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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, 1998
( ) 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 5, 1999 was $338,387,574 (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 5, 1999, there were 29,273,767 shares of the registrant's
Class A Common Stock and 2,770,991 shares of the registrant's Class B Common
Stock outstanding.
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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.
PART I
Item 1. Business
Overview
Wave Systems Corp. ("Wave" or the "Company") is creating a new
electronic commerce model for digital information and services based on
client-side security, transactions and trust. Since its inception in February of
1988, the Company has devoted substantially all of its efforts and resources to
research, feasibility studies, design, development, and market testing of a
distributed trust system that enables client based transactions, including the
metered usage of electronic content and services (the "Wave System"). Electronic
content and services refers to any data, graphic software, video or audio
sequence that can be digitally transmitted and/or stored. As its research and
development activities matured, the Company was able to devote increased
resources to creation of content distribution services, market development and
the application of the Wave System to end-user services.
The Company believes that the Wave System can fundamentally change
today's centralized e-commerce model by creating a distributed trust and
security system, where transactions are executed and recorded in the consumer's
devices, at the consumer's location. This means that electronic content and
services can be consumed with more efficient and flexible pricing, broader
distribution opportunities, greater protection against unauthorized usage and
secure, low-cost, and accurate data on the usage of the products and services.
The Wave System consists of an EMBedded Application Security SYstem
--- - - --
("EMBASSY") in consumer devices that provide the basis for a multi-party trusted
system using both hardware and software. The EMBASSY is a programmable, low cost
"system within a system" that can perform independent transactions such as meter
content usage, store sensitive information such as identities and account
balances and run secure applications for access to services. The EMBASSY is an
open system based on secure smart card hardware technology that can be
integrated into PCs, peripherals, set top boxes or used as an independent
component. The WaveMeter application running in the EMBASSY allows transactions
to occur without the expense of a real-time network connection for every
transaction. The EMBASSY securely stores electronic funds and transaction
information about the usage of electronic content to be transmitted securely to
a central transaction processing center ("WaveNet") periodically. WaveNet
manages encryption and decryption keys, processes credit and usage charges,
automatically obtains credit authorization, calculates royalty distributions,
and can provide user and usage data to electronic content owners. The Wave
System is designed to be compatible with every existing content delivery system
such as CD-ROM, the Internet, and digital broadcast. PC OEMs, content providers
and services providers such as telecommunications companies have expressed
interest in the Wave System and the Company believes that once there is a broad
installed base of the EMBASSY, electronic content and service providers from
other market segments are likely to be attracted to the Wave System.
In order to achieve broad market acceptance of the Wave System, the
Company pursues strategic relationships with major personal computer
manufacturers and technology suppliers, and promotes the use of the EMBASSY to
electronic content owners, particularly developers and distributors of
entertainment, audio, broadcast and educational software. The Company believes
that the EMBASSY can be the foundation for a "client-side subscriber management
system" that is independent of the content or delivery network. This means that
content can be delivered on CD-ROM, data broadcast, broadband and other forms of
transmission.
The Company believes that the Wave System provides a powerful
merchandising interface for electronic content and services at the point of
purchase. This may increase the interest of consumers to sample electronic
content that they are considering purchasing. The Wave System provides the
consumer with enhanced control of their individual privacy and secure storage of
sensitive information. The Wave System facilitates the payment of royalties to
content providers and service partners while allowing both customized and broad,
inexpensive distribution to customers.
In 1998, the Company enhanced the Wave System to make it acceptable as
an open industry standard for a broad range of security and e-commerce functions
in end user-devices. Wave has been successful in attracting other companies to
port their applications and services to the Wave System and its EMBASSY
platform, which the Company believes will increase the value of the system to
potential deployment partners. These strategic relationships have generated what
the Company believes to be significant joint marketing benefits in our efforts
to promote the Wave System to OEMs and the content industry.
-2-
During 1998 the Company established relationships with RSA Data
Security, NEC Technologies, Inc., Pollex Technology Ltd., Hewlett-Packard
Company's VerSecure division, Sun Microsystems, SMSC, ITE, IGST, Sarnoff Corp.,
Hauppauge Computer Systems and WavePhore. The Company also received a payment of
$4 million pursuant to a joint venture agreement with Internet Technology Group,
PLC ("ITG"), a United Kingdom company.
In 1999 the Company will seek to continue to expand its commitments
from additional hardware manufacturers, including personal computer
manufacturers, peripheral companies and companies involved in the commerce of
electronic content and services both in North America and overseas. The Company
also seeks to expand the role of the Wave System and EMBASSY as a general
security device in networks in order to provide new opportunities for the
creation of virtual private networks and services by telecommunications vendors
and Internet service providers.
Additionally, in 1996 the Company developed a production software
version of the WaveMeter application that offers a subset of the features of the
hardware version and has been implemented as part of the Company's Internet
commerce server (the "WaveMeter server"). The WaveMeter server enables content
owners to secure and sell their intellectual property from a web site. The
e-commerce services offered through the Wave Meter server do not require the
consumer or publisher to install any additional hardware or software.
Significant uncertainty currently exists with respect to the adequacy
of current funds to support the Company's activities. This uncertainty will
continue until a positive cash flow from operations can be achieved.
Additionally, the Company is uncertain as to the availability of financing from
other sources to fund any cash deficiencies.
In order to reduce these uncertainties, the Company is currently
evaluating additional financing options and may therefore elect to raise
capital, from time to time, through equity or debt financings in order to
capitalize on business opportunities and market conditions and to insure the
continued development of the Company's technology, products and services. In
January, 1999, the Company issued a convertible promissory note in aggregate
principal amount of $2 million, which was subsequently converted into Class A
common stock in March, 1999, in addition to and following the Company's
completion of an additional $23 million private placement with institutional,
strategic and accredited investors. There can, however, be no assurance that the
Company can raise additional financing in the future.
As of October 19, 1997, the Company became obligated to redeem for
approximately $465,000 all of the outstanding shares of the Series A Redeemable
Preferred Stock issued to a certain individual pursuant to the terms of the
Restated Certificate of Incorporation. As of December 31, 1998, the Company's
total obligation (principal plus interest) under the Series A redemption was
$493,201, and it continues to accrue dividends and interest. The Company has not
redeemed such shares as of March 30, 1999, nor has any demand for redemption
been made.
The Company presently has no material commitments for capital
expenditures. However, in order to bring the Wave System to market, the Company
anticipates spending additional amounts on contracting for software development,
licensing key technologies, and inventory items such as computer chips and
boards, additional hardware, and related materials. Such spending will vary
based on the Company's performance.
Effective from the close of trading on October 24, 1997 the Company was
delisted from The Nasdaq SmallCap Market. As a result, shares of the Company's
Class A Common Stock are now traded on the OTC Bulletin Board. Until October 3,
1997 the Company had been listed on The Nasdaq National Market. Because the
Company was unable to meet the minimum net tangible assets requirement of The
Nasdaq National Market, the Company was delisted from The Nasdaq National
Market. From October 3, 1997 to October 24, 1997, the Company was temporarily
listed on The Nasdaq SmallCap Market. Continued listing on The Nasdaq SmallCap
Market was dependent upon the Company meeting certain commercial objectives. The
Company was unable to meet these objectives within the prescribed time period.
The Company believes that not being listed on a national exchange or quotation
system will have a material adverse effect on the price and liquidity of its
securities and consequently its ability to raise capital in the future.
On January 29, 1999 the Company filed an application with the Listings
Qualifications Panel of the Nasdaq Stock Market, Inc., seeking to list on the
Nasdaq National Market. There can be no assurances that Nasdaq will approve the
application. As of March 30, 1999, Nasdaq has not issued its decision.
