease payable 60,169 -
Other accrued liabilities 150,199 56,378
---------- ----------
Total $3,029,158 $1,427,762
---------- ----------
---------- ----------
</TABLE>
(Continued)
<PAGE>
F-18
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(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.
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.
(Continued)
<PAGE>
F-19
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The Series C Preferred Stock ranks senior to the Company's common stock and
junior to the Series A and B Preferred Stock. Series C Preferred Stock
was convertible by the holder, in increments, into the Company's Class A
common stock based on the market price of the Company's Class A common
stock at the time of conversion.
The Series C Preferred Stock was convertible at the lesser of $2.31 per
share or 80%, as adjusted, of the average of the fair value of the Class
A common stock for the five days prior to the conversion date. During
1997 all of the Series C preferred stock was converted into 2,850,439
shares of the Company's Class A common stock.
In May of 1997 the Company raised approximately $1,316,000, net of issuance
costs of $272,000 ($162,000 of which related to the value ascribed to
warrants issued), through the placement of 80,000 shares of newly created
Series D Convertible Preferred Stock. The Series D Preferred Stock had a
stated value of $20 per share, which accrued dividends payable quarterly
in cash at 6%.
The Series D Convertible Preferred Stock was convertible into the Class A
common stock of the Company at an effective conversion price of the lower
of (i) $1.35, or (ii) 80% of the average closing bid price on the NASDAQ
National Market System of the Company's Class A common stock for the five
(5) trading days immediately preceding the date of conversion. During
1997 all of the Series D Convertible Preferred Stock was converted into
2,070,095 shares of the Company's Class A common stock.
(b) Convertible Preferred Stock
In October 1997 the Company raised approximately $1,850,000, net of
issuance costs of $397,000 ($224,000 of which related to the value
ascribed to warrants issued), though the private placement 112,500 shares
of newly created Series F Convertible Preferred Stock. The Series F
Convertible Preferred Stock has a stated value of $20 per share, which
accrued dividends payable quarterly in cash at 6%.
The Series F Convertible Preferred Stock was convertible into the Class A
common stock at an effective conversion price of the lower of (a) $1.05
and (b) 80% of the average of the five (5) lowest trading prices of Class
A common stock. During 1997 all of the Series F Convertible Preferred
Stock was converted into 2,961,086 shares of the Company's Class A common
stock.
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.
(Continued)
<PAGE>
F-20
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(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 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.
(Continued)
<PAGE>
F-21
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
During 1997 the Company sold approximately 800,000 shares of the Company's
Class A common stock and warrants to purchase 160,000 shares of the
Company's Class A common stock, which may be exercised at an exercise
price of $1.00, for an aggregate purchase price of $800,000. 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.
(d) Recapitalization
In January 1994, the Board of Directors authorized the Company to amend and
restate the Company's Certificate of Incorporation to reflect the
authorization of 25,000,000 shares of a newly created Class A common
stock, which stock has voting rights of one vote per share, and the
reclassification of the then current outstanding shares of common stock
into Class B common stock. In June 1994, the Board of Directors
authorized that the Class B common stock will have one vote per share,
except that Class B common stock will have five votes per share in cases
where one or more directors are nominated for election by persons other
than the Company's Board of Directors and where there is a vote on any
merger, consolidation or other similar transaction, which is not
recommended by the Company's Board of Directors. In addition, the Class B
common stock will have five votes per share on all matters submitted to a
vote of the stockholders in the event that any person or group of persons
acquires beneficial ownership of 20% or more of the outstanding voting
securities of the Company. The Class B common stock is convertible into
shares of Class A common stock at any time. The classes of common stock
are alike in all other respects.
(8) Options and Warrants
1991 Plan
In September 1991, the Board of Directors authorized the establishment of a
stock option plan (the "1991 Plan"). The total number of shares of Class B
common stock subject to the Plan is 2,700,000. Options terminate upon the
earlier of the date of the expiration of the option or upon termination of
the employment relationship between the Company or a subsidiary and the
optionee for any reason other than death, disability or retirement.
