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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
/ / 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)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, $.01 PAR VALUE
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of Common Stock of the
registrant held by non-affiliates as of March 18, 2002 was $103,218,887. (For
purposes of this calculation, the market value of a share of Class B Common
Stock was assumed to be the same as a share of Class A Common Stock, into
which it is convertible.)
As of March 18, 2002 there were 50,061,506 shares of the registrant's
Class A Common Stock and 327,083 shares of the registrant's Class B Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Stockholders'
Meeting to be held on or about June 24, 2002 are incorporated by reference into
Part III. The Exhibit index is located on page 23.
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EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS FORM 10-K CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE U.S. SECURITIES LITIGATION
REFORM ACT OF 1995. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND
UNCERTAINTIES THAT MAY CAUSE THE COMPANY'S ACTUAL RESULTS OR OUTCOMES TO BE
MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, THE
COMPANY OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE
AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND THE COMPANY'S
CONTROL. IMPORTANT FACTORS THAT THE COMPANY BELIEVES MIGHT CAUSE SUCH
DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE
FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN THE COMPANY'S
OTHER FILINGS WITH THE COMMISSION DURING THE PAST 12 MONTHS. IN ASSESSING
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY
ALL RISK FACTORS AND CAUTIONARY STATEMENTS CONTAINED IN THIS FORM 10-K AND IN
THOSE OTHER FILINGS WITH THE COMMISSION.
TABLE OF CONTENTS
PART I............................................................................................................1
Item 1. Business........................................................................................1
Item 2. Properties......................................................................................8
Item 3. Legal Proceedings...............................................................................8
Item 4. Submission of Matters to a Vote of Security Holders.............................................8
PART II...........................................................................................................9
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...........................9
Item 6. Selected Financial Data........................................................................10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..........................................................................11
Item 7A. Quantitative and Qualitative Disclosure about Market Risk......................................20
Item 8. Financial Statements and Supplementary Data....................................................20
Item 9. Changes in and Disagreements with Accountant on Accounting and
Financial Disclosure...........................................................................20
PART III.........................................................................................................20
Item 10. Directors and Executive Officers of the Registrant.............................................20
Item 11. Executive Compensation.........................................................................20
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................21
Item 13. Certain Relationships and Related Transactions.................................................21
PART IV..........................................................................................................22
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...............................22
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS...........................................................................F-44
PART I
ITEM 1. BUSINESS
Wave Systems Corp. ("Wave" or "we") develops, produces and markets
hardware and software based digital security products for the Internet and
e-commerce. Wave's technology involves the use of encryption, which is the
process of making data indecipherable. At the heart of Wave's technology is the
EMBASSY (EMBedded Application Security SYstem) Trust System (the "ETS"). The ETS
is a combination of client hardware and software and a back-office
infrastructure that manages its security functions. The client hardware consists
of the EMBASSY 2100 security chip (the "EMBASSY chip"). EMBASSY chips may be
embedded in such user devices as computer keyboards, smart card readers, PC
motherboards, PC and/or cable modems, personal digital assistants, cable set-top
boxes and potentially a wide variety of other user devices. The EMBASSY chip is
used to securely store the user's personal information such as usernames,
passwords, personal identification numbers, credit card information and personal
information such as social security number, name and address. In addition, the
EMBASSY system stores encrypted applets that can be called upon to perform a
variety of secure functions such as strong authentication, e-commerce and
digital rights management, electronic payments, metering of digital content and
other functions.
The ETS has been designed to combine the security strength of
hardware, with the flexibility of software, providing a distributed, open and
fully programmable platform. Wave believes the flexibility of the ETS positions
it to exploit future opportunities as privacy and security requirements evolve
and change. This flexibility allows EMBASSY to fulfill developing security
requirements, while addressing a broad range of advanced applications such as
content protection, user managed privacy, strong authentication of user
identities, and distributed e-commerce. While single function security solutions
are available, the architecture achieved by EMBASSY provides the capability for
multiple entities, such as service providers, content owners and individuals to
share a single device while trusting that their individual interests have been
strongly protected from both local and network sources of attack.
WAVE COMMERCE SYSTEM
The Wave Commerce System (the "Commerce System") comprises two
main functions: authentication and commerce. Each of these functions provides
multiple services enabled by the ETS. The authentication services component
positively identifies the person wishing to access protected content. It
accomplishes this through a protected applet in conjunction with the EMBASSY
device. The goal of the Commerce System is to provide digital commerce,
completely secure from unauthorized access. Web site owners would use
authentication services to replace less secure username/password pairs with
strong authentication. Content providers use commerce services to distribute
digital content. The Commerce System allows flexible purchase models for the
sale of digital content including rental, rent-to-own and event-based
charges. This means that content, goods and services can be consumed with
more efficient and flexible pricing, broader distribution opportunities and
greater protection against unauthorized usage, with better privacy protection
of the consumer's sensitive information.
The Commerce System utilizes the Wavenet back-office ("Wavenet").
Wavenet is a network of servers that supply full e-commerce functions, customer
relationship management tools, security capabilities and digital rights
management. Wavenet is transparent to the consumer. All of the account specific
commerce functionality occurs at the EMBASSY Client PC. Wavenet provides the
back-office capabilities that support the following capabilities: content
protection, content use metering, micro-transactions, Internet based
communities, Internet based strong authentication and e-commerce (multiple
language and currency capabilities, sales and value added tax capabilities,
transaction clearing services, royalty payment system and business logic and
royalty rule definition).
DIGITAL SIGNATURE AND ELECTRONIC DOCUMENT MANAGEMENT
On October 4, 2001 Wave acquired digital signature technology,
SmartSignature and SmartSAFE from SignOnLine, Inc. ("SignOnLine"), a
California-based company. SmartSignature is a digital signature application that
allows for the interaction of users ("Signers") and financial service providers,
such as banks,
brokerage houses, lessors and mortgage companies ("Providers"), whereby the
Signer can digitally sign a document that will then be considered a legally
binding signature. SmartSAFE is a web-based document management application,
with an upload process initiated by the Signer. Once uploaded, the documents are
validated and archived. A Provider may then log into the SmartSAFE to review and
manage documents that have been signed. When a document is requested for
viewing, the SmartSAFE creates a certified copy including pertinent signature
information. SmartSAFE also supports archival and management of unsigned
documents in virtually any format.
DATA BROADCAST
WaveXpress, Inc. ("WaveXpress"), a joint venture between Wave and
Sarnoff Corporation ("Sarnoff") which is 82% owned by Wave (assuming all of
Wave's and Sarnoff's convertible securities are converted), has developed
products designed to offer cable television multiple service operators ("MSOs")
a complete solution for implementing a new high speed delivery offering called
IP (Internet Protocol) Multicast that allows the consumer to experience and
manage rich digital content on their PC. These products are being actively
marketed to MSOs. Wave believes that benefits of these products to MSOs
include: new incremental revenue streams from dormant, underutilized and
off-peak bandwidth, service bundling opportunities, flexible content and pricing
offerings, strength of the ETS security products and an advanced consumer
experience.
Wave was 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 is (413) 243-1600.
Wave is a development stage company and has realized minimal
operating revenues since our inception. Substantially all of Wave's revenues in
each of the three years ended December 31, 2001 have been related to the ETS.
For the years ended December 31, 2001, 2000, and 1999 Wave incurred losses to
common shareholders of $48,701,057, $47,656,000, and $28,066,000, respectively.
At December 31, 2001 we had an accumulated deficit of approximately
$189,624,000. There can be no assurance that we will ever be successful in
achieving commercial acceptance of the Wave System.
MARKETS AND BUSINESS STRATEGY
Wave is seeking to become a leader in digital security and
e-commerce technology. Our objective is to make our EMBASSY Trust System the
preferred infrastructure for security in the digital economy. Key components in
achieving this goal include:
CAPITALIZING ON SECURITY INDUSTRY TRENDS
Wave believes that a key differentiator of the ETS is that it is
open and programmable and combines the strong security of hardware with the
flexibility of software. Wave believes that ultimately, a truly secure system
must include hardware protection. Additionally, Wave foresees that single
purpose hardware solutions will not be effective as the hardware will have to
support multiple applications to be an effective solution. Therefore, in a
business environment of evolving encryption algorithms, multiple digital rights
management solutions, multiple platforms needing to be supported (PC, PDA,
Mobile, set-top box); Wave's open and programmable, hardware based solution will
have significant advantages over software only, or single purpose hardware
device solutions.