-3-
The Company was incorporated in Delaware under the name Indata Corp. on
August 12, 1988. The Company changed its name to Cryptologics International,
Inc. on December 4, 1989. The Company further changed its name to Wave Systems
Corp. on January 22, 1993. The Company's principal executive offices are located
at 480 Pleasant Street, Lee, Massachusetts 01238 and the telephone number of the
Company is (413) 243-1600.
The Company is a development stage company and has realized minimal
operating revenues since its inception. At December 31, 1998 the Company had an
accumulated deficit of approximately $57.2 million. There can be no assurance
that the Company will be successful in achieving commercial acceptance of the
Wave System.
The Wave System
The Wave System is designed to create new revenue streams for owners of
electronic content by improving upon existing distribution systems for
electronic content. Using existing distribution systems such as CD-ROM and the
Internet, electronic content owners distribute their products to customers in an
encrypted or otherwise secured ("Wave-enabled") form so it can be offered for
sale through the EMBASSY E-Commerce System. Customers are then able to purchase
and access the electronic content on an as-desired basis. The Company believes
that the Wave System allows electronic content owners to deliver their products
to a larger market because the efficient and secure metering technology
facilitates greater flexibility in content distribution and pricing. The Company
believes that greater flexibility in electronic distribution and pricing makes
the Wave System particularly attractive to developers, distributors and
consumers of entertainment and educational software.
In addition, the programmable EMBASSY is able to support multiple
secure applications from a range of service providers, applications vendors, and
security companies. The Company seeks to exploit this multi-application
capability to create new sources of revenue through hosting secure applications
and creating additional services based on the EMBASSY distributed trust model.
The Company believes that its expansion of the EMBASSY has provided a source of
increased interest in Wave's technology as a general-purpose solution for
adoption by a wide range of companies in their platforms and as a secure
delivery mechanism.
The Wave System consists of the EMBASSY E-Commerce System, the
WaveMeter application, a subsystem that records and communicates the usage of
electronic content, and WaveNet, a central transaction processing network. The
EMBASSY controls the loading and execution of multiple secure applications. The
WaveMeter controls and monitors the customer's access to encrypted electronic
information and software. Because the Wave System uses asynchronous
communication, it is well suited to low-cost processing of micro, rental and
rent-to-own transactions. The Company has completed a prototype incorporating
the rental and rent-to-own functionality into the Wave System using Wave's
current chip technology. This is currently being integrated into a WinTV tuner
card from Hauppauge Computer Systems. This product is planned for introduction
into the market in 1999. With this version of the WaveMeter, application
transactions are executed locally against a source of funds stored in the
WaveMeter secure memory. The WaveMeter retains pricing and licensing
information, downloaded from WaveNet, for use in the execution of these
transactions. Transactions are securely stored in the usage log of the WaveMeter
for eventual reporting to WaveNet. The WaveMeters and WaveNet communicate using
Wave's secure communications protocol.
WaveNet is composed of the WaveNet Transaction Processing System
("TXP") and the WaveNet Information Clearing House ("ICH"). TXP acts as the
principal interface with the EMBASSY. Every EMBASSY-equipped device will contact
TXP on a periodic basis. During this secure communication, all stored event
information, such as purchase logs, are uploaded to TXP, additional credit may
be requested, pending events are delivered to the device, and a routine audit
check is performed. There may be a number of TXP systems to distribute access
around the globe. TXP routes all event logs to ICH where they are processed
against Wave's royalty contracts. ICH calculates royalties due to each partner
and handles the billing and reporting services, ensuring that all Wave partners
are properly compensated. WaveNet is presently in operation.
-4-
The Wave System is installed into the customer's PC or integrated into
an attached peripheral device. It is based on a semiconductor device that uses
secure certified integrated circuit technology to store decryption keys, credit
information, and usage data. Presently, the WaveMeter based on Wave's own
silicon chip is packaged on a half-size ISA board with a battery and a clock and
can be installed in the ISA slot of a PC. In 1999 Wave plans to deliver a new
version of the EMBASSY hardware with a Universal Serial Bus interface (USB)
which should easily integrated into a broad range of products including separate
dongles for portable EMBASSY devices. In 1996 the Company also developed a
production software version of the WaveMeter application which has been
implemented as a component of the WaveMeter server. The use of the software
version of the WaveMeter is compatible with the use of the hardware version of
the WaveMeter application.
The Company believes that the hardware version of the Wave System with
EMBASSY is the most secure form of content licensing management and metering
technology available today. The hardware and software of the EMBASSY contains a
wide range of security features to strengthen the trusted client capabilities in
user devices. Tampering with the EMBASSY or Wave System applications results in
automatically initiated system lockouts, and is readily detected by both the
EMBASSY and WaveNet. The encryption keys are loaded at the time of manufacture
and are unique and specific to each EMBASSY device. Every piece of electronic
content is protected using a unique key. Services are controlled by secure
applications running in the EMBASSY. Wave believes it has designed a security
architecture where the value of breaking an individual system to ascertain the
keys is low since there are no common keys that allow system-wide use.
Wave supplies the tools that developers need to build and successfully
supply applications to end-users. Electronic content must be Wave-enabled to be
available to end users on the Wave System. A data preparation tool kit
structures data packages, which are individual elements of electronic content
that are uniquely identified, encrypted, priced and formatted to use within the
Wave System. Once Wave-enabled, each data package can be delivered to the end
user in many electronic forms. Currently, the two primary mechanisms of delivery
of electronic content to the end user are the Internet and CD-ROM. The Wave
System, however, will work with point-to-multi-point data broadcasting via
satellite, terrestrial TV, FM sideband, magnetic media, cable modem, DVD and
broadband.
Markets and Business Strategy
The Company's long-term strategy is to achieve broad market acceptance
of the Wave System as a distributed trust platform for commerce performed in
user devices. To achieve this goal the Company pursues strategic relationships
with hardware manufacturers and companies involved in the development of
commerce in electronic content and services. In addition, the Company believes
that, since the Wave System permits greater flexibility in pricing and
distribution of electronic content, it is particularly well-suited for
merchandising consumer content, entertainment and educational software.
Therefore the Company is vigorously targeting this market segment as a means of
rapidly achieving the broad installed base of the Wave System. The Company
believes that once there is a broad installed base of the Wave System and
EMBASSY, electronic content owners from other market segments are likely to be
attracted to the Wave System. However, there can be no assurances that the Wave
System will achieve any significant market acceptance.
The Company has focused on forming agreements with strategic partners
that will help the Company promote the broad-based acceptance of the Wave System
as a platform for commerce in electronic content. Wave is currently in
discussion with original equipment manufacturers regarding the incorporation of
the Wave System and EMBASSY into their products. Wave has also focused on
pursuing strategic relationships with companies seeking to distribute electronic
content via the Internet. The compatibility of the Wave System with the Web has
provided the Company with a product that has already attracted the attention of
leaders in the development of electronic commerce solutions and particularly
commerce in electronic content. Wave will continue to focus on developing other
strategic relationships to seek to achieve the broad acceptance of the Wave
System as a platform for electronic commerce.
Wave has focused on promoting the acceptance of the Wave System by
electronic content owners. The initial target market is entertainment and
educational software developers and distributors. Wave believes
-5-
that the Wave System will provide the home consumer with a new way of acquiring
interactive content and can offer electronic content developers and distributors
benefits similar to those provided by video rental in the film industry. The
Company has invested heavily in developing relationships with entertainment and
educational software providers. Wave today has over 50 titles functional for
demonstration and is actively preparing others to be launched in 1999.
Competition
The Company operates in a highly competitive and fragmented environment
that is characterized by rapidly evolving technology. Many of the Company's
competitors and potential competitors have substantially greater financial and
technical resources than the Company. Also, many current and potential
competitors have greater name recognition and more extensive customer bases that
could be leveraged, thereby gaining market share or product acceptance to the
Company's detriment. The Wave System competes with conventional information
delivery systems, such as on-line services, subscription services on CD-ROM, and
services on the Internet. However, the Company believes that its metering
capability is competitive with other electronic content delivery systems in a
number of applications due to its superior protection against unauthorized
usage, accurate and detailed information on content usage, and transparent
operation. Further, the Company believes that it will be competitive with
existing distribution systems, including traditional retail outlets for
entertainment and educational software, due to its ability to offer these
innovative merchandising mechanisms.