Employees are entitled to exercise their options on dates determined by the
Compensation Committee of the Board of Directors. Vesting provisions for
options granted generally range from immediate vesting to 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.
(Continued)
<PAGE>
F-22
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Other Options
In 1993, in connection with an investment banking agreement, the Company
granted options to purchase 30,000 shares of Class B common stock at an
exercise price of $1.67 per share, and options to purchase 14,286 shares of
Class B common stock at an exercise price of $3.50 per share. The options
vested immediately and are exercisable for a period of seven years from the
date of issuance.
1994 Plans
In January 1994, the Board of Directors authorized the establishment of the
1994 Employee Stock Option Plan (the "1994 Plan"). The initial number of
shares of Class A common stock subject to the 1994 Plan was 1,000,000. The
terms of the 1994 Plan are similar to those of the 1991 Plan. Options are
granted with exercise prices that approximate fair market value at the date
of grant. In May 1996, 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.
(Continued)
<PAGE>
F-23
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Options under the Directors' Plan are exercisable for a period of ten years
from the date of grant. Options may not be exercised after the option
holder ceases to be a director of the Company, except that in the event of
death or disability of the option holder, the option may be exercised for a
period of one year after the date of death or disability, and, in the event
of retirement of the option holder, the option may be exercised for a
period of three months after the date of retirement.
1996 Plan
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 $ ( 11,895,944) $ (13,897,794) $ ( 8,683,815)
Net loss - pro forma ( 17,596,312) (15,300,187) (10,025,517)
Net loss to common stockholders - as reported ( 12,754,807) (16,380,776) (9,554,394)
Net loss to common shareholders - pro forma ( 18,455,175) (17,783,169) (10,896,096)
Loss per common share - as reported ( .44) (.78) (.64)
Loss per common share - pro forma ( .63) (.85) (.73)
</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-24
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Summary of Option Activity
A summary of option activity through December 31, 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 316,010 1.58
Options canceled (669,580) 1.58
Options exercised (70,326) 1.90
-----------
Balance at December 31, 1997 1,944,790 2.73
Options granted 5,665,278 2.48
Options canceled (701,267) 2.49
Options exercised ( 77,558) 1.95
------------
Balance at December 31, 1998 6,831,243 $2.48
</TABLE>
At December 31, 1998, there were approximately 1,760,568 options exercisable
at prices ranging from $1.06 to $7.06.
(Continued)
<PAGE>
F-25
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The following table summarizes information about stock options outstanding at
December 31, 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>
$1.06 131,250 50,167 $1.06 8.6 years
1.07 - 1.69 3,009,675 350,209 1.30 8.5 years
1.70 - 2.31 174,634 44,536 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>
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-26
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Due to the successful placement of 150,000 shares of the Company's Series C
Convertible Stock, Wharton Capital Partners Ltd. and The Shemano Group,
Inc., two financial consulting firms, were issued warrants by the Company
to purchase 37,500 Class A common shares each at a price of $2.54 per
share. These warrants expire on December 27, 1999.
In connection with the acquisition of WIN, the Company issued a warrant that
allows the holder the ability to purchase unregistered shares of the
Company's Class A common stock at a price of $1.25 per share at the earlier
of the conversion of a note or April 18, 1998 for a period of five years.
The number of shares able to be purchased under this warrant is based on a
formula of $170,000 divided by 80% of the fair market value of the Class A
common stock at the time of conversion.
As a result of the successful placement of 80,000 shares of the Company's
Series D Preferred Stock, JNC Opportunity Fund, the acquirer of the
placement, received 80,000 warrants to purchase the Company's unregistered
Class A common stock, and financial consultants, primarily Wharton Capital
Partners, received a total of 40,000 warrants. The warrants have an
exercise price of $1.62, and expire on May 30, 2002.
As a result of the successful placement of 112,500 shares of the Company's
Series F Preferred Stock, Combination Inc., the acquirer of the placement,
received 112,500 warrants to purchase the Company's unregistered Class A
common stock, and Wharton Capital Partners received 56,250 warrants. The
warrants have an exercise price of $1.26, and expire on October 9, 2002.
