<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission File Number 0-24752
Wave Systems Corp.
(Exact name of registrant as specified in its charter)
Delaware 13-3477246
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
480 Pleasant Street
Lee, Massachusetts 01238
(Address of principal executive offices)
(Zip code)
(413) 243-1600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
The number of shares outstanding of each of the issuer's classes of common
stock as of September 30, 2000: 46,867,440 shares of Class A Common Stock and
779,211 shares of Class B Common Stock.
<PAGE>
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
<TABLE>
<CAPTION>
Assets September 30, December 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 93,981,883 $ 6,290,045
Marketable securities 3,799,370 4,480,500
Inventories 494,043 431,686
Note Receivable (Note 8) 840,809 --
Prepaid expenses and other receivables 774,619 491,855
------------- -------------
Total current assets 99,890,724 11,694,086
Property and equipment, net 5,260,737 2,680,874
Goodwill and other intangibles, net of accumulated amortization 4,441,194 --
Other assets 3,540,443 2,156,923
------------- -------------
113,133,098 16,531,883
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses 7,772,734 6,823,643
------------- -------------
Total current liabilities 7,772,734 6,823,643
------------- -------------
Stockholders' equity:
Common stock, $.01 par value. Authorized 75,000,000 shares as Class A;
issued and outstanding 46,867,440 in 2000 and 39,445,683 in 1999 468,675 394,457
Common stock, $.01 par value. Authorized 13,000,000 shares as Class B;
issued and outstanding 779,211 in 2000 and 2,050,507 in 1999 7,792 20,505
Capital in excess of par value 227,983,521 99,854,111
Deficit accumulated during the development stage (126,898,994) (93,267,173)
Accumulated other Comprehensive Income - unrealized gain on marketable
securities 3,799,370 2,860,500
Less: Note receivable from stockholder, including accrued interest
of $105,985 in 1999 -- (154,160)
------------- -------------
Total stockholders' equity 105,360,364 9,708,240
------------- -------------
$ 113,133,098 $ 16,531,883
============= =============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
<PAGE>
2
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12,
1988 (inception)
Three months ended Nine months ended through
September 30, September 30, September 30, September 30, September 30,
2000 1999 2000 1999 2000
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenue $ 81,793 $ 51,002 $ 159,142 $ 70,229 $ 421,217
Cost of sales 5,113 24,226 55,316 34,974 200,684
------------- ------------- ------------- ------------- -------------
Gross margin 76,680 26,776 103,826 35,255 220,533
------------- ------------- ------------- ------------- -------------
Operating expenses:
Selling, general, and administrative 7,260,914 4,065,242 19,280,496 11,086,650 77,006,547
Research and development 5,974,662 2,967,458 14,043,367 7,281,088 47,447,147
In-process research and development 2,176,000 -- 2,176,000 -- --
Acquisition expenses -- 1,494,000 -- 1,494,000 7,559,000
Amortization of Goodwill 137,553 -- 137,553 -- 907,439
------------- ------------- ------------- ------------- -------------
15,549,129 8,526,700 35,637,416 19,861,738 132,920,133
------------- ------------- ------------- ------------- -------------
Other income (expense):
Interest Income 1,609,557 190,606 3,679,312 501,146 5,600,890
Interest Expense -- (1,162) -- (832,629) (1,695,460)
Equity in Net losses of Globalwave (2,320,000) -- (2,320,000) -- (2,320,000)
Gain on sale of marketable securities -- -- 542,457 -- 542,457
License Fee -- -- -- 1,250,000 5,000,000
License warrant cost -- -- -- -- (1,100,000)
Other income (expense) -- -- -- -- (227,281)
------------- ------------- ------------- ------------- -------------
(710,443) 189,444 1,901,769 918,517 5,800,606
------------- ------------- ------------- ------------- -------------
Net loss (16,182,892) (8,310,480) (33,631,821) (18,907,966) (126,898,994)
Accrued dividends on preferred stock -- 2,439 -- 13,239 4,350,596
------------- ------------- ------------- ------------- -------------
Net loss to common stockholders $ (16,182,892) $ (8,312,919) $ (33,631,821) $ (18,921,205) $(131,249,590)
============= ============= ============= ============= =============
Weighted average number of common
shares outstanding during the period 47,148,603 39,929,969 45,630,821 37,489,993 15,844,756
------------- ------------- ------------- ------------- -------------
Loss per common share $ (0.34) $ (0.21) $ (0.74) $ (0.50) $ (8.28)
============= ============= ============= ============= =============
</TABLE>
See accompanying notes to unaudited consolidated financial statements
<PAGE>
3
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
Nine months ended through
September 30, September 30, September 30,
2000 1999 2000
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (33,631,821) $ (18,907,966) $(126,898,994)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization of goodwill 137,553 -- 907,439
Depreciation and amortization 1,574,543 480,161 4,081,051
Reserve for note from affiliate -- -- 1,672,934
Accrued interest on marketable securities -- -- (106,962)
Noncash expenses:
Accretion of assured incremental yield on
convertible debt -- -- 119,000
Common stock issued in connection with
License and Cross-License Agreement -- -- 1,124,960
Gain on sale of marketable securities (542,457) -- (542,457)
Net losses realized on Globalwave Joint Venture 2,320,000 -- 2,320,000
Common stock issued for services rendered 108,333 728,092 3,600,197
Warrants issued as compensation for services -- 1,075,240 2,751,595
Issuance of warrants to Aladdin -- -- 2,939,000
Accrued interest on note payable -- 15,388 121,219