The Company is aware of other metering systems that compete directly
with Wave, and other current and evolving technologies that provide some of the
functionality of the Wave System. There are other companies that have developed
or are in the process of developing technologies that are, or in the future may
be, the basis for competitive products in the field of electronic content
distribution. Some of those technologies may have an entirely different approach
or means of accomplishing the desired effects of the products being developed by
the Company. There can be no assurance that either existing or new competitors
will not develop products that are superior to or that otherwise achieve greater
market acceptance than the Company's products.
The Wave System is subject to competition from producers of
hardware-based controllers such as dongles and software unlocking systems. The
Company will compete with well-established producers of dongle-based software
unlocking systems such as Rainbow Technologies, Inc. The Company also competes
with developers of software unlocking systems such as Portland Software. Wave
Systems also provides basic security services that compete with companies such
as QPass and PrivaSeek in providing electronic wallets and certain e-commerce
capabilities. The Company believes that the Wave System is superior to existing
hardware-based and software unlocking systems in several ways. These systems
primarily operate as "on/off switches" to control the use of electronic content
and services, but are very limited in their ability to measure and record usage
information. The Company believes that the Wave System offers superior
protection from unauthorized usage, low operating costs (because it does not
require constant communication with and authorization from a centralized
processor), and fast operation that is convenient and essentially transparent to
the end user. Both hardware controllers and software unlocking systems offer
only part of the functionality of the Wave System. Wave Systems distributed
trust model also provides a superior solution for broadcast and multicasting of
data. Distinct from the existing software unlocking systems, WaveNet provides
centralized back-office support to owners of electronic content.
Many large information industry players are forming alliances and
attempting to capitalize on the information delivery options offered by the
Internet. In electronic content delivery via the Internet, the Wave System
competes with electronic commerce payment technologies developed and offered by
IBM Micropayment Service, Broadvision Inc., Connect, Inc., CyberCash, Inc., and
Open Market, Inc. However, the Company believes that many of the electronic
commerce payment technologies may be used as acceptable currency through the
Wave System and may be complementary to, rather than competitive with, the Wave
System. The Company is also aware of other companies, such as TestDrive
Corporation, Release Software Corporation and InterTrust that provide electronic
content encryption and license management functionality for transmission of
electronic content over the Internet. The Company believes that the Wave System
is superior to currently available electronic content encryption technologies
due to the high level of persistent security and usage reporting capabilities of
the WaveMeter.
-6-
The Company believes that the interoperability of the Wave System with
currently available and developing distribution media makes the Wave System
attractive to both distributors and consumers of electronic content. A consumer
with an installed EMBASSY System will be able to purchase Wave-enabled content
from sources on CD-ROM and/or the Internet, as well as from sources distributing
electronic content on other developing media such as broadband. In addition,
with the incorporation of the rental and rent-to-own functionality, the Wave
System will offer greater merchandising flexibility than is possible using
currently available electronic commerce solutions. There can be no assurance
that the Wave System will achieve the broad-based acceptance necessary to make
the system a viable competitor with currently existing and developing electronic
commerce solutions.
International Market
The Company's technologies are controlled under various United States
export control laws and regulations and will require export licenses for certain
exports outside of the United States and Canada. The Company has received full
export license from the U.S. Department of Commerce for the sale and export of
the Company's single-key DES products. The Company has also received an export
license for its triple-key data encryption standard products under the
provisions of a License Exception KMI, granted by the Bureau of Export
Administration of the U.S. Department of Commerce. There can be no assurance
that the Company will have patent protection or that it will not infringe
patents of third parties in foreign jurisdictions. Because electronic monitoring
and the transmission of audited usage and financial information on end users or
payment instructions may be subject to varying statutory or regulatory controls
in foreign jurisdictions, there can be no assurance that the use of all portions
of the Wave System will be permitted in any particular foreign jurisdiction.
Exportable EMBASSY Systems with Strong Cryptography
Wave Systems formed a strategic alliance in 1998 with HP VerSecure in
the development of the trusted client architecture that is the basis of the
EMBASSY E-Commerce System. HP VerSecure provides a security management framework
for EMBASSY that controls the cryptography functions of the device and
application uses of encryption. The primary function of the VerSecure system is
to provide a policy management system that enables the EMBASSY hardware to have
strong cryptography features that can be selectively enabled or disabled in
order to comply with various nations' strength-of-cryptography regulations. This
capability is intended to allow PC OEMs to build a single, consistent product
which can be shipped worldwide, regardless of local cryptography restrictions.
Proprietary Rights and Licenses and Intellectual Property
The Company's success depends, in part, on its ability to enjoy or
obtain protection for its products and technologies under United States and
foreign patent laws, copyright laws and other intellectual property laws, to
preserve its trade secrets and to operate without infringing the proprietary
rights of third parties. There can be no assurance that any issued patent owned
or licensed by the Company affords adequate protection to the Company or will
not be challenged, invalidated, infringed or circumvented. Furthermore, there
can be no assurance that the Company's activities will not infringe patents
owned by others.
In addition, the Company may be required to obtain licenses to patents
or other proprietary rights of third parties. No assurance can be given that any
licenses required under any such patents or proprietary rights would be made
available on terms acceptable to the Company, if at all. If the Company is
required to and does not obtain such licenses it would be prevented from, or
encounter delays in the development and marketing of, its products and
technologies while it attempted to design around such patents or other rights
and there can be no assurance that such attempts would be successful. Failure to
obtain such licenses or to design around such patents or other rights would have
a material adverse effect on the Company.
The Company holds non-exclusive patent rights relating to the metered
use of encrypted data in local memory under a limited license (the "License
Agreement") from Titan Corporation ("Titan") to a patent (the "Licensed Patent")
jointly held by Titan and a third party. This License Agreement restricts Wave
from metering information produced and used solely by a government entity or
producing products that meter this information. In addition, the License
Agreement is subject to the rights of the joint owner of the Licensed
-7-
Patent, who has the right to exploit, or to license to third parties, the
Licensed Patent, including in a manner competitive with the Company. There can
be no assurance that the joint owner of the Licensed Patent will not compete
with the Company or license the Licensed Patent to a competitor of the Company,
or that the Company's business will not exceed the scope of the License
Agreement. Pursuant to the License Agreement, the Company is obligated to pay
certain royalties to Titan. Pursuant to the License Agreement, the Company has
granted to Titan the exclusive right to use the Company's patents for products
distributed to government entities. On February 28, 1997 the Company and Titan
executed an addendum to the License Agreement whereby the Company received a
sole license to the Licensed Patent to develop and distribute products to the
in-home consumer microcomputer market segment. Under this addendum to the
License Agreement, Titan waived any and all defaults by Wave under the License
Agreement occurring prior to February 28, 1997.
The Company is 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 the Company, some of
the claims of both the Licensed Patent and the Third Party Patents cover certain
material aspects of the Company's technology. Therefore, the commercialization
of the Company's technology would be subject to the rights of the holder of the
Third Party Patents unless the Company is able to invalidate or license such
claims. Also, the holder of the Third Party Patents or a licensee of the Third
Party Patents could seek to invalidate such claims of the Licensed Patent and
therefore be able to commercialize a technology similar to the Company's
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. There can be no assurance that
the Company 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 such claims of the
Licensed Patent. There also can be no 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 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 the Company's technology, then the Company would require a license
from the holder of the Third Party Patents to commercialize its technology and
make, use, or sell products or practice methods, or license others to sell
products or use methods, utilizing the technology in the United States. Due to
the uncertainty as to whether the Third Party Patents could be proved to be
invalid, the Company has engaged in preliminary negotiations with the holder of
the Third Party Patents to obtain a license under the Third Party Patents. The
negotiations have so far not produced any agreement and there can be no
assurance that a license will be obtainable on acceptable terms, if at all. The
inability to obtain a license, if needed, on commercially reasonable terms would
have a material adverse effect on the Company's business and its future
operations.