In connection with the private placement of approximately 800,000 shares of
the Company's Class A common stock, the Company issued 160,000 warrants to
purchase shares of the Company's unregistered Class A common stock at an
exercise price of $1.00. The warrants expire on September 16, 2000.
In connection with a technology license agreement with Aladdin, the Company
issued two warrants on July 18, 1997 to purchase the Company's Class A
common stock. The first warrant is 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-27
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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>
Class A and B shares Range of exercise Expiration
Year of issuance subject to warrants prices Term
---------------- ------------------- -------- ------
<S> <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
120,000 1.10 - 4.05 5 years
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-28
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Payment of royalties is secured by a security interest in and to the Licensed
Patents. Mr. Sprague assigned all of his right, title, and interest in the
Licensed Patents to the Company.
The Company believes that the agreements as a whole provide it with exclusive
rights under the Wave Patents. There can be no assurance that the Company
will enjoy exclusive rights to the Licensed patents under these agreements.
(b) Aladdin License Agreement
During the third quarter of 1997 the Company entered into a license agreement
with Aladdin Knowledge Systems, Ltd. ("Aladdin"), an Israeli company, for
technology and in-process research and development related to Aladdin's
proprietary persistent encryption system. Under the terms of the Aladdin
license agreement, the Company is prohibited from using any other
encryption technology for the first five years. This technology will be
incorporated into the Wave System to facilitate pay-per-view content
distribution.
The Company acquired the license for this technology in exchange for $950,000
plus two warrants to purchase the Company's Class A common stock valued at
approximately $2.9 million (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-29
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The License and Cross-License Agreement also provides for royalties to be
paid to the Company by Titan based upon Titan's "Allocable Net Revenues,"
as defined in the agreement. Allocable Net Revenues are generally defined
as that portion that a Company patent or information adds to Titan's gross
amounts invoiced to purchasers for all products or information services
making use of a Company patent or know-how and information. Royalties are
payable on a quarterly basis.
The License and Cross-License Agreement specifies certain events of
termination, some of which have already occurred but which have been waived
or extended by Titan.
A director of the Company, who resigned from the Board at the end of 1997, is
also the President, Chief Executive Officer, and a director of Titan.
Pursuant to the terms of a related stockholders agreement, Titan has the
right to designate a member of the Company's Board of Directors for as long
as Titan continues to own at least 50% of the shares originally issued to
Titan. As of December 31, 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.
(Continued)
<PAGE>
F-30
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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 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.
(Continued)
<PAGE>
F-31
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(13) Commitments and Contingencies
Litigation
The Company is party to legal proceedings generally incidental to its
business. Management believes that the outcome of such litigation will not
have a material adverse effect on the consolidated financial position or
results of operations of the Company.
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
In December 1994, the Company entered into an operating lease beginning March
1995 for its offices in New York, New York, which expired on February 28,
1998. The lease provided for minimum annual rent of $200,000 plus
applicable increases. The Company has subsequently terminated this lease
and entered into a new lease in the same facility. The minimum annual rent
for the new lease is approximately $81,000 and its expiration is June 1999.
The Company also leases premises in Princeton, New Jersey; San Jose,
California; and Lee, Massachusetts, under operating leases, which expire on
various dates through January 14, 2001.
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 plant and
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-32
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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 $203,937
2000 21,186 162,604
2001 - 119,382
Total minimum lease payments 63,558 $485,923
-------
-------
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 $47.6 million which expire beginning in 2003 through 2014.
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 $ 19,978,000 $15,493,000
License rights 980,000 1,307,000
---------- ---------
Total gross deferred tax assets 20,958,000 16,800,000
Less valuation allowance (20,958,000) (16,800,000)
----------- ----------
Net deferred tax asset $ -- $ --
----------- ----------
----------- ----------
</TABLE>
The valuation allowance increased by approximately $4.2 million and $5.2
million, during the years ended December 31, 1998 and 1997, respectively.