Preferred stock issued for services rendered -- -- 265,600
Compensation associated with issuance of
stock options -- -- 634,463
Amortization of deferred compensation -- -- 398,660
Amortization of discount on notes payable -- -- 166,253
Common stock issued by principal stockholder
for services rendered -- -- 565,250
In-process R&D 2,176,000 -- 2,176,000
Changes in assets and liabilities:
Decrease (increase) in accrued interest on note
receivable -- (3,613) --
Increase in inventories (62,357) -- (494,043)
Increase in prepaid expenses and
other receivables (231,568) (1,547,189) (723,426)
Increase in other assets (1,716,894) (31,758) (3,888,730)
Increase (decrease) in deferred revenue 209,426 (1,250,000) 209,426
Increase (decrease) in accounts payable and
accrued expenses (130,292) 812,541 6,930,863
------------- ------------- -------------
Net cash used in operating activities (29,789,534) (18,629,104) (101,670,702)
------------- ------------- -------------
</TABLE>
(Continued)
<PAGE>
4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows, Continued
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
Nine months ended through
September 30, September 30, September 30,
2000 1999 2000
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (3,181,617) (1,115,625) (8,139,473)
Purchase Acquisition of Businesses (7,445,358) -- (7,445,358)
Investment in Globalwave Joint Venture (1,450,043) -- (1,450,043)
Short-term loans to affiliate -- -- (1,672,934)
Organizational costs -- -- (14,966)
Note receivable (840,809) -- (840,809)
Proceeds from maturities/sales
of marketable securities 2,162,457 -- 649,419
------------- ------------- -------------
Net cash provided by (used in)
investing activities (10,755,370) (1,115,625) (18,914,164)
------------- ------------- -------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 128,082,582 27,498,373 198,746,908
Net proceeds from issuance of preferred stock
and warrants -- -- 12,283,031
Payment of note receivable from stockholder 154,160 -- --
Proceeds from notes payable and warrants to
stockholders -- 2,000,000 4,083,972
Repayments of notes payable to stockholders -- (575,254) (1,069,972)
Proceeds from notes payable and warrants -- -- 1,284,250
Repayments of note payable -- -- (255,000)
Redemption of Preferred Stock -- (506,440) (506,440)
------------- ------------- -------------
Net cash provided by financing activities 128,236,742 28,416,679 214,566,749
------------- ------------- -------------
Net increase in cash and cash equivalents 87,691,838 8,671,950 93,981,883
Cash and cash equivalents at beginning of period 6,290,045 4,451,175 --
------------- ------------- -------------
Cash and cash equivalents at end of period $ 93,981,883 $ 13,123,125 $ 93,981,883
============= ============= =============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
<PAGE>
5
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Unaudited)
<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, 1999 39,445,683 $394,457 2,050,507 $20,505 $99,854,111
Net loss
Unrealized gain on marketable securities
Comprehensive income (loss)
Shares issued at $34.00 per share, net of expenses 3,600,800 36,008 114,941,408
Shares issued for Purchase acquisition 374,889 3,749 7,231,609
Exercise of warrants to purchase Class A common stock 319,692 3,197 1,331,048
Exercise of options to purchase Class A common stock 1,847,201 18,472 4,517,091
Shares issued as compensation for services rendered 7,879 79 108,254
Repayment of note receivable
Exchange of Class B stock for Class A stock 1,271,296 12,713 (1,271,296) (12,713)
----------------------------------------------------------------------
Balance at September 30, 2000 46,867,440 $468,675 779,211 $7,792 $227,983,521
========== ======== ========== ======= ============
<CAPTION>
Deficit
accumulated Series G Accumulated Note
during the Convertible Other receivable
development Preferred Comprehensive from
Stage Stock Income Stockholder Total
----- ----- ------ ----------- -----
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999 $(93,267,173) 0 $2,860,500 $(154,160) $9,708,240
Net loss (33,631,821) (33,631,821)
Unrealized gain on marketable securities 938,870 938,870
Comprehensive income (loss) (32,692,951)
Shares issued at $34.00 per share, net of expenses 114,977,416
Shares issued for Purchase acquisition 7,235,358
Exercise of warrants to purchase Class A common stock 1,334,245
Exercise of options to purchase Class A common stock 4,535,563
Shares issued as compensation for services rendered 108,333
Repayment of note receivable 154,160 154,160
Exchange of Class B stock for Class A stock
----------------------------------------------------------------------------
Balance at September 30, 2000 $(126,898,994) - $ 0 - $3,799,370 - $ 0 - $105,360,364
============== ============= ========== ============= ============
</TABLE>
<PAGE>
6
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes To Consolidated Financial Statements
September 30, 2000 and 1999
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting only of normal
recurring adjustments) necessary to present fairly the financial position of the
Company as of September 30, 2000 and 1999, and the results of its operations and
cash flows for the nine months ended September 30, 2000 and 1999. Such financial
statements have been prepared in accordance with the applicable regulations of
the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted. It is suggested that these consolidated financial
statements be read in conjunction with the Company's audited financial
statements and notes thereto for the year ended December 31, 1999, included in
its Form 10-K filed in March 2000. The results of operations for the nine months
ended September 30, 2000 are not necessarily indicative of the operating results
for the full year.