The Company has been issued three United States patents relating to
encryption and to the Company's proprietary WaveMeter(R) and WaveNet(R)
technology. The Company also has one patent pending before the United States
Patent Office and three corresponding foreign patent applications pending before
the European Patent Office (collectively, the "Wave Patents"). The Wave Patents
are material to protecting certain of the Company's technology. The Company's
rights to the Wave Patent derive from a license, amended and restated in
February 1994, from Mr. Peter J. Sprague, Chairman and Chief Executive Officer
of the Company, of his rights in the Wave Patents (the "Amended License
Agreement"), and several agreements with former officers of the Company
regarding their rights in the Wave Patents. The Amended License Agreement
provides for royalty payments to be made to Mr. Peter J. Sprague and Dr. John R.
Michener, a former officer of the Company, in the aggregate amount of two
percent of gross revenues less certain adjustments as defined in the Amended
License Agreement. The royalty payment is to be apportioned 75 percent to Mr.
Peter J. Sprague and 25 percent to Dr. John R. Michener. Payment of royalties is
secured by a security interest in and to the Wave Patents. The Company believes
that the agreements as a whole provide it with exclusive rights under the Wave
Patents. There can be no assurance that the Company will enjoy exclusive rights
to the Wave Patents under such agreements.
-8-
On January 26, 1996, the Company received notice from E-Data
Corporation (formerly Interactive Gift Express, Inc.), claiming that the
Company's practice of its technology infringes U.S. and foreign patents owned by
E-Data Corporation, and offering to license such patents to the Company. The
Company is currently obtaining information needed to investigate the merits of
this claim. The Company believes that there is a viable argument for
non-infringement. The patents owned by E-Data Corporation are currently being
litigated by third parties. The Company is not involved in these proceedings.
The Company relies on trade secrets and proprietary know-how, which it
protects, in part, by confidentiality agreements with its employees and contract
partners. However, there can be no assurance that the Company's confidentiality
agreements will not be breached or that the Company would have adequate remedies
for any breach. There can be no assurance that the Company's trade secrets will
not otherwise become known or be independently discovered by competitors.
The Company also relies on copyright to prevent the unauthorized
duplication of its software and hardware products. The Company has and will
continue to protect its software and its copyright interest therein through
agreements with its consultants. There can be no assurance that the copyright
laws will adequately protect the Company's technology.
The Company has registered trademark and service mark registrations
with the United States Patent and Trademark Office for the marks WaveMeter(R)
and WaveNet(R), Great Stuff Network, Second Shift (the Wave juggler logo),
WaveCommerce, Wave Interactive Network, WINPublish, WINPurchase and CablePC. The
Company has submitted trademark registrations for EMBASSY, EMBASSY System and
EMBASSY E-Commerce System and 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. The Company has abandoned its prior
applications for DataWave, InfoWave, and WaveTrac.
Research and Development
The Wave System incorporates semiconductor, encryption/decryption,
software transaction processing and other technologies in which the Company has
made a substantial investment in research and development. The Company expects
that it will be required to continue to make substantial investments in the
design of the Wave System including EMBASSY, the WaveMeter, WaveNet and software
interfaces. For the years ended December 31, 1998, 1997, and 1996, the Company
expended approximately $3.5 million, $2.1 million and $3.3 million respectively,
on research and development activities (which amounts include the value of stock
issued). In addition to its ongoing research and development activities, in July
1997 the Company licensed technology and in-process research and development
from Aladdin Knowledge Systems for cash and warrants valued at $3.9 million.
From its inception in February 1988 through December 1998, the Company expended
approximately $18.3 million on research and development activities.
The success of the Wave System depends to a large extent on the
Company's ability to adapt the Wave System for use with various methods for the
distribution of electronic content, the ability of the Wave technology to
interface with various platform environments, and the ability of the Wave System
to work in many application environments. Incorporation of Aladdin's Hasp
technology furthered these efforts and illustrates the adaptive capabilities of
the Wave System. The Company believes that a significant portion of its future
research and development expenditures will be used to adapt the Wave System
accordingly.
The Company will also continue to expend a significant amount of
resources on the development of new iterations of the EMBASSY and the WaveMeter
application. The Company believes that by providing various means of linking the
EMBASSY to the customer's computer or network, the Company will be more likely
to achieve broad acceptance of the Wave System. The Company is currently
developing other forms of the EMBASSY to target other market needs.
Wave is now focusing increased resources on developing the operational
infrastructure of the Company. Greater emphasis is placed on developing internal
production and fulfillment systems and marketing infrastructure to distribute
the Wave System. The Company will also increase the resources available to
WaveNet to adapt to
-9-
changing market requirements. The Company plans to expand WaveNet to handle more
end users, to implement more sophisticated pricing methodologies and to add
greater financial system flexibility.
Employees
As of December 31, 1998, the Company employed 80 full-time employees,
38 of whom were involved in sales, marketing and administration and 42 of whom
were involved in research and development. As of December 31, 1998, the Company
employed 9 full-time consultants, which are reflected in the foregoing figures.
The Company believes its employee relations are satisfactory.
Item 2. Properties
The Company leases a 10,748 square foot facility for its executive
offices and to house the WaveNet installation, administration, and customer
support operations in Lee, Massachusetts at a monthly rent of $5,598 with a
monthly charge of $2,123 for common costs. The Lee, Massachusetts lease will
expire during February 2001. The Company leases offices in New York, New York,
at a monthly rent of $7,433. The lease is scheduled to expire in June 1999. The
Company leases a 6,400 square foot facility in Princeton, New Jersey at a
monthly base rent of $4,214 with a monthly payment for taxes, insurance and
maintenance reimbursements and improvements which currently totals approximately
$1,653 per month. This lease is scheduled to expire during January 2001. The
Company's principal research and development activities are conducted at the
Princeton facility. The Company leases a 2,728 square foot facility in San Jose,
California for $6,138 per month. The San Jose, California lease will expire
during December 2001.
Item 3. Legal Proceedings
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
On November 9, 1998, the Company held its Annual Meeting of
shareholders. At the Annual Meeting, the shareholders voted on the following
matters:
1. The election of six directors to hold office until the next
Annual Meeting and until their successors are duly elected and qualified. The
previous board was re-elected with the following results:
DIRECTOR FOR AGAINST
- - -------- --- -------
Peter J. Sprague 25,150,986 307,201
John E. Bagalay, Jr. 25,144,086 314,101
Philippe Bertin 24,994,643 463,544
George Gilder 25,151,623 306,364
John E. McConnaughy, Jr. 25,150,886 307,301
Steven Sprague 25,148,686 309.501
2. A proposal to amend the Restated Certificate of Incorporation of the
Company to increase the number of Class A Common Stock that the Company is
authorized to issue from 50 million to 75 million shares. The proposal passed,
with 24,236,103 votes for, 1,079,758 votes against and 151,326 abstentions.
3. A proposal to amend the Company's 1994 Employee Stock Option Plan to
(i) increase the number of shares of Class A Common Stock reserved for issuance
thereunder by 5,000,000 shares, and (ii) increase the maximum number of shares
of the Company's Class A Common Stock covered by options that may
-10-
be granted to any single individual in any fiscal year from 100,000 shares to
500,000 shares. The proposal passed, with 7,859,012 votes for, 1,711,250 votes
against and 375,777 abstentions.
4. A proposal to amend the Company's 1994 Non-Employee Directors Stock
Option Plan to (i) increase the number of shares of Class A Common Stock
reserved for issuance thereunder by 500,000 shares, and (ii) provide that
options issued to non-employee directors under such plan vest on the day
following the grant. The proposal passed, with 8,696,127 votes for, 1,571,551
votes against and 447,355 abstentions.