(Continued)
<PAGE>
F-33
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to 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 of 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 (1) 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 (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 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>
Part II
Information Not Required In Prospectus
Item 13. Other expenses of issuance and distribution
The following table sets forth the various expenses to be paid by Wave
in connection with the sale of the securities being registered, other than sales
commissions. All of the amounts shown are estimated except the Commission
registration fee.
<TABLE>
<S> <C>
Commission registration fee................. $23,304
Accounting fees and expenses................ 10,000
Printing expenses........................... 5,000
Miscellaneous .............................. 1,696
Legal fees and expenses..................... 50,000
-------
Total.................................... $90,000
-------
-------
</TABLE>
Item 14. Indemnification of director and officers
Section 145 of the Delaware General Corporation Laws empowers a
Delaware corporation to indemnify its officers and directors and certain other
persons to the extent and under the circumstances set forth therein.
Our Restated Certificate of Incorporation and Bylaws provide for
indemnification of our officers and directors and certain other persons against
liabilities and expenses incurred by them in certain stated proceedings and
under certain stated conditions.
Item 15. Recent sales of unregistered securities
On March 30, 1999 we sold 181,818 shares of our Class A common stock,
at a price of $11.00 per share, in satisfaction of the then outstanding
principal amount of $2,000,000 on a note we had issued to Carriage Partners,
LLC. This issuance was exempt from registration provisions of the Securities Act
of 1933 in accordance with the exemption available under Section 4(2) of the
Securities Act of 1933.
On March 23, 1999 we sold 2,090,954 shares of 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. Accordingly, this issuance was
exempt from the registration provisions of the Securities Act of 1933 in
accordance with the exemption provided by Section 4(2) of the Securities of
1933. 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 we issued warrants to purchase 275,000 shares of
Class A common stock at an exercise price of $4.00 per share, exercisable until
January 26, 2004, to one investor. That investor was an "accredited investor" as
that term is defined in Rule 501 of Regulation D of the Securities Act of 1933.
Accordingly, this issuance was exempt from the registration provisions of the
Securities Act in accordance with the exemption provided by Section 4(2) of the
Securities Act of 1933. If, over any sixty consecutive day period, the average
of the daily high and low prices of the Class A common stock, as reported by
Bloomberg Information Services, exceeds seven dollars, we may force the
conversion of these warrants. These warrants were issued as consideration for a
$2,000,000 promissory note, bearing no interest, due January 26, 2002.
<PAGE>
On January 25, 1999, we issued 46,667 shares of Class A common stock to Carl
A. Artopeous and Artopeous Capital Management and 23,333 shares of Class A
common stock to Barry Eskanos, each with respect to the settlement of legal
claims against Wave Systems. This issuance was exempt from registration
provisions of the Securities Act of 1933 in accordance with the exemption
available under Section 4(2) of the Securities Act.
We issued 3,093 shares of Class A common stock to Dr. Craig Mudge as partial
payment for consulting services rendered during 1998, with the remainder of the
fee paid in cash. This issuance was exempt from registration provisions of the
Securities Act in accordance with the exemption available under Section 4(2) of
said Act.
The Company issued 1,031 shares of Class A common stock to Bruce Schneier as
payment partial for consulting services rendered during 1998, with the remainder
of the fee paid in cash. Such issuance was exempt from registration provisions
of the Securities Act in accordance with the exemption available under Section
4(2) of said Act.
The Company issued 15,000 shares of Class A common stock to Lora Lee
Professional Recruiters, Inc. as payment for professional placement and
consulting services rendered during 1998. Such issuance was exempt from
registration provisions of the Securities Act in accordance with the exemption
available under Section 4(2) of said Act.
The Company issued 17,500 shares of Class A common stock to Jaffoni & Collins
Incorporated as payment for investor relations and consulting services rendered
during 1998. Such issuance was exempt from registration provisions of the
Securities Act in accordance with the exemption available under Section 4(2) of
said Act.
The Company issued 150,000 shares of Class A common stock to William Morris
Agency, Inc. as payment for investor relations and consulting services rendered
during 1998. Such issuance was exempt from registration provisions of the
Securities Act in accordance with the exemption available under Section 4(2) of
said Act.