1. Loss per Share:
Loss per share of $0.34 for the three months ended and $0.74 for the nine
months ended September 30, 2000 is computed based on the weighted average number
of common shares outstanding of 47,148,603 and 45,630,821, respectively. The
inclusion of common stock equivalents (warrants, options and convertible
preferred stock) in this computation would be antidilutive; therefore basic and
dilutive are the same.
2. Capital Stock:
On August 31, 2000 the Company issued 374,889 shares of its Class A Common
Stock, at a price of $19.30 per share, for an aggregate purchase price of
$7,235,358 to acquire substantially all of the assets of Indigo Networks, LLC
and its e-commerce shopping network, iShopHere.com. Additional costs to complete
the transaction totaled approximately $210,000.
On March 7, 2000 the Company sold 3,600,800 shares of its Class A Common
Stock, at a price of $34.00 per share, for an aggregate purchase price of
$122,427,200. The shares were sold to a group of accredited investors pursuant
to Regulation D promulgated under the Securities Act of 1933, as amended.
Pacific Growth Equities, Inc. acted as sole placement agent for the private
placement, receiving a commission of approximately $7.3 million, for their
services.
In January, 2000, the Company issued 275,000 shares of its class A Common
Stock to one (1) accredited investor, for an aggregate purchase price of
$1,100,000. These shares were issued upon the exercise of a warrant granted on
January 26, 1999. The warrant to purchase 275,000 shares of the Company's Class
A Common Stock at an exercise price of $4.00 per share, was exercisable until
January 26, 2004. The Warrants were issued as consideration for a $2,000,000
promissory note, bearing no interest, due January 26, 2002.
During the nine months ended September 30, 2000, the Company issued a
total of 1,847,201 shares upon the exercise of incentive stock options by
various employees. The aggregate proceeds to the Company for the issuance of
these options was $4,535,563 at an average exercise price of approximately $2.46
per share.
3. WaveXpress:
In April 1999, the Company joined with Sarnoff Corporation to announce the
formation of a new joint venture, WaveXpress. WaveXpress aims to provide secure
data broadcast architecture, infrastructure and content services
<PAGE>
7
to broadcasters and content providers. WaveXpress is developing technology and
services that will allow content providers to send electronic content to
properly equipped PCs by utilizing unused bandwidth in the Digital Television
(DTV) spectrum. Consumers will be able to purchase this electronic content
directly through a secure network connection, thus enabling a significant new
revenue stream for broadcasters. On October 15, 1999, Wave and Sarnoff signed a
Joint Venture Agreement which formally established WaveXpress. Under this
agreement Sarnoff and affiliates received a 40% equity stake in WaveXpress. Wave
and its affiliates who purchased founders stock in April 1999 for a nominal
amount, own the remaining 60% of the outstanding capital stock. The affiliates
of Wave include Peter Sprague and Steven Sprague, the Chairman and Chief
Executive Officer of Wave, respectively, certain members of the Board of
Directors of Wave and certain employees of Wave. This affiliate group owned, in
the aggregate, 7% of the outstanding capital stock of WaveXpress. In addition,
Wave is currently funding WaveXpress through a series of convertible notes and
warrants. Through September 30, 2000, Wave has loaned WaveXpress approximately
$11.9 million. The notes and warrants can be converted into equity at a
predetermined conversion rate. When converted, on a fully diluted basis which
would include all stock, warrants and the WaveXpress Employee Stock Option Pool,
Wave and its affiliates would own approximately 72% of WaveXpress's outstanding
capital stock. Neither Sarnoff nor any of the other minority shareholders are
obligated to provide any funding to the venture. Accordingly, Wave has included
the entire net loss of WaveXpress in its consolidated results of operations. For
the quarter and year to date period ended September 30, 2000, WaveXpress has
incurred a net loss of approximately $3.3 million and $7.1 million respectively.
WaveXpress has incurred expenditures for R&D of approximately $2.0 million and
$3.7 million for the quarter and year to date period ended September 30, 2000.
4. Cash and cash equivalents:
Cash and cash equivalents consist of cash in the bank used for
operations and cash on deposit in a government money market account presently
earning an annualized rate of return of approximately 6%. The cash on deposit
is liquid and immediately available for the Company's operating requirements.