CAPITALIZING ON E-COMMERCE INDUSTRY TRENDS
Wave has designed the ETS with features and functionality that it
believes uniquely positions its platform to capitalize on e-commerce issues and
trends. Wave sees these issues and trends as follows:
o Rampant piracy of digital goods including music, video,
software, and the need for digital goods providers to securely
distribute their content and prevent theft
o Mass media broadcast networks merging with the internet
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o Rapid development of new business and distribution models
o Lack of adequate security for e-commerce and vulnerability to
attacks
o Major privacy concerns o Convergence of consumer electronics and
PC's
o Legal status of digital identities and digital signatures
o Increased focus on security and privacy by government entities
Wave will continue to pursue strategic relationships with hardware
manufacturers, systems integrators and companies involved in the development of
commerce in electronic content and services to achieve broad market acceptance
of its products as a distributed security platform for commerce performed in
user devices.
PURSUE STRATEGIC MARKETING AND DISTRIBUTION ALLIANCES
We intend to continue to enter into strategic alliances with key
partners that could distribute our products in enterprise, government and
consumer markets. Over the past several months, we have formed alliances with
such industry leaders as Samsung Electro-Mechanics Co., Ltd, Maximus, Thomcast,
Inc. and SSP Solutions, Inc. ("SSP"). In addition, we are pursuing strategic
relationships with PC OEM's, Internet Service Providers and major systems
integrators.
ENHANCING OUR CURRENT PRODUCT OFFERINGS
We intend to continue to develop and extend our product offerings
to include features and functionality that will satisfy the changing needs in
the computer security arena and the computing and e-commerce industries in
general. Planned development efforts include a significantly enhanced version of
our SmartSignature and SmartSAFE products. We intend to also build upon and
enhance our Trusted PC concept, to continue development efforts towards
standards-based security platforms (such as the European Transactional IC Card
Reader standard, FINREAD) and to also pursue efforts to port the ETS to
different computing platforms, as needed.
MARKETING, SALES AND CUSTOMERS
Wave's business model targets revenues from various sources
including: licensing of our technology including EMBASSY and its supporting
software infrastructure; fees from entities who use EMBASSY to secure their
applets on PCs; and usage and transaction-based fees from content management,
e-commerce and other services enabled by EMBASSY. In addition, we derive revenue
from outright sales of hardware and development contracts.
Wave has identified four key markets where we believe the EMBASSY
Trust System provides unique benefits:
o Banking and Finance - in addition to our European initiatives to
be a leader in delivering FINREAD-standard devices, we are
aggressively cultivating interest and support from U.S.
financial institutions.
o Broadband Media - through our WaveXpress joint venture, we are
developing a broadband architecture for persistent protection of
content to the hard disk at home.
o PCs - Wave-sponsored market research strongly confirms the
existence of substantial consumer demand for PC trust and
security and a willingness to pay for such features. We are
aggressively targeting a PC manufacturer deployment opportunity.
o Government and Enterprise - the market for electronic security
systems in governmental units and large business enterprises is
growing and Wave believes this market represents a key
opportunity.
Directly and through our partners, Wave is aggressively targeting opportunities
in these markets as we believe the ETS provides an unequaled range of security
and trust capabilities.
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Our sales force will focus on business development opportunities
in these key markets and others. Within these key markets we will focus on
closing business with large systems integrators, financial institutions, Cable
MSOs, personal computer manufacturers, and government and enterprise customers.
BACKLOG
Wave's backlog consists of hardware sales and development contract
revenue expected to be recognized in 2002. Wave's backlog as of December 31,
2001 totaled $243,000. Backlog can fluctuate greatly based upon, among other
matters, the timing and receipt of orders. Therefore, backlog may not represent
a fair indication of future business trends.
COMPETITION
We operate in a highly competitive and fragmented environment that
is characterized by rapidly evolving technology. Many of our competitors and
potential competitors in these markets have substantially greater financial,
technical and marketing resources than Wave does. Also, many current and
potential competitors have greater name recognition and more extensive customer
bases that could be leveraged, thereby they can gain market share or product
acceptance to our detriment. In addition, the rate of market acceptance of
content protection solutions has remained slow. Wave Systems has developed
and/or acquired products and services in the following four primary areas:
o EMBASSY Trust System Platform
o Wave Commerce System
o Data Broadcasting
o Digital Signature Electronic Document Management Applications
These are developing markets, which have not yet established clearly defined
industry standards. Wave views these markets as having any number of competitors
and potential competitors from small emerging enterprises developing niche
technologies and products, to large well established computer and electronic
manufacturers, software companies and systems integrators.
The competitive factors defining these markets include product
performance, compatibility, standards compliance, quality and reliability,
ease of use, client services and support, distribution and price. Wave
believes its products meet the requirements to be successful viable products
in these markets. Wave's features that should allow its products to compete
favorably include product differentiation of a combined software/hardware
solution, system integrity, secure communication, fault tolerance, data
privacy, and independent customer operation. In addition, Wave may have the
opportunity to be "first to market" with its data broadcasting and digital
signature products.
One of the market challenges facing Wave is to the establishment
of a new market category for multifunction security devices that includes a more
complex business model for adoption. While Wave has developed a very complex
cryptographic system that required significant skills and resources, it is also
possible for other competitors to develop similar offerings to compete with the
ETS, or new technologies may emerge that could replace existing technology that
our products rely on, thereby making our products non-competitive or obsolete.
We can offer no assurances that Wave's products will become industry standards
or become widely accepted by the marketplace.
INTERNATIONAL MARKET
Most of our products and many components of the ETS are controlled
under various United States export control laws and regulations and may require
export licenses for certain exports of the products and components outside of
the United States and Canada. We have received full export license from the U.S.
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Department of Commerce for the sale and export of our single-key Data Encryption
Standard ("DES") products. We have also received an export license for our
triple-key DES chips under the provisions of License Exceptions KMI or ECN,
granted by the Bureau of Export Administration of the U.S. Department of
Commerce ("BXA"). The remainder of our products and components of the ETS are
generally exportable to any end-user in any country throughout the world with
the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria.
We can provide no assurance that we will have patent protection or
that we will not infringe patents of other 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 ETS may not be permitted in any particular foreign
jurisdiction.
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
upon or circumvented. Furthermore, you should understand that our activities may
infringe upon patents owned by others.
In addition, we may be required to obtain licenses to patents or
other proprietary rights of other 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 attempt 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 (the "Licensed Patent"). 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 owners
of this patent, who have the right to exploit, or to license this patent to
third parties in a manner that may be competitive with us. The joint owners of
this patent may compete with us or license this patent to a competitor of ours,
or 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 Wave 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 such claims or license such technology.
Also, the holder of the Third Party Patents or a licensee of the Third Party
Patents could seek to invalidate such claims of the Licensed Patent and
therefore be able to commercialize a technology similar to 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 provide any assurance 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 provide any assurance that the Third Party Patents could
be proven to be invalid on any other basis. Any proceeding involving the
validity of the Licensed Patent and the Third Party Patents would be protracted
and costly. In any suit contesting the validity of a patent, the
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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 engaged in
negotiations with the holder of the Third Party Patents to obtain a license
under the Third Party Patents. As a result of these negotiations, Wave has
entered into a license of limited rights to use the Third Party Patents in
connection with certain uses. Wave did not obtain, however, a general license to
use such patents in connection with activities not connected with the licensor.
Wave has been issued ten (10) United States patents relating to
encryption and to our proprietary EMBASSY and Wave Commerce technology. We also
have six patents pending before the United States Patent Office. In addition, we
have filed foreign patent applications for seven patents. Our patents are
material to protecting some of our technology.
Some of our patent rights derive from a license from Wave's
Chairman, Mr. Peter J. Sprague, 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. There can be no assurance that we will enjoy exclusive rights
to these patents under such agreements.
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 if such a breach occurs.
Furthermore, we can provide no assurance that our trade secrets will not
otherwise become known or be independently discovered by competitors.
We also rely on copyright law 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 agreements with
our consultants. We can provide no assurance 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, EMBASSY, Great Stuff Network, Second Shift (the Wave juggler logo),
WaveCommerce, Wave Interactive Network, WaveDirect, WINPublish,
WINPurchase,CablePC, iShopHere and Face/Eye logo (iShopHere.com face logo). We
have submitted trademark registrations for, EMBASSY System, Netpass, CharityWave
and Trust @ the Edge, Signon-line, Inc., Smartsignature, Smartsafe and others.