On March 6, 1998 we issued 150,000 shares of newly created Series G
Convertible Preferred Stock, par value $.01 at a price of $20 per share, for an
aggregate purchase price of $3,000,000. The shares were sold to one (1)
accredited investor pursuant to Regulation D promulgated under the Act. The
Series G Convertible Preferred Stock is convertible into Class A common stock,
par value $.01 ("Class A common stock") at an effective conversion price of the
lower of (a) $1.12 and (b) 80% of the average of the five (5) lowest trading
prices of the Class A common stock during (x) a day on which the Class A common
stock is traded on The Nasdaq National Market or The Nasdaq SmallCap Market or
principal national securities exchange or market on which the Class A common
stock has been listed, or (y) if the Class A common stock is not listed on The
Nasdaq National Market or The Nasdaq SmallCap Market or any stock exchange or
market, a day on which the Class A common stock is traded in the
over-the-counter market, as reported by the OTC Bulletin Board, or (z) if the
Class A common stock is not quoted on the OTC Bulletin Board, a day on which the
Class A common stock is quoted in the over-the-counter market as reported by the
National Quotation Bureau Incorporated (or any similar organization or agency
succeeding its functions of reporting prices), as reported by Bloomberg
Information Services, Inc. during the ten (10) trading days immediately
preceding the conversion date, as defined in the Certificate of Designation of
the Series G Convertible Preferred Stock. In addition to the Series G
Convertible Preferred Stock, 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.
II-2
<PAGE>
On October 9, 1997 we issued 112,500 shares of newly created Series
F Convertible Preferred Stock, par value $.01, at a price of $20 per share,
for an aggregate purchase price of $2,250,000. The shares were sold to one
(1) accredited investor pursuant to Regulation D promulgated under the Act.
The Series F Convertible Preferred Stock is convertible into the Class A
common stock at an effective conversion price of the lower of (a) $1.05 and
(b) 80% of the average of the five (5) lowest trading prices of the Class A
common stock during (x) a day on which the Class A common stock is traded on
The Nasdaq National Market or The Nasdaq SmallCap Market or principal
national securities exchange or market on which the Class A common stock has
been listed, or (y) if the Class A common stock is not listed on The Nasdaq
National Market or The Nasdaq SmallCap Market or any stock exchange or
market, a day on which the Class A common stock is traded in the
over-the-counter market, as reported by the OTC Bulletin Board, or (z) if the
Class A common stock is not quoted on the OTC Bulletin Board, a day on which
the Class A common stock is quoted in the over-the-counter market as reported
by the National Quotation Bureau Incorporated (or any similar organization or
agency succeeding its functions of reporting prices), as reported by
Bloomberg Information Services, Inc. during the ten (10) trading days
immediately preceding the conversion date, as defined in the Certificate of
Designation of the Series F Convertible Preferred Stock. In addition to the
Series F Convertible Preferred Stock, we also issued warrants to purchase a
total of 168,750 shares of Class A common stock at an exercise price of $1.26
per share, exercisable until October 9, 2002. As of December 31, 1997, all of
the shares of the Series F Preferred stock have been converted into Class A
common stock.
On September 16, 1997, we issued 800,000 shares of our Class A common
stock, and warrants to purchase 160,000 shares of Class A common stock, which
may be exercised at an exercise price equal to $1.00, for an aggregate purchase
price of $800,000 pursuant to Regulation D promulgated under the Securities Act
of 1933, as amended, to six (6) accredited investors.
On May 30, 1997 we issued 80,000 shares of newly created Series D Convertible
Preferred Stock, at a price of $20 per share, for an aggregate of $1,600,000.
The shares were sold to one (1) accredited investor pursuant to Regulation D
promulgated under the Act. The Series D Convertible Preferred Stock is
convertible into our Class A common stock 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 our Class A common stock for the five (5)
trading days immediately preceding the Date of Conversion, defined in the
Certificate of Designation of the Series D Convertible Preferred Stock. In
addition to the Series D Convertible Preferred Stock, we also issued warrants to
purchase a total of 120,000 shares of Class A common stock at an exercise price
of $1.62 per share, exercisable until May 30, 2002. As of December 31, 1997, all
of the shares of the Series D Preferred Stock have been converted into Class A
common stock.