5. Marketable securities:
In 1999, Concentric (now Nextlink) acquired ITG. In consideration for
the 1,000,000 shares the Company held in ITG, when Concentric acquired ITG,
the Company received $2,162,457 in cash and 83,910 shares in Concentric. The
cost basis of the ITG shares to the Company was $1,620,000, resulting in a
gain of $542,457 during the first quarter of 2000. On May 10, 2000, Nextlink
Communications, Inc. acquired Concentric. As a result of the acquisition, the
Company now holds 107,975 common shares of Nextlink, Inc. due to the
conversion of the 83,910 Concentric shares at a conversion price of 1.2868.
As of September 30, 2000 the Nextlink common stock had a market value of
$3,799,370 based on that day's closing price of $35.1875 per share. The
change in the fair value of the Nextlink shares is recorded as an unrealized
gain in stockholders' equity.
6. Other assets:
Other assets consist primarily of security deposits associated with
facilities the Company leases. In January 2000 WaveXpress signed a ten year
lease for facilities in New York. As part of the agreement Wave placed a
deposit for $773,000 with a bank to secure the letter of credit in that
amount.
7. Global Wave:
In June, 2000, Wave increased its ownership percentage of Globalwave
Limited, (a joint venture) from 25% to 40% through its wholly-owned holding
company Earthquest Limited. As part of the new joint venture agreement, Wave's
partner in the venture, Redwave, Plc, (formerly ITG plc.) had agreed to
contribute $7.5 million and 500,000 shares of Wave Systems common stock held by
Redwave, in exchange for 600,000 shares of Global Wave class A common stock.
Earthquest received 400,000 shares of Globalwave class B common stock in
exchange for a
<PAGE>
8
technology license granted by Wave, on behalf of Earthquest to Globalwave. Prior
to September 30, 2000, no value had been assigned to these shares, as neither
Earthquest nor Wave had provided any funding to Globalwave.
On October 10, 2000, Wave and Earthquest had entered into an agreement
with Globalwave and Redwave to subscribe for additional class B shares of
Globalwave. Under the terms of the agreement, Wave shall procure that
Earthquest subscribes for 40,000 additional "B" shares of Globalwave at
(pound)100 per share (approximately $142.80), the consideration for which
will consist of (pound)1.5M (approximately $2.14M) in development costs
incurred by Wave on behalf of Globalwave, (pound)1.4M in cash ($2.0M), and
(pound)1.1M (approximately $1.6M) in future development services, for total
consideration of (pound)4.0M (approximately $5.7M). In addition, Redwave has
agreed to subscribe for an additional 60,000 Globalwave "A" shares, the
consideration for which will consist of the conversion of debt and cash
totaling (pound)6.0M (pound)5,966,615 in debt and (pound)33,385 in cash,
approximately $8.6 million). The resulting ownership interest in the venture
will remain 60% for Redwave and 40% for Wave.
As of September 30, 2000, Wave has contributed approximately $1.5M of
its committed investment in the form of development costs incurred. Pursuant
to the equity method of accounting, and because Wave has committed to provide
funding to the venture, the Company has recognized its equity share (40%) of
Globalwave's net losses since inception in its results for the quarter-ended
September 30, 2000. Globalwave's accumulated net losses (unaudited) since
inception are approximately $5.8 million through September 30, 2000.
Accordingly, Wave has recorded its equity in the net losses of $2.3M for the
quarter-ended September 30, 2000. Because Wave had previously not provided
any funding, and had not committed to provide any funding to Globalwave, none
of its equity in the prior period losses were recognized by Wave.
Also, in October, 2000, Wave and Redwave plc formed a joint venture
holding company, Wave European Technologies plc, for their European interests,
including their respective 40% and 60% stakes in Globalwave.
8. Purchase Acquisition
On August 31, 2000, the Company purchased substantially all of the assets
of Indigo Networks, LLC (Indigo) and its e-commerce shopping network,
iShopHere.com. The aggregate purchase price totaled $7,445,000, which consisted
of 374,889 shares of Class A Common Stock priced at $19.30 per share, for a
total value of $7,235,000 plus transaction costs of $210,000. The purchase price
was based on the average closing price of the company's Class A common stock for
the ten trading days immediately preceding the date of the purchase, in
accordance with the purchase agreement. The consolidated financial statements
include the operating results of iShopHere.com from the date of acquisition,
which consisted of a net loss of approximately $165,000.
The amount allocated to in-process research and development totaling
$2,176,000 was determined using established valuation techniques and was
expensed upon acquisition as technological and/or commercial feasibility had
not been established. The amount allocated to goodwill and purchased
intangible assets amounted to $4,578,000 and is being amortized on a
straight-line basis over periods not exceeding three years.