Wave intends to apply for additional name and logo marks in the United States
and foreign jurisdictions as appropriate. No assurance can be given that federal
registration of any of these trademarks in the United States will be granted. We
have abandoned our prior applications for DataWave, InfoWave, and WaveTrac.
RESEARCH AND DEVELOPMENT
Wave's products incorporate semiconductor, encryption/decryption,
software transaction processing and other technologies in which we have made a
substantial investment in research and development. We will likely be required
to continue to make substantial investments in the design of the ETS, the
Commerce System our SmartSignature and SmartSafe products, and IP Multicasting
products. For the years ended December 31, 2001, 2000, and 1999 we expended
approximately $17.7 million, $20.9 million, and $10.7 million, respectively, on
research and development activities (such amounts include the value of stock
issued). In addition to our ongoing research and development activities, in July
1997 we licensed
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technology and in-process research and development from Aladdin Knowledge
Systems ("Aladdin") for cash and warrants valued at $3.9 million. This
technology is an integral part of the Commerce System. 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
Wave's technology to interface with various platform environments, and the
ability of Wave's products to work in many application environments.
Incorporation of Aladdin's Hasp technology furthered these efforts and
illustrates the adaptive capabilities of Wave's products. 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 ETS and the Commerce System. By
providing various means of linking the ETS to the customer's computer or
network, we will be more likely to achieve broad acceptance of our technology.
We are currently researching other form factors for the EMBASSY chip 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 Wave's products. We will also increase the resources available to the
Commerce System to adapt to changing market requirements. We plan to continue to
expand the Commerce System to handle more end users, to implement more
sophisticated pricing methodologies and to add greater financial system
flexibility.
RECENT DEVELOPMENTS
On February 2, 2001, Wave entered into a stock purchase agreement
(the "Agreement") with BIZ Interactive Zone, Inc. ("BIZ"), a privately held
company, under which it acquired 3,600,000 shares of the Series B Preferred
Stock of BIZ in exchange for 2,000,000 shares of Wave's Class A Common Stock, at
a price of $7.16 per share, for an aggregate purchase price of $14,312,800.
Wave's investment in BIZ represented approximately 17.8% of the outstanding
capital stock of BIZ. Accordingly, Wave accounted for this investment using the
Cost Method of accounting, as the investment represents less than a 20%
ownership interest in BIZ and because Wave does not have significant influence
over BIZ. On August 24, 2001 Litronic, Inc. ("Litronic"), a provider of
authentication and encryption security technology, completed a merger with BIZ
to form SSP. SSP trades on the NASDAQ National Stock Market as SSPX. As a result
of the merger, Wave now holds 3,083,083 shares (14.95%) of the common stock of
SSP. (See also Item 7A. Quantitative and Qualitative Disclosure about Market
Risk).
In June of 2001, Wave and SCM Microsystems, Inc. formed a
strategic relationship to produce EMBASSY smart card readers designed to address
European Level 5 standards for secure pin entry and secure display. Level 5
specifications guarantee a level of online security that is among the highest in
the world, enabling secure electronic transaction protocols and other forms of
secure financial services transactions. The new EMBASSY readers will have the
ability to support a continually high level of flexibility and security by
working in conjunction with Wave's back office infrastructure for secure
distribution of applets to the devices that can provide various security
functions.
In August of 2001, Wave and Maximus signed a strategic
agreement to identify and close joint business opportunities through
co-marketing their products and services to government agencies nationwide.
Maximus, a leading provider of program management, information technology and
consulting services to government agencies, will offer the ETS as part of their
total security solutions portfolio. Wave will co-market Maximus development
services for creating EMBASSY applications.
In October of 2001, Wave acquired digital signature and electronic
document management technology from SignOnLine, Inc. Wave acquired two products,
SmartSignature and SmartSAFE, which combine powerful e-signature capability with
secure storage functions thus meeting both the signing and authoritative record
requirements of the e-Sign legislation. The technology ensures the integrity of
a legally-binding digital contract by a process of ensuring a signer's identity
through strong authentication methods. Wave is marketing these products to
financial institutions as a means for them to enable their customers to sign
documents electronically, thus eliminating the need to move paper documents back
and forth between the
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institution and the consumer. The financial institution will then have the
ability to store legally executed documents electronically, as opposed to
keeping paper copies of these documents.
In November of 2001, Wave and Samsung Electro-Mechanics Co., Ltd
began working together to manufacturer and market secure keyboards containing a
built in smart card reader built around Wave's EMBASSY chip. Wave believes this
is a key step to bring its secure smart card reader technology to market by
integrating a secure EMBASSY-based smart card reader directly into the PC
keyboard, with no other attachments needed.
EMPLOYEES
As of December 31, 2001, we employed 180 full-time employees, 86
of whom were involved in sales, marketing and administration and 94 of whom were
involved in research and development (including 34 employed by WaveXpress, 14 of
whom were in sales, marketing and administration and 20 of whom were involved in
research and development.) As of December 31, 2001 we retained the services of 7
full-time consultants, 1 of whom was retained by WaveXpress. We believe our
employee relations are satisfactory.
ITEM 2. PROPERTIES
Summarized below is a listing of properties leased by Wave. Our
principal research and development activities are conducted at the Princeton and
Cupertino facilities.
UTILITY/COMMON
FACILITY SQ. FT. MONTHLY BASE RENT COSTS LEASE EXPIRES
Lee, MA 16,548 $ 12,258 - 0 - Aug. 2004
New York, NY 4,500 14,250 - 0 - May 2002
Nashville, TN 5,757 3,409 526 Sept. 2002
Princeton, NJ 21,673 43,346 2,312 Dec. 2002
Cupertino, CA 12,329 42,712 2,609 Oct. 2002
New York, NY 12,282 42,987 9,371 Apr. 2010
Orvault, France 1,000 2,674 400 Sept. 2010
ITEM 3. LEGAL PROCEEDINGS
As of December 31, 2001 Wave was not involved in any material
litigation, nor, to management's knowledge is any material litigation threatened
against them or their properties other than routine litigation arising in the
ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-8-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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.
HIGH LOW
Year Ended December 31, 2001
First Quarter $9.34 $3.47
Second Quarter 5.37 3.26
Third Quarter 4.19 1.69
Fourth Quarter 3.48 1.52
Year Ended December 31, 2000
First Quarter $47.94 $11.50
Second Quarter 32.44 13.00
Third Quarter 24.06 15.06
Fourth Quarter 16.00 4.50
As of March 18, 2002, there were approximately 33,000 holders of
our Class A Common Stock. As of such date, there were 30 holders of our Class B
Common Stock.
On March 18, 2002, the last sale price reported on the Nasdaq
National Market for the Class A Common Stock was $2.10.
We have never declared nor 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.
RECENT SALES OF UNREGISTERED SECURITIES
On February 2, 2001, Wave issued 2,000,000 shares of its Class A Common
Stock, at a price of $7.16 per share, for an aggregate purchase price of
$14,312,800 to acquire 3,600,000 shares of the Series B Preferred Stock of
BIZ, then a privately held company. Wave's investment in BIZ represented
approximately 17.8% of the outstanding capital stock of BIZ. Accordingly, the
investment had been accounted for under the cost method of accounting,
because the investment is less than 20% of the outstanding capital stock of
BIZ and because Wave could not exercise significant influence over BIZ. On
August 24, 2001, Litronic and BIZ completed a merger of the two companies and
renamed the newly formed company SSP Solutions, Inc. ("SSP"). As a result of
the merger, Wave now holds 3,083,083 shares (14.95%) of the common stock of
SSP. Wave has accounted for this investment as non-current marketable equity
securities available for sale based upon our intent to hold these securities
as a long-term investment. As of December 31, 2001, this investment was
valued at $11,160,758 based on that day's closing price of SSP Common Stock
on the NASDAQ national exchange of $3.62 per share.