5. A proposal to ratify the appointment of KPMG Peat Marwick LLP as the
Company's independent auditors for the year ending December 31, 1998. The
proposal passed, with 22,532,604 votes for, 44,794 votes against and 502,259
abstentions.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The Company made its initial public offering on August 31, 1994 at a
price to the public of $5.00 per share. Until October 3, 1997, the Company's
Class A Common Stock had been traded on The Nasdaq National Market tier of The
Nasdaq Stock Market. From October 3, 1997 to October 24, 1997 the Company's
Class A Common Stock was traded on The Nasdaq SmallCap Market. The Company's
Class A Common Stock now trades on The OTC Bulletin Board under the symbol:
WAVX. Except as provided below, the following table sets forth, for the periods
indicated, the high and low closing sales prices per share for the Company's
Class A Common Stock as reported by The Nasdaq National Market. For the period
from October 24, 1997 to December 31, 1997 the following table sets forth the
high and low bid quotations for the Company's Class A Common Stock obtained from
Bloomberg Information Services, Inc. Such quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions. There is no established trading market for the
Company's Class B Common Stock.
High Low
---- ---
Year Ended December 31, 1998
First Quarter (January 1, 1998-March 31, 1998) $1.68 $0.97
Second Quarter (April 1, 1998-June 30, 1998) 4.75 1.56
Third Quarter (July 1, 1998-September 30, 1998) 4.56 2.25
Fourth Quarter (October 1, 1998-December 31, 1998) 5.63 2.44
High Low
---- ---
Year Ended December 31, 1997
First Quarter (January 1, 1997-March 31, 1997) $3.00 1.56
Second Quarter (April 1, 1997-June 30, 1997) 1.81 1.25
Third Quarter (July 1, 1997-September 30, 1997) 2.00 0.94
Fourth Quarter (October 1, 1997-October 23, 1997) 1.94 1.06
Fourth Quarter (October 24, 1997-December 31, 1997) 2.00 0.63
As of March 5, 1999, there were approximately 394 holders of the
Company's Class A Common Stock. As of such date, there were 57 holders of the
Company's Class B Common Stock.
The Company has never declared or paid any cash dividends on its
capital stock. The Company currently anticipates that it will retain all future
earnings, if any, to fund the development and growth of its business and does
not anticipate paying any cash dividends on its Common Stock in the foreseeable
future.
Recent Sales of Unregistered Securities
-11-
On March 30, 1999 the Company sold 181,818 shares of its Class A Common
Stock, at a price of $11.00 per share, in satisfaction of the then outstanding
principal amount of $2,000,000 on a note it had issued to Carriage Partners,
LLC.
On March 23, 1999 the Company sold 2,090,954 shares of it Class A
Common Stock, at a price of $11.00 per share, for an aggregate purchase price of
$23,000,494. The shares were sold to a group of accredited investors pursuant to
Regulation D promulgated under the Act. Pacific Growth Equities, Inc.
acted as sole placement agent for the private placement, receiving a commission
of approximately $1.2 million.
On January 26, 1999 the Company issued warrants to purchase 275,000
shares of its Class A Common Stock at an exercise price of $4.00 per share,
exercisable until January 26, 2004, (the "Warrants") to one (1) accredited
investor. If, over any sixty (60) consecutive day period, the average of the
averaged daily high and low prices of the Class A Common Stock, as reported by
Bloomberg Information Services, Inc., exceeds seven dollars ($7.00), the Company
may force the conversion of the Warrants. The Warrants were issued as
consideration for a $2,000,000 promissory note, bearing no interest, due January
26, 2002.
On March 6, 1998 the Company issued 150,000 shares of newly created
Series G Convertible Preferred Stock, par value $.01 ("Series G Convertible
Preferred Stock") at a price of $20 per share, for an aggregate purchase price
of $3,000,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series G Convertible Preferred Stock
is convertible into Class A Common Stock, par value $.01 ("Class A Common
Stock") at an effective conversion price of the lower of (a) $1.12 and (b) 80%
of the average of the five (5) lowest trading prices of the Class A Common Stock
during (x) a day on which the Class A Common Stock is traded on The Nasdaq
National Market or The Nasdaq SmallCap Market or principal national securities
exchange or market on which the Class A Common Stock has been listed, or (y) if
the Class A Common Stock is not listed on The Nasdaq National Market or The
Nasdaq SmallCap Market or any stock exchange or market, a day on which the Class
A Common Stock is traded in the over-the-counter market, as reported by the OTC
Bulletin Board, or (z) if the Class A Common Stock is not quoted on the OTC
Bulletin Board, a day on which the Class A Common Stock is quoted in the
over-the-counter market as reported by the National Quotation Bureau
Incorporated (or any similar organization or agency succeeding its functions of
reporting prices) ("Trading Days"), as reported by Bloomberg Information
Services, Inc. during the ten (10) Trading Days immediately preceding the
Conversion Date, as defined in the Certificate of Designation of the Series G
Convertible Preferred Stock. In addition to the Series G Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 225,000 shares of
Class A Common Stock at an exercise price of $1.38 per share, exerciseable until
October 9, 2002. As of February 18, 1999, all of the shares of the Series G
Convertible Preferred Stock have been converted into Class A Common Stock.
On October 9, 1997 the Company issued 112,500 shares of newly created
Series F Convertible Preferred Stock, par value $.01 ("Series F Convertible
Preferred Stock"), at a price of $20 per share, for an aggregate purchase price
of $2,250,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series F Convertible Preferred Stock
is convertible into the Class A Common Stock at an effective conversion price of
the lower of (a) $1.05 and (b) 80% of the average of the five (5) lowest trading
prices of the Class A Common Stock during (x) a day on which the Class A Common
Stock is traded on The Nasdaq National Market or The Nasdaq SmallCap Market or
principal national securities exchange or market on which the Class A Common
Stock has been listed, or (y) if the Class A Common Stock is not listed on The
Nasdaq National Market or The Nasdaq SmallCap Market or any stock exchange or
market, a day on which the Class A Common Stock is traded in the
over-the-counter market, as reported by the OTC Bulletin Board, or (z) if the
Class A Common Stock is not quoted on the OTC Bulletin Board, a day on which the
Class A Common Stock is quoted in the over-the-counter market as reported by the
National Quotation Bureau Incorporated (or any similar organization or agency
succeeding its functions of reporting prices) ("Trading Days"), as reported by
Bloomberg Information Services, Inc. during the ten (10) Trading Days
immediately preceding the Conversion Date, as defined in the Certificate of
Designation of the Series F Convertible Preferred Stock. In addition to the
Series F Convertible Preferred Stock, the Company also issued warrants to
purchase a total of 168,750 shares of Class A Common Stock at an exercise price
of $1.26 per share, exerciseable until October 9, 2002. As of December 31, 1997,
all of the shares of the Series F Preferred stock have been converted into Class
A Common Stock
-12-
On September 16, 1997, the Company issued 800,000 shares of the
Company's Class A Common Stock, and warrants to purchase 160,000 shares of Class
A Common Stock, which may be exercised at an exercise price equal to $1.00, for
an aggregate purchase price of $800,000 pursuant to Regulation D promulgated
under the Securities Act of 1933, as amended (the "Act"), to six (6) accredited
investors.
On May 30, 1997 the Company issued 80,000 shares of newly created
Series D Convertible Preferred Stock, at a price of $20 per share, for an
aggregate of $1,600,000. The shares were sold to one (1) accredited investor
pursuant to Regulation D promulgated under the Act. The Series D Convertible
Preferred Stock is convertible into the Class A Common Stock of the Company at
an effective conversion price of the lower of (i) $1.35, or (ii) 80% of the
average closing bid price on the Nasdaq National Market System of the Company's
Class A Common Stock for the five (5) trading days immediately preceding the
Date of Conversion, defined in the Certificate of Designation of the Series D
Convertible Preferred Stock. In addition to the Series D Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 120,000 shares of
Class A Common Stock at an exercise price of $1.62 per share, exercisable until
May 30, 2002. As of December 31, 1997, all of the shares of the Series D
Preferred Stock have been converted into Class A Common Stock.