In conjunction with the purchase, the Company loaned $1,000,000 to the
partners of Indigo which was to be used by Indigo to pay existing accounts
payable and to cover operations up to the date of the purchase. As of
September 30, 2000, the balance of the note receivable from shareholder was
$840,809. This amount is included in the consolidated financial statements.
On October 24, 2000, Indigo's successor, Blue Windup, LLC signed a promissory
note for the outstanding balance owed to the Company. The note carries an
interest rate of 2% above the prime rate published in The Wall Street
Journal, and is payable in full on November 23, 2000.
PRO FORMA FINANCIAL INFORMATION
The selected unaudited pro forma condensed consolidated financial
information presented below has been derived from the audited and unaudited
historical financial statements of Wave and Indigo, and reflects management's
present estimate of pro forma adjustments, including a preliminary estimate of
the purchase price allocations, which ultimately may be different. This pro
forma presentation does not purport to represent what our financial position or
results of operations would actually have been if such transactions and events
had in fact occurred on those dates or to project our results of operations for
any future period.
<PAGE>
9
The unaudited pro forma consolidated statements of operations give effect
to the acquisition of Indigo as if it had occurred on January 1, 1999. The
unaudited pro forma consolidated balance sheet gives effect to the acquisition
of Indigo as if it had occurred on, June 30, 2000 pursuant to the purchase
method of accounting. These statements are based on historical financial
statements of Wave and Indigo and the estimates and assumptions set forth in the
accompanying notes to the Unaudited Pro Forma Condensed Consolidated Financial
Information.
WAVE SYSTEMS CORP. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR
THE YEAR ENDED DECEMBER 31, 1999
(000's omitted)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
Wave Indigo Adjustments Consolidated
---- ------ ----------- ------------
<S> <C> <C> <C> <C>
Net revenue $ 188 $ 32 $ -- $ 220
Cost of Sales 93 -- -- 93
------------ ------------ ------------ ------------
Gross Margin 95 32 -- 127
Operating Expenses 28,941 2,995 (1)(2)3,827 35,763
Other income (expense) 794 (5) -- 789
------------ ------------ ------------ ------------
Net loss (28,052) (2,968) (3,827) (34,847)
============ ============ ============ ============
Accrued dividends on
Preferred stock 13 -- -- 13
Net loss to common stockholders $ (28,065) $ (2,968) $ (3,827) $ (34,860)
============ ============ ============ ============
Weighted average common shares
outstanding during the period 38,365 -- 374,889 38,741
Loss per common share $ (0.73) $ -- $ -- $ (0.90)
============ ============ ============ ============
</TABLE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR
THE SIX MONTHS ENDED JUNE 30, 2000
(000's omitted)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
Wave Indigo Adjustments Consolidated
---- ------ ----------- ------------
<S> <C> <C> <C> <C>
Net revenue $ 77 $ 40 $ -- $ 117
Cost of Sales 50 -- -- 50
------------ ------------ ------------ ------------
Gross Margin 27 40 -- 67
Operating expenses 20,088 1,231 (1)825 22,144
Other income (expense) 2,612 (4) 2,608
------------ ------------ ------------ ------------
Net loss to common stockholders $ (17,449) $ (1,195) $ (825) $ (19,469)
============ ============ ============ ============
Weighted average common shares
Outstanding during the period 45,893 -- 375 46,268
Loss per common share $ (0.38) $ -- $ -- $ (0.42)
============ ============ ============ ============
</TABLE>
<PAGE>
10
WAVE SYSTEMS CORP. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION
AS OF JUNE 30, 2000
(000's omitted)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
Assets Wave Indigo Adjustments Consolidated
---- ------ ----------- ------------
<S> <C> <C> <C> <C>
Current Assets $ 110,408 $ 33 (3) $(10) $ 110,431
Property and Equipment, net 3,639 707 (3) (40) 4,306
Goodwill & Other Intangibles, net -- -- (1)(3)4,579 4,579
Other Assets 3,882 -- -- 3,882
------------ ------------ ------------ ------------
Total Assets $ 117,929 $ 740 $ 4,529 $ 123,198
============ ============ ============ ============
Liabilities and Stockholders Equity
Total Current Liabilities 4,887 2,525 (3) (2,315) 5,097
Non-Current Liabilities -- 421 (3) (421) --
Total Stockholders' equity 113,042 (2,206) (3) 7,265 118,101
------------ ------------ ------------ ------------
Total liabilities and stockholders' equity $ 117,929 $ 740 $ 4,529 $ 123,198
============ ============ ============ ============
</TABLE>
Notes to the Unaudited Pro Forma Condensed Consolidated Financial Information:
PRO FORMA ADJUSTMENTS
The following pro forma adjustments have been made to the selected unaudited
condensed consolidated statements of operations for the year ended December 31,
1999 and the six months ended June 30, 2000, and the condensed consolidated
statement of financial position as of June 30, 2000.
(1) To record amortization expense for the acquisition of goodwill and
other intangibles resulting from the allocation of the purchase
price as noted below, using useful lives not exceeding three years,
as if the acquisition of Indigo had been completed as of January 1,
1999.