-9-
ITEM 6. SELECTED FINANCIAL DATA
STATEMENT OF OPERATIONS DATA
YEAR-ENDED DECEMBER 31,
2001 2000 1999 1998 1997
------------ ------------ ------------ ------------ ------------
Revenues, Net ............................ $ 692,125 $ 332,522 $ 187,515 $ 47,681 $ 23,659
Cost of Sales ......................... 369,959 58,864 93,170 37,488 12,947
------------ ------------ ------------ ------------ ------------
Gross Margin .......................... 322,166 273,658 94,345 10,193 10,712
------------ ------------ ------------ ------------ ------------
Operating expenses:
Selling, general and
administrative ..................... 24,184,317 26,553,634 16,749,276 11,945,273 9,557,198
Research and development .............. 17,691,051 20,866,055 10,697,971 6,247,105 4,715,334
Acquisition Costs ..................... -- -- 1,494,000 -- --
Amortization of Goodwill .............. 1,720,632 573,544 -- -- --
Write-off of
Goodwill ........................... 2,284,570 -- -- -- 769,886
Write-off Impaired Assets ............. 1,761,917 -- -- -- --
Aladdin Technology License
Expense ............................ -- -- -- -- 3,889,000
In- Process Research &
Development ...................... -- 2,176,000 -- -- --
------------ ------------ ------------ ------------ ------------
47,642,487 50,169,233 28,941,247 18,192,378 18,931,418
------------ ------------ ------------ ------------ ------------
Other income (expense):
ITG Technology License Fee ............ -- -- 1,250,000 2,750,000 1,000,000
License ITG Warrant Cost .............. -- -- -- (1,100,000) --
Loss on Other than Temporary
Decline in Equity Securities ....... (1,736,682) -- -- -- --
Equity in net losses of Global
Wave ............................... (2,332,159) (3,406,491) -- -- --
Net interest and other income
(expense) ............................. 2,688,105 5,646,173 (455,670) (53,842) (91,929)
============ ============ ============ ============ ============
Net loss ................................. (48,701,057) (47,655,893) (28,052,572) (16,586,027) (18,012,635)
Accrued dividends on preferred
stock ................................. -- -- 13,239 108,863 809,982
Assured incremental yield ................ -- -- -- 750,000 1,673,000
------------ ------------ ------------ ------------ ------------
Net loss to common stockholders........... $(48,701,057) $(47,655,893) $(28,065,811) $(17,444,890) $(20,495,617)
Weighted average number of common
shares outstanding during the
period ................................ 49,949,875 46,149,587 38,365,573 31,580,665 23,224,569
Loss per common share-basic and
diluted ............................... $ (0.97) $ (1.03) $ (.73) $ (.55) $ (.88)
============ ============ ============ ============ ============
Cash dividends declared per common
share ................................. -0- -0- -0- -0- -0-
See Notes to Financial Statements
-10-
BALANCE SHEET DATA
AS OF DECEMBER 31
-----------------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- ----------
Working capital (deficiency) ........... $36,963,617 $76,099,347 $ 4,870,443 $ (770,959) $ 4,772,873
Total assets ............................ 60,234,302 98,084,06 16,531,883 6,023,991 7,965,827
Long-term liabilities ................... -- -- -- -- 522,124
Total Liabilities ....................... 6,428,896 7,870,009 6,823,643 5,289,634 2,342,526
Redeemable preferred stock .............. -- -- -- 493,201 471,601
----------- ----------- ----------- ----------- ----------
Total stockholders' equity ............. $53,805,406 $90,214,452 $ 9,708,240 $ 241,156 $ 5,151,700
=========== =========== =========== =========== ==========
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Wave Systems Corp. develops, produces and markets hardware and
software based digital security products for the Internet and e-commerce. The
Company is also engaged in various research, development and marketing efforts
to commercialize the Wave Commerce 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 also develops data broadcasting and products
that perform digital signature and electronic document management functions.
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 our products and technology. As our research and
development activities matured, we have been able to devote increased resources
to the creation of content distribution services, market development and the
application of the our technology to end-user products and services. From
inception through December 31, 2001, 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.
In June 2000, Wave increased its ownership percentage of Global
Wave Limited ("Global Wave"), from 25% to 40% through its wholly owned
holding company Earthquest Limited ("Earthquest"). On October 10, 2000, Wave
and Earthquest entered into an agreement with Global Wave and its Joint
Venture partner Redwave, Plc. ("Redwave"), formerly Internet Technology
Group, plc. ("ITG"), to subscribe for additional shares to maintain a 40%
ownership interest in the venture. As consideration for the additional
shares, Wave committed to invest approximately $5.7 million in cash and
development services. Wave accounts for its investment in Globalwave using
the equity method of accounting, and accordingly recognizes its share (40%)
of Globalwave's results of operations in the accompanying consolidated
statement of operations.
On July 27, 1999, Wave completed the acquisition of N*ABLE
Technologies, Inc., ("N*ABLE") a security solutions company that produces
hardware-based security solutions for the protection of sensitive user data
within network client systems, including a hardware-based security co-processor
that manages the secure transfer of payment or sensitive personal information to
and from desktop computers. Wave paid the shareholders of N*ABLE total
consideration of 2,280,821 shares of our Class A Common Stock (subject to
certain post closing adjustments). The closing price per share as of the closing
date was $10.38. Founded in 1996, N*ABLE was located in Danvers, Massachusetts,
with offices in Cupertino, California and Bouguenais, France. The transaction
was accounted for under the pooling-of-interests method of accounting and the
financial data in the Selected Financial Data table above and in the discussion
below has been restated for all periods assuming the acquisition occurred on the
first day of the first period presented.
-11-
In April 1999, WaveXpress, a joint venture between Wave and
Sarnoff Corporation was established. For technology licensed to WaveXpress,
Sarnoff and affiliates received a 40% equity stake in WaveXpress. Wave and
its affiliates who purchased, for a nominal amount, founders stock in April
1999 owned 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. As of
December 31, 2001. the equity interests of Wave, Sarnoff and the Company's
affiliates referred to above, assuming all of Wave's and Sarnoff's
convertible securities are converted and warrants are exercised, would be
approximately 82%, 15%, and 3%, respectively. Wave is also funding WaveXpress
through a series of convertible notes and expects to continue to provide
funding until an external round of funding can be attained. These notes can
be converted into equity by Wave. Through December 31, 2001, Wave has loaned
approximately $25.9 million in funds under these notes, of which $9.5 million
had been converted to WaveXpress Common Stock as of December 31, 2001.
The financial statements of WaveXpress have been consolidated with
those of Wave for the years ended December 31, 2001, 2000 and 1999. As the joint
venture minority partners, Sarnoff Corporation and the Wave affiliates, have not
contributed any cash and are not required to fund the operations of the joint
venture, Wave has not recorded a minority interest in WaveXpress in the
consolidated financial statements and therefore, has reflected 100% of
WaveXpress' operating results in these consolidated financial statements.
The following discussion related to the consolidated financial
statements of Wave should be read in conjunction with the financial statements
appearing in Item 8.
-12-
CRITICAL ACCOUNTING POLICIES
The following accounting policies are deemed critical to the
understanding of the consolidated financial statements included under Item 8 -
Financial Statements and Supplementary Data.
Method of Accounting for Joint Ventures - Wave accounts for its investments in
joint ventures using the equity method of accounting when its ownership interest
in the joint venture is less than fifty percent and it is determined that Wave
has the ability to exercise significant influence over the joint venture's
operating and financial policies. The financial statements of joint ventures in
which Wave owns greater than a fifty percent interest are consolidated with
Wave's financial statements pursuant to APB Opinion No. 18.
Marketable Securities - debt securities and publicly traded equity
securities are classified as available for sale and are recorded at market using
the specific identification method. Unrealized gains and losses are reflected in
other comprehensive income. Unrealized losses that are determined to be other
than temporary are recognized as charges against earnings. Factors considered
when determining if an other than temporary declines has occurred include:
whether a decline in market value is related to specific concerns of the issuer
of the securities as opposed to general market conditions, the length of time of
the decline in market price, the financial condition and near-term prospects of
the issuer and other factors that may indicate that the value of the securities
will not recover. All other investments, excluding joint venture arrangements,
are recorded at cost.
Inventories - Inventories, which are stated at the lower of cost
or net realizable value, consist of inventory held for resale to customers. Cost
is determined on the first-in, first-out basis and includes freight and other
incidental costs incurred. Wave provides inventory allowances based on excess
and obsolete inventories.
Goodwill and Purchased Intangible Assets - Goodwill and purchased
intangible assets are carried at cost less accumulated amortization.
Amortization is computed using the straight-line method over the expected useful
life of the asset (currently 2 to 3 years). In accordance with the Financial
Accounting Standards Board's ("FASB") Statement of Financial Accounting Standard
No. 121 ("SFAS 121"), Wave assesses the recoverability of goodwill and purchased
intangible assets 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 Wave's average cost of funds. The
assessment of the recoverability of goodwill is impacted if estimated future
operating cash flows are less than the net carrying value of the asset.