-13-
Item 6. Selected Financial Data
Statement of Operations Data
Period from
February 12,
1988
(inception)
through
Year ended December 31 December 31
-------------------------------------------------------------------------------- ------------
1998 1997 1996 1995 1994 1998
---- ---- ---- ---- ---- ----
Net Revenues $ 10,193 $ 10,712 $ 1,458 $ - $ $ 22,363
------------ ------------ ------------ ------------ ------------ ------------
Operating expenses:
Selling, general and
administrative------ 9,874,166 7,983,151 5,560,620 4,080,185 2,432,283 37,310,672
Write-off of Goodwill - 769,886 - - - 769,886
Aladdin Technology
License Expense----- - 3,889,000 - - - 3,889,000
Research and
development--------- 3,508,968 2,146,127 3,309,022 3,324,735 1,761,366 18,254,781
------------ ------------ ------------ ------------ ------------ ------------
13,383,134 14,788,164 8,869,642 7,404,920 4,193,649 60,224,339
------------ ------------ ------------ ------------ ------------ ------------
Other income (expense):
Technology License
Fee----------------- 2,750,000 1,000,000 - - - 3,750,000
Technology Warrant Cost (1,100,000) - - - - (1,100,000)
Net interest and other
income (expense)---- ( 173,003) 184,369 572,054 (77,852) 331,569
------------ ------------ ------------ ------------ ------------ ------------
(120,342)
Net loss------------- ( 11,895,944 ) (13,897,794) (8,683,815) (6,832,866) (4,271,501) ( 57,220,407)
Accrued dividends on
preferred stock----- 108,863 809,982 199,614 40,600 39,484 1,243,393
------------ ------------ ------------ ------------ ------------ ------------
Assured incremental
yield--------------- 750,000 1,673,000 670,965 - - 3,093,965
------------ ------------ ------------ ------------ ------------ ------------
Net loss to common
stockholders-------- $(12,754,807) $(16,380,776) $(9,554,394) $(6,873,466) $(4,310,985) $(61,557,765)
============= ============= ============ =========== =========== =============
Weighted average
number of common
shares outstanding
during the period--- 29,299,844 20,943,748 14,956,584 13,794,373 10,503,621 11,570,172
Loss per common share
$(.44) $(.78) $(.64) $(.50) $(.41) $(5.32)
============= ============= ============ ============ =========== ============
-14-
Balance Sheet Data
Year ended December 31
-------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Working capital
(deficiency)--------- $ (3,778,895) $ (669,041) $ 3,197,519 $ 5,458,512 $ 12,463,502
Total assets------------ 2,057,812 1,678,213 6,237,219 7,754,042 13,766,864
Current liabilities----- 4,840,989 1,949,886 937,163 1,210,778 867,145
Long-term liabilities--- - 522,124 465,500 - -
Series A Cumulative
Redeemable Preferred
Stock---------------- 493,201 471,601 432,334 390,534 349,934
Series B Cumulative
Convertible Preferred
Stock---------------- - - 195,520 - -
Series C Cumulative
Convertible Preferred
Stock---------------- - - 2,647,742 - -
Deficit accumulated during
the development stage
(57,220,407) (45,324,463) (31,426,669) (22,742,854) (15,909,988)
------------ ------------ ------------ ------------ ------------
Total stockholders'
equity (deficiency)-- $ (3,276,378) $ (743,274) $ 1,558,960 $ 6,152,730 $ 12,549,785
=============== ============== ============ ============= ============
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview
Wave Systems Corp. ("Wave" or the "Company") is creating a new
electronic commerce model for digital information and services based on
client-side security, transactions and trust. Since its inception in February of
1988, the Company has devoted substantially all of its efforts and resources to
research, feasibility studies, design, development, and market testing of a
distributed trust system that enables client based transactions, including the
metered usage of electronic content and services (the "Wave System"). Electronic
content and services refers to any data, graphic software, video or audio
sequence that can be digitally transmitted and/or stored. As its research and
development activities matured, the Company was able to devote increased
resources to creation of content distribution services, market development and
the application of the Wave System to end-user services. During 1998 the Company
established relationships with RSA Data Security, NEC Technologies, Inc., Pollex
Technology Ltd., Hewlett-Packard Company's VerSecure division, Sun Microsystems,
SMSC, ITE, IGST, Sarnoff Corp., Hauppauge Computer Systems and WavePhore. The
Company received payments of $1 million and $4 million pursuant to a joint
venture agreement with Internet Technology Group, PLC ("ITG"), a United Kingdom
company, and has recognized $3.75 million to date as license fees and recorded
the net cost to the Company of $1.1 million for an exchange of warrants between
the Company and ITG for 1,000,000 shares of common stock in each company which
is to occur due to attainment of the final milestones and payment of the final
installment of the license fee. From inception through December 31, 1998, the
Company has realized only minimal
-15-
operating revenues, and does not anticipate significant revenues in the near
future. There are numerous risks that could adversely affect the Company's
efforts to achieve profitability.
Results of Operations
Years Ended December 31, 1998 and 1997
For the years ended December 31, 1998 and December 31, 1997 the Company
had only minimal operating revenues.
Selling, general and administrative expenses for the year ended
December 31, 1998 were $9,874,166 as compared with $7,983,151 for 1997. The
increase in selling, general and administrative expenses was primarily
attributable to increased headcount, as well as trade-show related expenses.
In the third quarter of 1997 the Company wrote off approximately
$770,000 of Goodwill recorded for the Win acquisition because the Company was
uncertain as to whether the anticipated future operations of the business would
be sufficient to justify the carrying value.
Research and development expenses for the year ended December 31, 1998
were $3,508,968 as compared with $2,146,127 for 1997. The increase in research
and development expenses is attributable to increased headcount and
consulting-related expenses.
License fee income for the year ended December 31, 1998 was $2,750,000,
as compared with $1,000,000 for 1997. The $2,750,000 for the year ended December
31, 1998 is before a charge of $1.1 million related to the net cost to the
Company of a warrant it is obligated to issue to ITG as part of the technology
licensing agreement. The $1.1 million charge includes the estimated fair value
of the ITG warrant that the Company will receive as part of the warrant
exchange. The license fee for both 1998 and 1997 were portions of a $5 million
fee paid by ITG to the Company as part of a joint venture agreement under which
ITG receives the right to market the Wave technology in European and Middle
Eastern markets.
Net interest expense for the year ended December 31, 1998 was $173,003
as compared with net interest expense of $120,342 for 1997. The increase in
interest expense for the year ended December 31, 1998 was primarily attributable
to the restated and amended note for Southeast Interactive Technologies Fund I
(see Note 5), offset by an increase in interest-bearing assets. Interest income
of $55,282 for the year ended December 31, 1997 was attributable to the interest
earned on marketable securities purchased with proceeds from the issuance of
convertible preferred stock of the Company in May 1996. The Company held no
marketable securities at December 31, 1998.
Due to the reasons set forth above, the Company's net loss was
$11,895,944 for the year ended December 31, 1998, as compared with $13,897,794
for 1997.
Years Ended December 31, 1997 and 1996
For the years ended December 31, 1997 and December 31, 1996 the Company
had only minimal operating revenues.
Selling, general and administrative expenses for the year ended
December 31, 1997 were $7,983,151 as compared with $5,560,620 for 1996. The
increase in selling, general and administrative expenses was primarily
attributable to development and marketing of new applications of the Company's
technology as well as accrued expenses related to the ITG Joint Venture
Agreement, and bonuses and salary increases.