(2) To record in-process research and development expense based on a
preliminary valuation and purchase price allocation.
(3) To eliminate the equity, cash and liabilities of Indigo not acquired
or assumed, and to record the issuance of 374,889 shares of Wave
Class A common stock, at an issuance price of $19.30 per share, as
if the acquisition of Indigo had occurred on June 30, 2000.
The purchase price was allocated on a preliminary basis. This preliminary
allocation is still subject to review, and is subject to change. The pro forma
adjustments included herein, were based on this preliminary allocation. A final
allocation of purchase price will be determined during the final quarter of
2000, and changes, if any, will result in a change to the amount of goodwill and
in process research and development recorded in connection with the acquisition.
The following is a summary of the allocation of the purchase price used for
purposes of the pro forma presentations included herein (000's omitted):
Purchase consideration $7,235,358
Direct Acquisition costs 210,000
----------
Total Purchase Price $7,445,358
Less tangible and intangible assets acquired:
Fair market value of tangible assets 691,612
In-Process R&D 2,176,000
----------
4,578,746
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11
Goodwill & other intangible assets:
Developed Technology $ 779,000
Assembled Work force 310,000
Contracts 77,300
Excess over identifiable assets 3,412,446
----------
Goodwill and other intangible assets $4,578,746
==========
CERTAIN FORWARD-LOOKING INFORMATION:
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. These statements include, but are not
limited to, statements regarding contingencies, future prospects, liquidity and
capital expenditures herein under "Part I Financial Information--Item 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations." Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below and
detailed in our other filings with the Commission during the past 12 months.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
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. The Company is
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 in a secure, trusted environment.
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,
movie and video 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 are also developing a secure e-commerce shopping
network, which will offer consumers access to quality
brands and retailers as well as special offers and
savings. 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, make use of software, or purchase traditional
retail goods and services, from the consumer's computer
or other interactive device. This means that content,
goods 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 secure delivery of electronic content, goods 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
<PAGE>
12
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.
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.
The iShopHere.com e-commerce shopping network provides
consumers access to quality brands and retailers. By
combining iShopHere.com's access to leading merchants
with Wave's EMBASSY Trusted Client e-commerce
technology, consumers will be able to complete
transactions over the internet securely and reliably.
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. Since 1998, we've 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, Compaq Computer, National
Semiconductor, KiSS Nordic, Cyber-COMM, INTERVU, AMD,
Hitachi, Lego Media, WavePhore and Biz Interactive Zone.
We hope to expand the number of commitments from
hardware manufacturers, including personal computer
manufacturers, peripheral companies and other companies
involved in e-commerce.
Recent Financings.......On March 7, 2000 the Company completed a $122 million
private placement with institutional, strategic and
accredited investors, which we feel will be sufficient
to fund operations through the end of 2001. We may
choose to raise additional capital from time to time,
through equity or
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13
debt financings, in order to capitalize on business
opportunities and market conditions. This would help to
ensure the continued development of our technology,
products and services. In January 1999, we issued a $2
million convertible promissory note, which was
subsequently converted into Class A common stock in
March 1999. We also completed a $23 million private
placement with institutional, strategic and accredited
investors in March 1999. We cannot, however, assure you
that we can raise additional financing in the future.
While we do not have any material commitments for
capital expenditures at this time, in order to bring the
Wave System to market, we do anticipate spending
additional amounts on contracting for software
development, licensing key technologies, and purchasing
inventory items such as computer chips and boards. Such
spending will vary based on our performance.
Growth..................We are focusing on our operational and marketing
infrastructure, in order to evolve our internal
production and fulfillment systems. We plan also to
increase the resources available to WaveNet to adapt to
changing market requirements, and expand it to handle
more end users, to implement more sophisticated pricing
methodologies and to add greater financial system
flexibility.
R&D.....................We are a development stage company and have realized
minimal operating revenues since our inception. At
September 30, 2000, we had an accumulated deficit of
approximately $126.9 million. We have made a substantial
investment in research and development, of $6.0 million
and $14.0 million for the quarter and year to date
period ended September 30, 2000, and we expect that we
will be required to continue to make substantial
investments in our products and technology. For the
years ended December 31, 1999, 1998, and 1997, we spent
approximately $10.7 million, $6.2 million and $4.7
million, respectively, on research and development
activities (which amounts include the value of stock
issued). In addition, we licensed technology and
in-process research and development from Aladdin
Knowledge Systems for cash and warrants valued at $3.9
million in July 1997. From our inception in February
1988 through September 2000, we have spent approximately
$47.4 million on research and development activities.
Nasdaq Listing..........We filed an application with the Nasdaq Stock Market on
January 29, 1999, seeking to list our common stock on
the Nasdaq National Market. As of May 27, 1999 we were
re-listed on the Nasdaq National Market.