Research and Development and Software Development Costs - Research
and development costs are expensed as incurred. Software development costs are
accounted for pursuant to Statement of Financial Accounting Standards No. 86
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed" which requires software development costs to be capitalized when a
product's technological feasibility has been established. In accordance with
SFAS 121, Wave assesses the recoverability of capitalized costs of software
development costs by determining whether the amortization of the balance over
their remaining life can be recovered through undiscounted future operating cash
flows of the related acquired operation. The amount of capitalized software
development costs impairment, if any, is measured based on projected discounted
future operating cash flows using a discount rate reflecting Wave's average cost
of funds. The assessment of the recoverability of capitalized software
development costs is impacted if estimated future operating cash flows are less
than the net carrying value of the asset.
Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of - Wave 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.
-13-
Revenue Recognition - Wave generally recognizes product revenue
when delivery has occurred, the price is fixed and determinable, and collection
is probable. Wave recognizes revenue on fixed-price long-term service contracts
using the percentage-of-completion method. Cash payments received in advance of
product or service contract revenue are recorded as deferred revenue.
-14-
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND 2000
RESULTS OF OPERATIONS
For the twelve months ended December 31, 2001 and December 31,
2000, revenues were $692,125 and $332,522 respectively. Revenue growth can be
primarily attributed to a significant increase in hardware sales and contract
revenues. The contract revenue is derived primarily from a development contract
with SSP, a shareholder of Wave. Wave also owns 14.95% of SSP. Revenue on the
contract is being recognized on a percentage of completion basis, and is subject
to cash received and milestones accomplished. Cost of sales for the twelve
months ended December 31, 2001, was $369,166 compared with $58,864 for the same
period in 2000. Cost of sales in 2001 is not comparable to costs of sales for
2000, as the sales mix differed substantially in 2001 versus 2000. Sales in the
year-ended 2001 from contracts and hardware produced margins of 45% versus sales
for the year ended 2000 which consisted largely of license revenues, producing a
much higher overall profit margin of 82%.
Research and development expenses for the twelve months ended
December 31, 2001 were $17,691,051, as compared to $20,866,055 for the
comparable period of 2000. This 15% decrease in research and development
expenses was primarily attributable to a decrease in consultant costs associated
with a lessened design and development effort with respect to our proprietary
integrated circuit technology and software. Significant development initiatives
undertaken during the year ended December 31, 2000 included major enhancements
to Wavenet, the development of EMBASSY II, the development of the EMBASSY applet
developers kit, the creation of the "Trust Assurance Network" and the
development of core EMBASSY applets. Many of these projects were substantially
completed near the end of the 1st quarter of 2001. Accordingly, as the
development of these projects were substantially complete, Wave reduced its
consultant work force early in 2001 resulting in significantly less research and
development costs incurred during the year. WaveXpress' research and development
expenses were $3,916,845 for the year ended December 31, 2001 versus $5,188,098
for the year ended December 31, 2000. The amounts set forth above include the
WaveXpress amounts referred to here in. Also, the reasons for the reduction in
expenditures set forth above pertain to both Wave as a whole and WaveXpress.
Selling, general and administrative expenses for the twelve months
ended December 31, 2001 were $24,184,317 as compared to $26,553,634 for the
comparable period of 2000. The 9% decrease in selling, general and
administrative expenses was attributable to several factors. A number of
consultant positions were eliminated during 2001 and were either not replaced or
were converted to in-house employees, reducing the overall cost per headcount.
Consultants that supported products and/or lines of business that Wave
de-emphasized, including MyPublish, Wave Direct and IshopHere.com were
eliminated. Wave also realized significant savings in trade show costs,
advertising and marketing. These savings were achieved by attending fewer trade
shows and by bringing the corporate marketing function in-house and using fewer
outside marketing consultants. Additionally, during 2001 Wave undertook an
aggressive cost cutting program that resulted in significant reductions in
travel and office supplies expenses. Finally, substantial savings were achieved
by eliminating recruiting expenses as Wave stabilized its work force late in the
year-ended 2000 and into 2001. WaveXpress incurred selling, general and
administrative expenses of $4,800,927 in 2001, compared to $4,992,285 for 2000,
for a decrease of 4%. The reasons set forth above encompass WaveXpress as well
as Wave as a whole.
Goodwill amortization associated with the acquisition of
iShopHere.com, for the year ended December 31, 2001 was $1,720,632 versus
$573,544 in the year ended December 31, 2000. This is the result of a full
year's amortization having been taken for the year-ended December 31, 2001,
while only four months' expense was taken in the year ended December 31,
2000, as the acquisition took place on August 31, 2000.
In the first quarter of 2001, Wave took a charge of $1,562,500 to
write off a technology license that it had purchased in connection with the
development of the WaveXpress data broadcast system. Additionally in the fourth
quarter of 2001, Wave wrote off $199,417 for hardware; also part of the
WaveXpress terrestrial data casting system. These write-offs totaling $1,761,917
were the result of modifications to WaveXpress' business model; consequently,
the value of these assets became impaired because they were no longer needed in
the business and had no alternative uses.
-15-
As a result of the decline in current business conditions, and
Wave's realignment of resources to focus on what it considers high-growth
markets and core opportunities, Wave recorded in the fourth quarter of 2001, a
charge of $2,284,570 related to the impairment of goodwill and purchased
intangible assets associated with the Indigo asset purchase. This amount is
equal to the carrying amount of the assets prior to the impairment charge.
Accordingly, the carrying amount of the goodwill and purchased intangible assets
as of December 31, 2001 is $0.
Wave recorded a provision for inventory obsolescence totaling
$933,304 in 2001. This charge related to chips based on legacy technology
that wave is no longer actively marketing, and therefore became impaired.
The in-process research and development ("IPRD") expense incurred
in the year-ended December 31, 2000 was related to the acquisition of Indigo
Networks LLC ("Indigo") and its e-commerce shopping network, iShopHere.com. The
portion of the purchase price allocated to in-process research and development
for this acquisition was approximately 29% of the total purchase price of
$7,445,000. The IPRD was valued using an income approach. The cash flows were
discounted to present value at an appropriate rate. The discount rate was
determined by an analysis of the risks associated with each of the identified
intangible assets. The resulting net cash flows to which the discount rate of
27% was applied were based on management's estimates of revenues, operating
expenses and income taxes from such acquired in-process technology.
OTHER INCOME AND EXPENSES
Interest income for the year ended December 31, 2001 was
$2,688,105 versus $5,103,716 for the year ended December 31, 2000, for a
decrease of 47%. This decrease resulted from a decrease in interest bearing
assets during 2001 and lower rates earned on those interest bearing assets.
Equity in losses of Global Wave were $2,332,159 and $3,406,491 for the year
ended December 31, 2001 and 2000, respectively. The decrease resulted from a
reduction in Global Wave's net loss, and Wave's portion being limited to Wave's
investment in Global Wave of $5.7 million, which was reached in the fourth
quarter of 2001.
As of December 31, 2001 the Company took a charge for an "other
than temporary decline" in the value of its investment in SSP of $1,736,682.
This charge was taken because a decline in SSP's share price had occurred due to
concerns about SSP's financial condition and near-term prospects. As a result of
this charge the cost basis of the investment as of December 31, 2001 has been
adjusted to $12,576,118.
The Gain on Sale of marketable equity securities in the year ended
December 31, 2000 resulted from the acquisition of ITG. Wave recognized the gain
as the amount of cash received in the transaction over the book basis of the
1,000,000 shares.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 1999
For the twelve months ended December 31, 2000 and December 31,
1999, revenues were $332,522 and $187,515 respectively. Revenue growth can be
attributed to increased software and technology licensing agreements in 2000 as
opposed to hardware security co-processor and associated software products from
which most of the 1999 revenues were derived. The cost of sales for the twelve
months ended December 31, 2000, was $58,864 compared with $93,170 for the same
period in 1999. This was the result of higher margins on sales associated with
licensing arrangements versus sales of hardware products.
Research and development expenses for the twelve months ended
December 31, 2000 were $20,866,055, as compared to $10,697,971 for the
comparable period of 1999. This 95% increase in research and development
expenses was primarily attributable to an increase in headcount and consultant
costs associated with the design and development of our proprietary integrated
circuit technology and software. Significant development initiatives undertaken
during the year ended December 31, 2000 included major enhancements to Wavenet,
the development of EMBASSY II, the development of the EMBASSY applet developers
kit, the creation of the "Trust Assurance Network" and the development of core
EMBASSY applets. In addition, WaveXpress experienced significant expenditures in
developing its data broadcast system. WaveXpress' research and development
expenses were $5,188,098 for the year ended December 31, 2000 versus $769,733 in
for the year ended December 31, 1999, since its operations only began in October
of 1999.