On December 27, 1996 we issued 150,000 shares of newly created Series C
Convertible Preferred Stock, par value $.01, at a price of $20 per share, for an
aggregate price of $3,000,000. The Series C Preferred Stock was sold to one (1)
accredited investor pursuant to Regulation D promulgated under the Act. The
Series C Preferred Stock is convertible into the Class A common stock at an
effective conversion price of the lower of (i) $2.31, or (ii) 80%, which is
subject to adjustment, of the average closing bid price on the Nasdaq National
Market System of our Class A common stock for the five (5) trading days
immediately preceding the date that the holders of the Series C Preferred Stock
choose to convert the Series C Preferred Stock into the Class A common stock. In
addition to the Series C Preferred Stock, we also issued warrants to purchase a
total of 75,000 shares of Class A common stock at an exercise price of $2.54 per
share as part of the aforementioned transaction. As of July 23, 1997, all of the
shares of the Series C Preferred stock have been converted into Class A common
stock.
On May 29, 1996 we issued 350 shares of newly created Series B
Preferred Stock, par value $.01, at a price of $10,000 per share, for an
aggregate price of $3,500,000. The Series B Preferred Stock was sold to five (5)
off-shore investors pursuant to Regulation S promulgated under the Act. The
II-3
<PAGE>
Series B Preferred Stock was convertible into the Class A common stock at an
effective conversion price of the lower of (i) $3.01, or (ii) 85% of the average
closing bid price on the Nasdaq National Market System of our Class A common
stock for the five (5) trading days immediately preceding the date that the
holders of the Series B Preferred Stock chose to convert the Series B Preferred
Stock into the Class A common stock. As of March 17, 1997, all of the shares of
Series B Preferred Stock have been converted into Class A common stock.
II-4
<PAGE>
Item 16. EXHIBITS AND FINANCIAL STATEMENTS AND SCHEDULES
Exhibit No. Description of Exhibit
3.1 -- Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement on Form S-1, File
No. 33-75286)
3.2 -- Bylaws of Registrant (incorporated by reference to
Exhibit 3.2 of the Registrant's Registration Statement
on Form S-1, File No. 33-75286)
4.1 -- Form of Stock Certificate of Class A common stock
(incorporated by reference to Exhibit 4.1 of the
Registrant's Registration Statement on Form S-1, File
No. 33-75286)
4.2 -- Form of Representative's Warrant Agreement, including
the form of Representative's Warrant (incorporated by
reference to Exhibit 4.2 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
4.3 -- Certificate of Designation of Series B Preferred Stock
of Wave Systems Corp. as filed with the Delaware
Secretary of State on May 24, 1996 (incorporated by
reference to Exhibit 3.1 of the Registrant's Current
Report on Form 8-K filed on May 30, 1996, File No.
0-24752)
4.4 -- Certificate of Designation of Series C Convertible
Preferred Stock of Wave Systems Corp. as filed with the
Delaware Secretary of State on December 27, 1996
(incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on
January 8, 1997, File No. 0-24752)
4.5 -- Certificate of Designation of Series D Convertible
Preferred Stock of Wave Systems Corp. as filed with the
Delaware Secretary of State on December 27, 1996
(incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on June
3, 1997, File No. 0-24752)
4.6 -- Certificate of Designation of Series F Convertible
Preferred Stock of Wave Systems Corp. as filed with the
Delaware Secretary of State on October 9, 1997
(incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on
October 15, 1997, File No. 0-24752)
4.7 -- Certificate of Designation of Series G Convertible
Preferred Stock of Wave Systems Corp. as filed with the
Delaware Secretary of State on March 5, 1998
(incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on March
19, 1998, File No. 0-24752)
5 -- Opinion of Bingham Dana LLP with respect to the
legality of the shares being offered. (incorporated
by reference to Exhibit 5 of the Registrant's
Pre-Effective Amendment No. 1 to the Registration
Statement on Form S-1 filed on June 11, 1999, File No.