Acquisitions............On August 31, 2000, the Company purchased substantially
all of the assets of Indigo Networks, LLC (Indigo) and
its e-commerce shopping network, iShopHere.com. The
aggregate consideration paid by the Company to Indigo
consisted of 374,889 shares of Class A Common Stock
priced at $19.30 per share, for a total purchase price
of $7,445,000, which includes $210,000 in transaction
costs. The purchase price was based on the average
closing price of the company's Class A common stock for
the ten trading days immediately preceding the date of
the purchase, in accordance with the purchase agreement.
The consolidated financial statements include the
operating results of iShopHere.com from the date of
acquisition.
On July 28, 1999 the Company announced it had acquired
all of the outstanding common and preferred shares of
N*ABLE Technologies, a security solutions company, in
exchange for 2,781,263 shares of the Company's Class A
Common Stock. The transaction was accounted for under
the pooling-of interest method of accounting and
accordingly, all financial data presented herein for
1999 has been restated as if N*Able was acquired on
January 1, 1999.
Subsequent Event........On October 10, 2000, Wave through its wholly-owned
holding company Earthquest Limited entered into an
agreement with GlobalWave and Redwave to subscribe for
additional class B shares of GlobalWave. Under the terms
of the agreement, Wave shall procure that Earthquest
subscribes for 40,000 additional "B" shares of
Globalwave at (pound)100 per share (approximately
$142.80), the consideration for which will consist of
(pound)1.5 million (approximately $2.14 million) in
development costs incurred by Wave, (pound)1.4 million
in cash ($2.0 million), and (pound)1.1 million
(approximately $1.6 million) in future development
services, for total consideration of (pound)4.0 million
pounds sterling (approximately $5.7 million). In
addition, Redwave has agreed to subscribe for an
additional 60,000 Globalwave "A" shares, the
consideration for which will consist of the conversion
of debt and cash totaling (pound)6.0 million
<PAGE>
14
(pound)5,966,615 in debt and (pound)33,385 in cash,
approximately $8.6 million). The resulting ownership
interest in the venture will remain 60% for Redwave and
40% for Wave. As a result of Wave's commitment to fund
the joint venture, Wave has recorded a charge of
$2,320,000 to recognize its equity in Globalwave's
losses since their inception.
Also, in October, 2000, Wave and Redwave plc formed a
joint venture holding company, Wave European
Technologies plc, for their European interests,
including their respective 40% and 60% stakes in
Globalwave.
We are incorporated in Delaware, and were known previously as Indata Corp.
We changed our name to Wave Systems Corp. in January 1993. Our principal
executive offices are located at 480 Pleasant Street, Lee, Massachusetts 01238,
and our telephone number is (413) 243-1600.
Results of Operations
Three Months Ended September 30, 2000 and 1999
Revenues for the three months ended September 30, 2000 were $81,793 as
compared to $51,002 for the three months ended September 30, 1999. Revenues
consisted primarily of internet services, license fees and hardware sales.
Selling, general and administrative expenses for the three months ended
September 30, 2000 were $7,260,914, as compared to $4,065,242 for the comparable
period of 1999, an increase of 79%. This increase is primarily attributable to
an increase in personnel, consultants and professional fees, trade shows,
equipment and other related costs associated with the marketing of new
applications and development of new markets for our technology, as well as
expenses of WaveXpress and iShophere.com. Selling, general and administrative
expenses for WaveXpress and iShopHere.com were $1,324,943 and $101,800,
respectively for the three months ended September 30,2000
Research and development expenses for the three months ended September 30,
2000 were $5,974,662, as compared to $2,967,458 for the comparable period of
1999, an increase of 101%. This increase is primarily attributable to an
increase in headcount and consulting-related expenses, as well as the impact of
the WaveXpress development work during the three months ended September 30,
2000. WaveXpress' research and development expenses were $1,998,502 for the
quarter ended September 30, 2000. iShopHere.com's development expenses for the
quarter-ended September 30, 2000 were $63,472.
Interest income for the three months ended September 30, 2000 was
$1,609,557, as compared to $190,606 for the comparable period of 1999. The
increase in interest income is primarily attributable to an increase in
interest-bearing assets, which were a direct result of the private placement of
Class A Common Stock for an aggregate purchase price of approximately $122.0
million.
One time in-process research and development and acquisition expenses for
the three months ended September 30, 2000 were $2,176,000, related to the Indigo
Networks, LLC acquisition. This compares to one time charges of $1,494,000 for
the three months ended September 30, 1999, which were incurred as a result of
the acquisition of N*able Technologies was accounted for as a pooling of
interests.
Our equity in losses on our investments in Globalwave were $2,320,000 for
the three month period ended September 30, 2000. There was no loss realized on
investments in joint ventures for the comparable period in 1999.
<PAGE>
15
Due to the reasons set forth above, our net loss to common stockholders
for the three months ended September 30, 2000 was $16,182,892, as compared to
$8,312,919 for the comparable period of 1999.
Nine months Ended September 30, 2000 and 1999
For the nine months ended September 30, 2000 and September 30, 1999, we
had revenues of $159,142 and $70,229 respectively, from a combination of
hardware services, internet sales and license fees.