-16-
Selling, general and administrative expenses for the twelve months
ended December 31, 2000 were $26,553,634 as compared to $16,749,276 for the
comparable period of 1999. The 58.5% increase in selling, general and
administrative expenses was primarily attributable to an increase in personnel,
consultants and professional fees, trade shows, equipment and other related
costs associated with the development and marketing of new applications and
pursuing new markets for our technology. In addition, WaveXpress was in
operation for the entire year ended December 31, 2000, as its operations began
in October of 1999. WaveXpress incurred selling, general and administrative
expenses of $4,992,285 in 2000, compared to $1,084,415 for 1999.
In addition to the increases in research and development and
selling, general and administrative expenses referred to above, Wave recognized
an in-process R&D expense of $2,176,000 and goodwill amortization of $573,544 in
the year ended December 31, 2000 associated with the acquisition of
iShopHere.com. These expenses were not incurred for the year-ended December 31,
1999. Acquisition costs associated with pooling-of-interest acquisitions were $0
for the year-ended December 31, 2000, versus $1,494,000 for the year-ended
December 31, 1999. For the reasons described above, total operating expenses for
the year-ended December 31, 2000 were $50,169,234 compared with $28,941,247 for
the year-ended December 31, 1999.
Net interest and other income/(expense) for the twelve months
ended December 31, 2000 was $5,646,173 as compared to ($455,669) for the
comparable period of 1999. This change resulted from increased interest income
of $4,486,410, primarily attributable to an increase in interest-bearing assets.
This was a direct result of the private placement of Class A Common Stock for an
aggregate purchase price of $122,427,000; a gain of approximately $542,000 on
the sale of marketable equity securities; and the elimination of $833,000 of
interest expense resulting from the pay-off of all outstanding debt. In
addition, Wave incurred other charges of $240,000 in 1999. No such charges were
incurred in 2000.
Equity in the net losses of Global Wave, an unconsolidated
subsidiary accounted for under the equity method, was $3,406,491 for the
year-ended December 31, 2000. No losses associated with this subsidiary were
recognized in 1999 or any prior years, as Wave had not funded nor had it
committed to provide any funding prior to 2000.
Wave did not realize any license fee income for the year ended
December 31, 2000 versus the $1,250,000 that was recognized for the year ended
December 31, 1999. The license fee for 1999 was the final portion of a $5
million fee paid by ITG to Wave as part of a joint venture agreement under which
ITG received the right to market the Wave technology in European and Middle
Eastern markets. Additional development work had been committed to support
increased distribution efforts in 2001 at a cost of approximately $1.6 million.
For the year ended December 31, 2000, WaveXpress incurred a net
loss of approximately $11.2 million versus approximately $1.9 million for the
year ended December 31, 1999. WaveXpress has not realized any revenues since
inception. The expense components that make up their net losses for the
years-ended December 31 2000 and 1999 are described above.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
During the year ended December 31, 2000, Wave recorded IPRD
charges of $2,176,000 related to the acquisition of Indigo and its e-commerce
shopping network, iShopHere.com. The portion of the purchase price allocated to
in-process research and development for this acquisition was approximately 29%
of the total purchase price of $7,445,000. Wave's management was primarily
responsible for estimating the fair value of purchased in-process research and
development. At the acquisition date, Indigo was in the process of developing
technology which would add functionality and features, and developing a new
platform for its product. The IPRD had not yet reached technological
feasibility, had no alternative uses, and may not have achieved commercial
viability. At the acquisition date, management estimated that completion of the
IPRD would be accomplished in November 2000. The initial development effort had
commenced in January, 2000. At the valuation date, the new technology had not
reached a completed prototype stage, although some beta testing on portions of
the technology had begun. At the valuation date, the IPRD was approximately 75%
complete, based on costs incurred on the IPRD through the acquisition date
versus the total costs estimated to complete the project. The IPRD was
substantially completed within the time originally estimated. The IPRD project
was valued using an income approach. This approach took into consideration
earnings remaining after deducting from cash flows related to the in-process
technology, the market rates of return on contributory
-17-
assets, including assembled workforce, merchant agreements working capital and
fixed assets. The cash flows were then discounted to present value at an
appropriate rate. The discount rate was determined by an analysis of the risks
associated with each of the identified intangible assets. The resulting net cash
flows to which the discount rate of 27% was applied were based on management's
estimates of revenues, operating expenses and income taxes from such acquired
in-process technology.
LIQUIDITY AND CAPITAL RESOURCES
We have experienced net losses and negative cash flow from
operations since our inception, and, as of December 31, 2001, had a deficit
accumulated during the development stage of $189,624,124, and stockholders'
equity of $53,805,406. We have financed our operations principally through the
issuance of Class A and B Common Stock and various series of preferred stock,
for total proceeds since inception of approximately $204,775,000.
At December 31, 2001, we had $40,437,119 in unrestricted cash and
cash equivalents. At December 31, 2000, we had $80,703,890 in cash and cash
equivalents. We held marketable equity securities with a value of $11,171,124
($11,160,758 of which is classified as non-current) as of December 31, 2001
versus $1,923,305 in marketable securities at December 31, 2000. The decrease in
cash and cash equivalents resulted from $38,214,486 used in operating activities
and $1,507,598 used to purchase property and equipment, including the purchase
of software and intangible assets. In addition, $544,687 was used in financing
activities which consisted of loans to officers of $1,299,640, offset by
proceeds from the issuance of Common Stock - primarily from exercises of
employee stock options and warrants totaling $754,953. Loans to officers
totaling $963,320 came due in February and March of 2002, and were extended for
an additional one year.
Wave's commitment to invest approximately an additional $1.6
million in Global Wave was satisfied in the first quarter of 2002. This
amount is included in Accrued Expenses as of December 31, 2001. In addition,
as of December 31, 2001, Wave was committed to provide $850,000 in loans to
Specialty Broadcast Networks, Inc. ("SBN"), under an Unsecured Convertible
Term Note Agreement (the "SBN Note") that Wave entered into with SBN on
August 3, 2001. Wave owns 50% of SBN's outstanding common stock. and had
provided approximately $150,000 under the SBN Note as of December 31, 2001.
Wave's commitment to make further loans under this note expired in February
2002. Wave has no plans to renew its commitment to providing any additional
loans to SBN. Wave accounts for its investment in SBN using the equity method
of accounting. SBN's operations are not material to Wave's financial position
and results of operations. Wave's significant fixed commitments with respect
to leases and inventory purchases are as follows:
2002 2003 2004 2005 2006 Thereafter Total
------------- ------------ ----------- ------------ ------------ -------------- -------------
Leases $1,826,621 $761,281 $641,758 $621,623 $646,187 $2,208,267 $6,705,737
Inventory Purchases 983,723 - - - - - 983,723
------------- ------------ ----------- ------------ ------------ -------------- -------------
Total Committments $2,810,334 $761,281 $641,758 $621,623 $646,187 $2,208,267 $7,689,460
WaveXpress has been funded entirely by Wave through a series of
convertible promissory notes (the "Notes"). Through December 31, 2001 Wave has
provided approximately $25.9 million in funds under the Notes, including accrued
interest of $2.3 million. Wave expects to continue funding WaveXpress through
the Notes and similar notes for the foreseeable future. Presently, Wave has
committed to funding WaveXpress up to an additional $1.6 million under the
Notes.
As of December 31, 2001, we had available net operating loss
carryforwards for Federal income tax purposes of approximately $145 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.
-18-
At December 31, 2001, we had working capital of $36,963,617. Wave
expects to continue to incur substantial additional expenses resulting in
significant losses for the foreseeable future. However, considering our current
cash balance and Wave's projected operating cash requirements, we anticipate
that our existing capital resources will be adequate to satisfy our cash flow
requirements through the first quarter of 2003.
However, as Wave has not yet attained commercial acceptance of
its products and has not generated any significant operating revenue,
considerable uncertainty currently exists with respect to the adequacy of
current funds to support our activities beyond the first quarter of 2003.
This uncertainty will continue until a positive cash flow from operations is
achieved. Additionally, Wave is uncertain as to the availability of financing
from other sources to fund any cash deficiencies.