In the third quarter of 1997 the Company wrote off approximately
$770,000 of Goodwill recorded for the Win acquisition because the Company was
uncertain as to whether the anticipated future operations of the business would
be sufficient to justify the carrying value.
-16-
Research and development expenses for the year ended December 31, 1997
were $2,146,127 as compared with $3,309,022 for 1996. The decrease in research
and development expenses is attributable in part to the agreement with Aladdin
whereby Wave licensed Aladdin's Hasp technology for a share in content revenues
as well as cash and warrants totaling $3,889,600. More generally, the decrease
in research and development is attributable to the shift in the focus of the
Company from research and development to commercialization and marketing and
personnel adjustments consequent thereto.
In July of 1997, the Company entered into a joint-venture with Internet
Technology Group, PLC (ITG), a United Kingdom Internet service provider.
Pursuant to the joint venture agreement, the Company will receive a license fee
of up to $5 million in exchange for the joint venture's right to market the Wave
technology in European and Middle Eastern markets. During the third quarter of
1997, the Company received $1.0 million from the joint-venture representing
partial payment of the license fee, with the remaining payment to be made upon
the Company's attaining certain milestones related to the number of Wave Meters
distributed. The amount received was recorded as deferred license fee income in
the third quarter as it was uncertain whether the Company had met the
contractual requirements required in order to have earned the first payment.
During the fourth quarter of 1997, the Company met these requirements and
recorded the $1 million as a license fee. Also, the Company accrued $490,000 in
the fourth quarter for expenses related to the Company's obligation to assist
the joint-venture in setting up the Wave system in the designated markets. These
costs are included in selling, general and administrative expense. Additionally,
upon attainment of the final milestones and final cash payment by ITG, ITG and
Wave will exchange warrants for 1 million shares of each company.
Net interest expense for the year ended December 31, 1997 was $120,342
as compared with net interest income of $184,369 for 1996. Interest income of
$55,282 for the year ended December 31, 1997 was attributable to the interest
earned on proceeds from the issuance of convertible preferred stock of the
Company in May of 1996. Interest income of $194,766 for the year ended December
31, 1996 was attributable to the interest earned on proceeds from the issuance
of convertible preferred stock of the Company in May of 1996. The Company held
no marketable securities at December 31, 1997.
Due to the reasons set forth above, the Company's net loss was
$13,897,794 for the year ended December 31, 1997, as compared with $8,683,815
for 1996.
Liquidity and Capital Resources
The Company has experienced net losses and negative cash flow from
operations since its inception, and, as of December 31, 1998 had a deficit
accumulated during the development stage of approximately $57.2 million. The
Company has financed its operations through December 31, 1998 principally
through the private placement of Class B Common Stock for an aggregate amount of
$6,201,931 (before deduction of expenses incurred in connection therewith), the
issuance of $2,873,250 in aggregate principal amount of its 10% Convertible
Notes and 15% Notes (of which $2,098,250 was converted into Class B Common
Stock), the sale of 3,728,200 shares of its Class A Common Stock in an initial
public offering raising approximately $15,711,000 after all expenses, the
private placement of 800,000 shares of Class A Common Stock and warrants raising
$800,000 (before deduction of expenses incurred in connection therewith), and
the private placements of convertible preferred stock for an aggregate amount of
$13,350,000 (before deduction of expenses incurred in connection therewith). In
addition, the Company has attempted to reduce cash flow requirements by
compensating key employees, consultants, suppliers and other vendors with Common
Stock and options to purchase Common Stock.
At December 31, 1998, the Company had approximately $1.1 million in
cash and cash equivalents. The Company held no marketable securities at December
31, 1998. At December 31, 1997, the Company had approximately $759,000 in cash
and cash equivalents. The Company held no marketable securities at December 31,
1997. The increase in cash and cash equivalents is attributable to cash proceeds
of approximately $2.8 million from the issuance of Series G Convertible
Preferred Stock, the last two licensing payments of $750,000 and $3.25 million
from ITG, and Aladdin Knowledge System's exercise of its warrant for 1 million
shares for $2.55 million, less cash used for operating expenses. At December 31,
1998, the Company had working capital deficiency of approximately $3.8 million.
In January, 1999 the Company issued a convertible promissory note in aggregate
principal amount of $2 million, which was subsequently converted into Class A
common stock in March, 1999, following the Company's completion of an additional
$23 million private placement with institutional, strategic and accredited
investors.
The Company expects to incur substantial additional expenses resulting
in significant
-17-
losses at least through the period ending December 31, 1999 due to minimal
revenues associated with initial market entry, continued research and
development costs as well as increased sales and marketing expenses associated
with market testing and roll-out. However, considering the funds received from
the latest common stock offering and the Company's projected operating cash
requirements, the Company anticipates that its existing capital resources will
be adequate to satisfy its capital requirements through the end of the third
quarter of 2000.
However, as the Company has not yet attained commercial acceptance of
its products and has not yet generated any significant operating revenue,
considerable uncertainty currently exists with respect to the adequacy of
current funds to support the Company's activities. This uncertainty will
continue until a positive cash flow from operations can be achieved.
Additionally, the Company is uncertain as to the availability of financing from
other sources to fund any cash deficiencies.
In order to reduce this uncertainty, the Company 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 the Company's technology, products and services. There can,
however, be no assurance that the Company can raise additional financing in the
future.
The Company presently has no material commitments for capital
expenditures.
As of December 31, 1998, the Company had available net operating loss
carryforwards for Federal income tax purposes of approximately $47.6 million.
Because of the "change in ownership" provisions of the Tax Reform Act of 1986,
the Company's 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
the Company occurs within any three-year period. The Company has made no
determination concerning whether there has been such a cumulative change in
ownership. However, the Company believes that it is likely that such a change in
ownership occurred prior to or following the completion of its initial public
offering.
Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Under this concept, all revenues, expenses, gains and losses recognized during
the period are included in income, regardless of whether they are considered to
be results of operations of the period. SFAS 130, which the Company adopted
effective January 1, 1998, did not impact the consolidated financial statements
of the Company.
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report selected information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS 131,
which the Company adopted effective January 1, 1998, did not impact the
Company's consolidated financial statements and footnote disclosures, as the
Company operates in one segment
The Financial Accounting Standards Board ("FASB") recently issued
Statement of Financial Standards Number 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and hedging,
requiring recognition of all derivatives as either assets or liabilities in the
statement of financial position measured at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
The effects of adopting SFAS 133 is not expected to have a material impact on
the Company's financial condition, results of operations or cash flows.
The AICPA Accounting Standards Executive Committee recently issued
Statement of Position ("SOP")98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. This
-18-
statement requires that certain costs related to the development or purchase of
internal-use software be capitalized and amortized over the estimated useful
life of the software, and is effective for fiscal years beginning after December
15, 1998. The statement also requires that costs related to the preliminary
project stage and post implementation/operations stage in an internal-use
computer software development project can be expensed as incurred. The Company
will comply with the provisions of SOP 98-1 in fiscal 1999. The adoption of this
SOP is not expected to have a material impact on the Company's financial
position or results of operations.
The AICPA Accounting Standards Executive Committee recently issued SOP
98-5, Reporting on the Costs of Start-Up Activities. This Statement requires
that costs incurred during start-up activities, including organization costs, be
expensed as incurred, and is effective for fiscal years beginning after December
15, 1998. The Company will comply with the provisions of SOP 98-5 in fiscal
1999. The adoption of this SOP is expected to have no impact on the Company's
financial position or results of operations.
Impact of Year 2000 Issue
The Year 2000 issue results from computer programs written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.