Selling, general and administrative expense for the nine months ended
September 30, 2000 were $19,280,496 as compared to $11,086,650 for the
comparable period of 1999, an increase of 74%. This increase is primarily
attributable to an increase in personnel, trade shows, equipment and other
related costs associated with the marketing of new applications and the
development of new markets for our technology, as well as selling, general and
administrative expenses of WaveXpress
Research and development expenses for the nine months ended September 30,
2000 were $14,043,367 as compared to $7,281,088 for the comparable period of
1999, an increase of 92%. This increase is attributable to an increase in
headcount, consulting-related expenses and WaveXpress development work during
the first nine months of 2000. WaveXpress' research and development expenses
were $3,706,807 for the year to date period ended September 30, 2000.
Interest income for the nine months ended September 30, 2000 was
$3,679,312 as compared to $501,146 for the same period in 1999. The interest
income in 2000 is due to the $122 million private placement, which occurred in
March 2000. Interest expense for the nine months ended September 30, 1999 was
$832,629, while no interest expense was incurred for the comparable period of
2000. The interest expense in 1999 was primarily attributable to non-cash
expenses associated with the issuance of warrants as part of the 1999 bridge
financing.
In 1999, Concentric (now Nextlink) acquired ITG. In consideration for
its 1,000,000 shares in ITG, the Company received approximately $2,162,457 in
cash and 83,910 shares of Concentric. The cost basis of the ITG shares to the
Company was approximately $1,620,000, for a gain of $542,457. During January
of 2000, Concentric Network Corporation completed their acquisition of ITG.
On May 10, 2000 Concentric was acquired by Nextlink Communications,
Incorporated. As a result, the Company's holdings became 107,975 shares of
Nextlink common stock, which had a market value of $3,799,370 based on that
day's closing price of $35.1875 per share.
Net losses realized on investments in our Globalwave joint venture were
$2,320,000 for the nine month period ended September 30, 2000. There was no loss
realized on investments in joint ventures for the comparable period in 1999.
Due to the reasons set forth above, our net loss to common stockholders
for the nine months ended September 30, 2000 was $33,631,821 as compared to
$18,921,205 for the comparable period of 1999.
Liquidity and Capital Resources
We have experienced net losses and negative cash flow from operations
since our inception, and, as of September 30, 2000, had a $126,898,994
deficit accumulated during the development stage, and stockholders' equity of
$105,360,364. We have financed our operations through September 30, 2000
principally through the issuance of Class A and B common stock, and various
series' preferred stock, for total proceeds of approximately $228,460,000.
<PAGE>
16
At September 30, 2000, we had $93,981,883 in cash and cash equivalents. At
December 31, 1999, we had $6,290,045 in cash and cash equivalents. We held
marketable securities with a value of $3,799,370 and $2,860,500 at September 30,
2000 and December 31, 1999, respectively. The increase in cash and cash
equivalents is primarily attributable to cash proceeds from a private placement
during the first quarter of 2000. In March 2000, we issued 3,600,800 shares of
our Class A Common stock for $114,977,416, net of expenses. The Company also
received $2,162,457 of cash associated with its ownership of 1,000,000 ITG
shares. Warrants were exercised during the period for proceeds of $1,334,245,
and employee incentive stock options were exercised for proceeds of $4,535,563
during the period.
As of December 31, 1999, the Company had net operating loss carryforwards
for tax return purposes of approximately $80.1 million, which expire beginning
in 2003 through 2020.
Pursuant to the Internal Revenue Code, Section 382 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.
At September 30, 2000, we had working capital of $92,117,990. We expect we
may incur substantial additional expenses resulting in significant losses at
least through the period ending December 31, 2001, due to minimal revenues and
increased sales and marketing expenses associated with market entry, and
continued research and development costs. We anticipate that our existing
capital resources will be adequate to satisfy our capital requirements through
the end of 2001. Beyond 2001, in order to continue operations, we will need to
raise additional funds through public or private financings. We have no current
commitment to obtain additional funds, nor can we state the amount or source of
such additional funds.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The exposure to market risk associated with interest rate-sensitive
instruments is not material to the Company. Our investment portfolio consists
primarily of money market funds that meet high credit quality standards and the
amount of credit exposure to any one issue is limited. In addition, we hold a
minority equity investment in a publicly traded company, the value of which is
subject to market price volatility.
PART II - OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K
Exhibits
27 Financial Data Schedule
Reports on Form 8-K: The Company filed a current report on Form 8-K on
September 15, 2000 (as subsequently amended on November 13, 2000), to report the
acquisition of substantially all of the assets of Indigo Networks, LLC.
<PAGE>
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 14, 2000
WAVE SYSTEMS CORP.
(Registrant)
By:
----------------------------------------------
Name: Steven Sprague
Title: President and CEO
(Duly Authorized Officer of the Registrant)
By:
----------------------------------------------
Name: Gerard T. Feeney
Title: Chief Financial Officer