333-76103)
+10.1 -- Joint Technology Development Agreement, dated as of May
1, 1992, between The Titan Corporation and Cryptologics
International, Inc. (incorporated by reference to
Exhibit 10.2 of the Registrant's Registration Statement
on Form S-1, File No. 33-75286)
+10.2 -- License and Cross-License Agreement, dated as of May 1,
1992, between The Titan Corporation and Cryptologics
International, Inc.
II-5
<PAGE>
(incorporated by reference to Exhibit 10.3 of the
Registrant's Registration Statement on Form S-1,
File No. 33-75286)
10.3 -- Amendment to License and Cross-License Agreement, dated
as of August 27, 1993, between The Titan Corporation
and Wave Systems Corp. (incorporated by reference to
Exhibit 10.4 of the Registrant's Registration Statement
on Form S-1, File No. 33-75286)
10.4 -- Amended and Restated License Agreement, dated February
14, 1994, by and among Wave Systems Corp., Peter J.
Sprague and John R. Michener (incorporated by reference
to Exhibit 10.5 of the Registrant's Registration
Statement on Form S-1, File No. 33-75286)
#10.5 -- Wave Systems Corp. 1994 Stock Option Plan (incorporated
by reference to Exhibit 10.6 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
#10.6 -- Wave Systems Corp. Non-Employee Directors Stock Option
Plan (incorporated by reference to Exhibit 10.7 of the
Registrant's Registration Statement on Form S-1, File
No. 33-75286)
10.7 -- Regulation S Securities Subscription Agreement, dated
as of May 29, 1996 (incorporated by reference to
Exhibit 4.1 of the Registrant's Current Report on Form
8-K filed on May 30, 1996, File No. 0-24752)
10.8 -- Purchase Agreement between Wave Systems Corp. and JNC
Opportunity Fund Ltd., dated as of December 27, 1996
(incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on
January 8, 1997, File No. 0-24752)
10.9 -- Registration Rights Agreement between Wave Systems
Corp. and JNC Opportunity Fund Ltd., dated as of
December 27, 1996 (incorporated by reference to Exhibit
4.2 of the Registrant's Current Report on Form 8-K
filed on January 8, 1997, File No. 0-24752)
10.10 -- Purchase Agreement between Wave Systems Corp. and JNC
Opportunity Fund Ltd., dated as of May 30, 1997
(incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on June
3, 1997, File No. 0-24752)
10.11 -- Registration Rights Agreement between Wave Systems
Corp. and JNC Opportunity Fund Ltd., dated as of May
30, 1997 (incorporated by reference to Exhibit 4.2 of
the Registrant's Current Report on Form 8-K filed on
June 30, 1997, File No. 0-24752)
10.12 -- Purchase Agreement between Wave Systems Corp. and
Combination, Inc., dated as of October 9, 1997
(incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on
October 15, 1997, File No. 0-24752)
10.13 -- Registration Rights Agreement between Wave Systems
Corp. and Combination Inc., dated as of October 9, 1997
(incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on
October 15, 1997, File No. 0-24752)
10.14 -- Purchase Agreement between Wave Systems Corp. and
Combination Inc., dated as of March 6, 1998
(incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on March
19, 1998, File No. 0-24752)
II-6
<PAGE>
10.15 -- Registration Rights Agreement between Wave Systems
Corp. and Combination Inc., dated as of March 6, 1998
(incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on March
19, 1998, File No. 0-24752)
10.16 -- Addendum to License and Cross-License Agreement, dated
February 28, 1997, between The Titan Corporation and
Wave Systems Corp. (incorporated by reference to
Exhibit 10.10 of the Registrant's Annual Report on Form
10-K filed on March 24, 1997, file No. 0-24752).
10.17 -- Convertible Promissory Note, dated January 26, 1999,
between Carriage Partners, LLC and Wave Systems Corp.