In order to reduce this uncertainty, Wave continues to evaluate
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 Wave's technology, products and services. There can be no
assurance that Wave can raise additional financing in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
On July 20, 2001, FASB issued Statements No. 141, Business
Combinations ("SFAS 141") and No. 142 Goodwill and Other Intangible Assets
("SFAS 142"). SFAS 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. Poolings initiated prior
to June 30, 2001 are grandfathered. SFAS 142 replaces the requirement to
amortize intangible assets with indefinite lives and goodwill with a requirement
for an impairment test. SFAS 142 also requires an evaluation of intangible
assets and their useful lives and a transitional impairment test for goodwill
and certain intangible assets. After the transition, the impairment tests must
be performed annually. A company must adopt SFAS 142 at the beginning of the
fiscal year. Thus, as a calendar year-end company, Wave must adopt SFAS. 142 no
later than January 1, 2002. Wave is currently examining the impact of this
pronouncement on its results of operations and financial position, but currently
believes the impact will not be material.
FASB recently issued SFAS 143, Accounting for Asset Retirement
Obligations ("SFAS 143") which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS 143 requires an enterprise to record the
fair value of an asset retirement obligation as a liability in the period in
which it incurs a legal obligation associated with the retirement of a tangible
long-lived asset. SFAS 143 also requires the enterprise to record the contra to
the initial obligation as an increase to the carrying amount of the related
long-lived asset and to depreciate that cost over the remaining useful life of
the asset. The liability is changed at the end of each period to reflect the
passage of time and changes in the estimated future cash flows underlying the
initial fair value measurement. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. Wave is currently examining the impact of this
pronouncement on the results of its operations and financial position, but
currently believes the impact will not be material.
On October 3, 2001, FASB issued SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("SFAS 144"), which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets and supersedes SFAS 121. SFAS 144, retains many of the fundamental
provisions of SFAS 121. SFAS 144 also supersedes the accounting and reporting
provisions of Accounting Principle Board Opinion 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("ABP
30"), for the disposal of a segment of a business. However, it retains the
requirement in APB 30 to report separately discontinued operations and extends
that reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for
sale. SFAS 144 is effective for fiscal years beginning after December 15, 2001
and interim periods within those fiscal years. Wave is currently examining the
impact of this pronouncement on its results of operations and financial
position, but currently believes the impact will not be material.
-19-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Wave's investment portfolio consists of minority equity
investments in publicly traded companies. Most predominantly, we hold a 14.95%
interest in SSP. (See Recent Sales of Unregistered Securities under Item 5).
These securities are generally classified as available for sale and,
consequently, are recorded on the balance sheet at fair value with unrealized
gains and losses reported as a separate component of accumulated other
comprehensive income (loss), net of tax. These investments are inherently risky
because the market for the technologies or products they have under development
are typically in the early stages and may never materialize. In addition, the
values of these investments are subject to significant market price volatility.
For example, as a result of market price volatility, we experienced a $3.3
million decrease in net unrealized gains during the year ended December 31,
2001. In addition, we recorded a charge against earnings associated with a loss
in value on our investment in SSP of $1.7 million that was considered to be
"other than temporary". These equity securities are held for purposes other than
trading. The following table presents the hypothetical change in fair values of
Wave's investments in marketable equity securities of publicly traded entities
using the high and low closing prices of the securities from January 1, 2001
through March 22, 2002:
Fair Value at the lowest Fair Value at the highest
closing price January 1, Fair Value as of closing price January 1,
2001 through March 22, 2002 December 31, 2001 2001 through March 22, 2002
----------------------------- ------------------------ ----------------------------
Corporate Equities $ 7,712,027 $ 11,171,124 $ 23,351,456
The exposure to market risk associated with interest
rate-sensitive instruments is not material. Wave's cash and cash equivalents
consist primarily of money market funds that meet high credit quality standards
and the amount of credit exposure to any one issue is limited.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, the notes thereto, and the
independent auditors' report thereon are presented beginning at page F-1 of this
Form 10-K and are hereby incorporated by reference into this Item 8. The
quarterly financial information required by this Item 8 is included in the Notes
to Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANT ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is incorporated by reference from the
discussion responsive thereto under the captions "Management" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in Wave's Proxy Statement for the
2002 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated by reference from the
discussion responsive thereto under the caption "Executive Compensation" in
Wave's Proxy Statement for the 2002 Annual Meeting of Stockholders.
-20-
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated by reference from the
discussion responsive thereto under the caption "Security Ownership of Certain
Beneficial Owners and Management" in Wave's Proxy Statement for the 2002 Annual
Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated by reference from the
discussion responsive thereto under the captions "Certain Relationships and
Related Transactions" in Wave's Proxy Statement for the 2002 Annual Meeting of
Stockholders.
-21-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements:
PAGE(S)
Index to Consolidated Financial Statements F-1
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3
Consolidated Statements of Operations for each of the years
ended December 31, 2001, 2000 and 1999 and
for the period from February 12, 1988 (inception)
through December 31, 2001 F-4
Consolidated Statements of Stockholders' Equity
(Deficiency) and Other Comprehensive Income (Loss)
for each of the years ended December 31, 2001, 2000
and 1999 and for the period from February 12, 1988
(inception) through December 31, 2001 F-5
Consolidated Statements of Cash Flows for each of the
years ended December 31, 2001, 2000 and 1999 and for
the period from February 12, 1988 (inception) through
December 31, 2001 F-10
Notes to Consolidated Financial Statements F-12
(a) (2) Financial Statement Schedules:
All schedules have been omitted since they are either not required or
not applicable.
(a) (3) Exhibits:
EXHIBIT NO. DESCRIPTION OF EXHIBIT
--------------------- ------------------------------------------------------------------------------------
3.1* -- Restated Certificate of Incorporation of Wave (incorporated by
reference to Exhibit 3.1 of Wave's Registration Statement on
Form S-1, File No. 33-75286)
3.2* -- Bylaws of Wave (incorporated by reference to Exhibit 3.2 of
Wave'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 Wave'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
Wave's Registration Statement on Form S-1, File No. 33-75286).
4.3* -- Certificate of Designation of Series B Preferred Stock of Wave as filed with
the Delaware Secretary of State on May 24, 1996 (incorporated by reference to
Exhibit 3.1 of Wave'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 as
filed with the Delaware Secretary of State on December 27, 1996 (incorporated
by reference to Exhibit 3.1 of Wave'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 as
filed with the Delaware Secretary of State on December 27, 1996 (incorporated
by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K
filed on June 3, 1997, File No. 0-24752)
-22-
4.6* -- Certificate of Designation of Series F Convertible Preferred Stock of Wave
as filed with the Delaware Secretary of State on October 9, 1997
(incorporated by reference to Exhibit 3.1 of Wave'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
as filed with the Delaware Secretary of State on March 5,--1998 (incorporated
by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K
filed on March 19, 1998, File No. 0-24752)
+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 Wave's Registration Statement on Form
S-1, File No. 33-75286)
+10.2* -- License and Cross-License Agreement, dated as of May 1, 1992, between The
Titan Corporation and Cryptologics International, Inc. (incorporated by
reference to Exhibit 10.3 of Wave'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 (incorporated by reference to
Exhibit 10.4 of Wave'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 , Peter J. Sprague and John R. Michener (incorporated by reference to
Exhibit 10.5 of Wave'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 Wave'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 Wave's Registration Statement on Form
S-1, File No. 33-75286)
+10.7 -- Wave Systems Corp. 1996 Performance Stock Option Plan
10.8* -- Addendum to License and Cross-License Agreement, dated February 28, 1997,
between The Titan Corporation and Wave (incorporated by
reference to Exhibit 10.10 of Wave's Current Report on Form 10-K
filed on March 24, 1997, file No. 0-24752).
+10.9* -- Employment Contract, dated June 8, 1998, between Gerard T. Feeney and Wave
(incorporated by reference to Exhibit 10.18 of Wave's Current Report
on Form 10-K filed on April 1, 1999, file No. 0-24752).
+10.10* -- Employment Contract, dated November 10, 1998, between Steven Sprague and Wave
(incorporated by reference to Exhibit 10.19 of Wave's Current Report on
Form 10-K filed on April 1, 1999, file No. 0-24752).
-23-
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- --------------------------- ------------------------------------------------------------------------------------
10.11* -- Asset Purchase Agreement dated August 13, 2000, by and among Wave
and Indigo Networks, LLC (incorporated by reference to Exhibit 99.1 of
Wave's current report on Form 8-K, filed on September 15, 2000
(File #0-24752).