(incorporated by reference to Exhibit 10.17 of the
Registrant's Annual Report on Form 10-K filed on March
31, 1999, file No. 0-24752).
#10.18 -- Employment Contract, dated June 8, 1998, between Gerard
T. Feeney and Wave Systems Corp. (incorporated by
reference to Exhibit 10.18 of the Registrant's Annual
Report on Form 10-K filed on March 31, 1999, file No.
0-24752).
#10.19 -- Employment Contract, dated November 10, 1998, between
Steven Sprague and Wave Systems Corp. (incorporated by
reference to Exhibit 10.19 of the Registrant's Annual
Report on Form 10-K filed on March 31, 1999, file No.
0-24752).
10.20 -- Securities Purchase Agreement, dated March 23, 1999, by
and among Wave Systems Corp. and the purchasers listed
therein. (incorporated by reference to Exhibit 10.20
of the Registrant's Registration Statement on Form
S-1 filed on April 12, 1999, File No. 333-76103)
10.21 -- Registration Rights Agreement, dated March 23, 1999, by
and among Wave Systems Corp. and the investors listed
therein. (incorporated by reference to Exhibit 10.21
of the Registrant's Registration Statement on Form S-1
filed on April 12, 1999, File No. 333-76103)
23.1 -- Consent of Bingham Dana LLP (included as part of
Exhibit 5 hereto)
23.2 -- Consent of Independent Auditors - KPMG LLP
(incorporated by reference to Exhibit 23.2 of
the Registrant's Pre-Effective Amendment No. 1 to
the Registration Statement on Form S-1 filed on June
11, 1999, File No. 333-76103)
24 -- Power of Attorney (included on signature pages)
27 -- Financial Data Schedule (incorporated by reference to
Exhibit 27 of the Registrant's Pre-Effective
Amendment No. 1 to Registration Statement on Form
S-1 filed on June 11, 1999, File No. 333-76103)
+Confidential treatment has been granted as to portions of this exhibit.
#Management contract or compensatory plan.
(b) Financial Statement Schedules:
All schedules have been omitted since they are either not required
or not applicable.
II-7
<PAGE>
Item 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of a prospectus
filed with the Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in volume and price represent no more than a 20% change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
PROVIDED, however, that paragraphs (1)(i) and (1)(ii) do not
apply if the registration statement is on Form S-3 or Form S-8, and the
information required to be included in a post-effective amendment by
those paragraphs is contained in periodic reports filed by the
registrant pursuant to Section 13 or Section 15(d) of the Exchange Act
that are incorporated by reference in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to
be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, we have been advised that in the opinion of the Commission
such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than payment
by Wave of expenses incurred or paid by a director, officer or
controlling person of Wave in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered,
we will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
II-8
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-1 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the Town of Lee, Commonwealth of Massachusetts, on the 29th day
of June, 1999.
Wave Systems Corp.
By: /s/ Peter J. Sprague
Name: Peter J. Sprague
Title: Chairman and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Peter J. Sprague Chairman and Chief Executive June 29, 1999
- ----------------------------------- Officer
Peter J. Sprague
/s/ Steven Sprague * President, Chief Operating Officer June 29, 1999
- ----------------------------------- and Director
Steven Sprague
/S/ John E. Bagalay, Jr. * Director June 29, 1999
- -----------------------------------
John E. Bagalay, Jr.
/s/ Philippe Bertin * Director June 29, 1999
- -----------------------------------
Philippe Bertin
/s/ George Gilder * Director June 29, 1999
- -----------------------------------
George Gilder
/s/ John E. McConnaughy, Jr. * Director June 29, 1999
- -----------------------------------
John E. McConnaughy, Jr.
/s/ Gerard T. Feeney * Senior Vice President, Finance June 29, 1999
- ----------------------------------- and Administration, Chief Financial
Gerard T. Feeney Officer and Secretary (Principal
Accounting Officer)
* /s/ Peter J. Sprague as attorney-in-fact
- -------------------------
Peter J. Sprague
</TABLE>
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