10.12 -- Agreement to subscribe for 40,000 shares of Global Wave, dated
October 10, 2000, by and among Wave, Redwave, Global Wave, and
Earthquest, Ltd. (a United Kingdom Company and wholly-owned subsidiary of
Wave).
10.13 -- Form of Stock Purchase Agreement, dated February 2, 2002 by and between Wave
and BIZ.
10.14 -- Consulting Services Agreement dated September 14, 2001, by and between Wave
and Archon Technologies, Inc.
10.15 -- Form of Asset Purchase Agreement dated October 4, 2001, by and between Wave
and SignOnLine.
10.16 -- First Amendment to Asset Purchase Agreement dated October 4, 2001, by and
between Wave and SignOnLine.
21.1 -- Subsidiaries of Registrant.
23.1 -- Consent of Independent Auditors - KPMG LLP
99.1 -- Demand Note, dated March 26, 2001 between Gerard T. Feeney and Wave
99.2 -- Demand Note, dated February 27, 2001 between Peter J. Sprague and Wave
99.3 -- Demand Note, dated July 25, 2001 between Peter J. Sprague and Wave
99.4 -- Demand Note, dated September 5, 2001 between Peter J. Sprague and Wave
99.5 -- Co-marketing agreement dated May 14, 2001, by and between Wave and Maximus
* Incorporated herein by reference
+ Confidential treatment has been granted as to portions of this exhibit.
+ Management contract or compensatory plan.
(b) Reports on Form 8-K
There have been no reports on Form 8-K filed during the quarter-ended
December 31, 2001.
-24-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 27, 2002
WAVE SYSTEMS CORP.
By: /s/ PETER J. SPRAGUE
Name: Peter J. Sprague
Title: Chairman
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/S/ PETER J. SPRAGUE
- --------------------------------
Peter J. Sprague Chairman March 27, 2002
/S/ STEVEN SPRAGUE
Steven Sprague President, Chief Executive Officer and March 27, 2002
Director
/S/ JOHN E. BAGALAY, JR.
- --------------------------------
John E. Bagalay, Jr. Director March 27, 2002
/S/ GEORGE GILDER
George Gilder Director March 27, 2002
/S/ JOHN E. MCCONNAUGHY, JR.
John E. McConnaughy, Jr. Director March 27, 2002
/S/ NOLAN BUSHNELL
Nolan Bushnell Director March 27, 2002
/S/ GERARD T. FEENEY
- --------------------------------
Gerard T. Feeney Senior Vice President, Finance March 27, 2002
and Administration, Chief Financial
Officer and Secretary (Principal
Financial Officer and Duly Authorized
Officer of the Registrant
-25-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE(S)
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3
Consolidated Statements of Operations for each of the years
ended December 31, 2001, 2000 and 1999 and for the period
from February 12, 1988 (inception) through December 31, 2000 F-4
Consolidated Statements of Stockholders' Equity (Deficiency)
and Other Comprehensive Income (Loss) for each of the
years ended December 31, 2001, 2000 and 1999 and for
the period from February 12, 1988 (inception) through
December 31, 2001 F-5
Consolidated Statements of Cash Flows for each of the years ended
December 31, 2001, 2000 and 1999 and for the period from
February 12, 1988 (inception) through December 31, 2001 F-10
Notes to Consolidated Financial Statements F-12
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited the consolidated financial statements of Wave Systems Corp. and
subsidiaries (a development stage corporation) as listed in the accompanying
index. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, 2001 and 2000, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2001 and for the period from February 12, 1988 (date of
inception) to December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Boston, Massachusetts
March 7, 2002
F-2
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
December 31, 2001 and 2000
ASSETS
2001 2000
------------------- -------------------
Current assets:
Cash and cash equivalents $ 40,437,119 $ 80,703,890
Cash Collected on Behalf of Charities 358,531 --
Marketable securities 10,366 1,923,305
Notes Receivable from Officers 1,380,050 --
Inventories 581,912 625,148
Prepaid expenses and other receivables 624,535 717,013
------------- -------------
Total current assets 43,392,513 83,969,356
Marketable Equity Securities 11,160,758 --
Investment in Global Wave
-- 735,509
Property and equipment, net 4,291,228 5,201,869
Intangible assets, net
-- 2,895,000
Goodwill and acquisition intangibles, net of accumulated amortization
-- 4,005,202
Other assets 1,389,803 1,277,525
------------- -------------
Total Assets
60,234,302 98,084,461
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable and accrued expenses 5,807,878 7,870,009
Due to Charities 423,053 --
Deferred Revenue 197,965 --
------------- -------------
Total current liabilities 6,428,896 7,870,009
Stockholders' Equity:
Common Stock, $.01 par value. Authorized 75,000,000 shares as Class A;
49,996,506 shares issued and outstanding in 2001 and 47,051,197 in 2000 499,965 470,512
Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B;
357,083 shares issued and outstanding in 2001 and 779,211 in 2000 3,571 7,792
Capital in excess of par value 244,330,985 228,735,910
Deficit accumulated during the development stage (189,624,123) (140,923,066)
Other Comprehensive Income - unrealized gain (loss) on marketable securities (1,404,992) 1,923,304
------------- -------------
Total stockholders' equity 53,805,406 90,214,452
------------- -------------
Total Liabilities and Stockholders' Equity $ 60,234,302 $ 98,084,461
============= =============
See accompanying notes to consolidated financial statements.
F-3
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Operations
Years ended December 31, 2001, 2000, 1999, and
period from February 12, 1988 (date of inception)
through December 31, 2001
PERIOD FROM
FEBRUARY 12,
1988 (DATE OF
INCEPTION)
THROUGH DECEMBER 31,
Net Revenues: 2001 2000 1999 2001
------------ ------------ ------------- -------------------
Product $ 192,506 $ 4,400 $ 67,234 $ 364,140
Services
430,724 -- -- 430,724
Licensing and Other 68,895 328,122 20,281 491,858
------------ ------------ ------------- -------------
Total Net Revenues 692,125 332,522 187,515 1,286,722
------------ ------------ ------------- -------------
Cost of sales:
Product 135,134 3,520 77,632 216,286
Services 227,124 -- -- 227,124
Licensing and Other 7,701 55,344 15,538 130,780
------------ ------------ ------------- -------------
Total Cost of Sales 369,959 58,864 93,170 574,190
------------ ------------ ------------- -------------
Gross margin 322,166 273,658 94,345 712,532
Operating expenses:
Selling, general and administrative 24,184,317 26,553,634 16,749,276 108,471,913
Research and development 17,691,051 20,866,055 10,697,971 71,952,976
Amortization of Goodwill 1,720,632 573,544 -- 2,294,176
Write-off of Intangibles and otherd
Impaired Assets 1,761,917 -- -- 1,761,917
Write-off of Goodwill 2,284,570 -- -- 3,054,456
In Process research and development
expense -- 2,176,000 -- 2,176,000
Acquisition Costs -- -- 1,494,000 1,494,000
Aladdin license expense -- -- -- 3,889,000
------------ ------------ ------------- -------------
47,642,487 50,169,233 28,941,247 195,094,438
Other income (expense):
Interest income 2,688,105 5,103,716 617,306 9,713,399
Interest expense -- -- (832,976) (1,695,461)
Equity in net losses of Global Wave (2,332,159) (3,406,491) -- (5,738,650)
Loss on Other than Temporary Decline in
Marketable Equity Securites (1,736,682) -- -- (1,736,682)
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 (expense) -- -- (240,000) (227,280)
------------ ------------ ------------- -------------
(1,380,736) 2,239,682 794,330 4,757,783
------------ ------------ ------------- -------------
Net loss (48,701,057) (47,655,893) (28,052,572) (189,624,123)
Accrued dividends on preferred Stock -- -- 13,239 4,350,597
------------ ------------ ------------- -------------
Net loss to common stockholders $(48,701,057) $(47,655,893) $ (28,065,811) $(193,974,720)
------------ ------------ ------------- -------------
Loss per common share - basic and diluted $ (0.97) $ (1.03) $ (0.73) $ (10.43)
------------ ------------ ------------- -------------
Weighted average number of common
shares outstanding during the period 49,949,875 46,149,587 38,365,573 18,601,112
------------ ------------ ------------- -------------
See accompanying notes to consolidated financial statements.
F-4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency)
And Comprehensive Income (Loss)