The Company made an assessment, with regard to whether its own internal
information systems are Year 2000 compliant. Since January 1998, in addition to
updating employee computers and workstations, the Company has upgraded various
accounting, telecommunications, customer care systems and transaction systems at
an aggregate cost of approximately $400,000, with systems that are warranted by
the vendors to be Year 2000 compliant. To the extent the Company purchases
additional systems, the Company requires that such systems are warranted by the
vendors to be Year 2000 compliant. The Company continues to seek assurances from
its existing vendors whose systems are not warranted to be Year 2000 compliant
that such systems will be Year 2000 compliant. The Company employs a manager of
management information systems, whose responsibilities include oversight of Year
2000 compliance. The Company does not separately track the internal costs
incurred for Year 2000 projects, which are principally the related payroll costs
for its information systems personnel. Although the Company does not believe
that any additional Year 2000 compliance-related costs will be significant,
there can be no assurance that costs incurred to address unanticipated issues
would not have a material adverse effect on the Company's business, operating
results and financial conditions. Any failure of third-party equipment or
software comprising any part of the Company's systems to operate properly with
regard to Year 2000 and thereafter could require the Company to incur
unanticipated expenses to address associated problems, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
The Company believes, based on an internal assessment, that the current
versions of its software products are Year 2000 compliant. The Company has no
plan to ascertain whether the internal systems and products of its potential
future customers are Year 2000 compliant. The Company may in the future be
subject to claims based on Year 2000 problems in others' products or issues
arising from the integration of multiple products within an overall system.
Although the Company has not been involved in any litigation or proceeding to
date involving its products or services related to Year 2000 issues, there can
be no assurance that the Company will not in the future be required to defend
its products or services or to negotiate resolutions of claims based on Year
2000 issues. The costs of defending and resolving Year 2000-related disputes,
and any liabilities of the Company for Year 2000-related damages, including
consequential damages, could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company does not have any specific contingency plans if any Year
2000 problems develop with respect to the Company's embedded systems or systems
acquired from vendors. Contingency plans will be developed if the Company
identifies instances of non-compliance and such
-19-
noncompliance is expected to have a material adverse impact on the Company's
operations. The cost of developing and implementing such plans may itself be
material.
Year 2000 issues may affect the purchasing patterns of customers and
potential customers in a variety of ways. Many companies are expending
significant resources to replace or remedy their current hardware and software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase products such as those offered by the Company. The Company
does not believe that there is any practical way to ascertain the extent of, and
has no plan to address problems associated with such a reduction in purchasing
resources of its customers. Any such reduction could, however, result in a
material adverse effect on the Company's business, operating results and
financial condition. The Year 2000 problem is pervasive and complex, as
virtually every computer operation will be affected in some way. Consequently,
no assurance can be given that Year 2000 compliance can be achieved without
significant additional costs.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Not applicable.
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.
Item 9. Changes in and Disagreements with Accountant on Accounting and
Financial Disclosure
Not Applicable.
-20-
PART III
Item 10. Directors and Executive Officers of the Registrant
Directors of the Registrant
Business Experience and Principal Occupation or
Employment During Past 5 Years; Positions held with Director
Name Age Company; Other Directorships Since
- - ---- --- ------------------------------------------------------- --------
Peter J. Sprague(1)(4) 59 Chairman of the Company since 1988 and Chief Executive 1988
Officer of the Company since July 1991; Chairman of
National Semiconductor Corporation from 1965 until May
1995; Director of EnLighten Software, Inc. and Imagek,
Inc.; Trustee of the Strang Clinic; Member of Academy
of Distinguished Entrepreneurs, Babson College.
John E. Bagalay, Jr., 65 Senior Advisor to Chancellor, Boston University from 1993
Ph.D.(1)(2)(4) January 1998; Managing Director of Community Technology
Fund, a venture capital affiliate of Boston University,
from September 1989 until January 1, 1998; Chief
Operating Officer, Chief Financial Officer and Director
of Eurus Technologies, inc. since January 15, 1999;
General Counsel of Lower Colorado River Authority from
October 1984 to September 1988; former General Counsel
of Texas Commerce Bancshares, Inc. and Houston First
Financial Group; Director of Seragen, Inc., Cytogen,
Inc., AES, Inc. and several privately-held
corporations; President and CEO of Cytogen Corporation
from January 1998, CFO since October 1997; Managing
Director of Boston University Venture Capital Fund from
1989-1997.
Philippe Bertin(3) 49 Manager of Financiere Wagram Poncelet (direct marketing; 1993
media) since December 1991; Manager of Midial S.A.
(consumer goods) from 1984 until 1991; Manager of
FINOVELEC since October 1997.
George Gilder(4) 59 Chairman of the Executive Committee of the Company since 1993
1996; Senior Fellow at the Discovery Institute in
Seattle, Washington; author of nine books, including
Life After Television, Microcosm, The Spirit of
Enterprise and Wealth and Poverty; contributing editor
to Forbes Magazine; Director and President of Gilder
Technology Group, Inc. (publisher of monthly technology
reports); former chairman of the Lehrman Institute
Economic Roundtable; former Program Director for the
Manhattan Institute; recipient of White House award for
Entrepreneurial Excellence from President Reagan.
John E. McConnaughy, 69 Chairman and Chief Executive Officer of JEMC Corporation 1988
Jr. (1)(2)(3)(4) (private investments); Chairman and Chief Executive
Officer of Peabody International Corporation (an
environmental services company) from 1969 through 1985;
Chairman and Chief Executive Officer of GEO
International Corporation (a nondestructive testing,
screen printing and oil field services company which was
spun off from
-21-
Peabody) from February 1981 to October 1992; Director of
Riddell Sports Inc., Levcor International, Inc.,
Transact International, Inc., De-Vlieg Bullard, Inc. and
Mego Financial Corp. Mr. McConnaughy is also a member of
the Board of Trustees of the Strang Clinic and the
Chairman of the Board of the Harlem School of the Arts.
Steven Sprague 34 President and Chief Operating Officer of the Company 1997
since May 1996; President of Wave Interactive Network
from June 1995 to December 30, 1996; Vice President of
Operations of the Company from April 1994 to June 1995;
employee of the Company in the areas of operations and
strategic planning from November 1992 to April 1994;
consultant to the Company from March 1992 to November
1992; President of Tech Support, Incorporated (hardware
technical support information on CD-ROM) from June 1992
to November 1992; sole proprietor of SKS Environmental
Sales (manufacturers' representative for water treatment
companies) from June 1991 to November 1992.
- - -------------------
(1) Member of Nominating Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.
(4) Member of Executive Committee.
Involvement in Certain Legal Proceedings
Mr. McConnaughy is the Chairman of the Board of the Excellence Group,
LLC, which filed a petition for bankruptcy under Chapter 11 on January 13, 1999.
The Excellence Group's subsidiaries produced labels for a variety of customers.
Executive Officers of the Registrant
The executive officers of the Company are Mr. Peter J. Sprague,
Chairman and Chief Executive Officer, Mr. Steven Sprague, President and Chief
Operating Officer and Mr. Gerard T. Feeney, Senior Vice President of Finance and
Administration, Chief Financial Officer and Secretary.
All officers are elected annually at the first meeting of the Board of
Directors following the annual meeting of the stockholders, and are subject to
removal at any time by the Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's directors and executive officers, and
persons owning more than ten percent of a registered class of the Company's
equity securities, to file with the Securities and Exchange Commission reports
of ownership and changes in ownership of equity securities of the Company. Such
persons are also required to furnish the Company with copies of all such forms.
Based solely upon a review of the copies of such forms furnished to the
Company and, in certain cases, written representations that no Form 5 filings
were required, the Company believes that, with respect to the 1998 fiscal year,
all required Section 16(a) filings were made, except that Mr. Gerard T.
Feeney filed his Forms 3 and 5 late.
-22-
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information with respect to the
compensation paid or awarded by the Company to the Chief Executive Officer and
the other executive officers whose cash compensation exceeded $100,000.
(collectively, the "Named Executive Officers") for services rendered in all
capacities during 1996, 1997 and 1998.
Long-Term
Compensation Awards
-------------------
Annual Compensation Number of Shares
-------------------
Name and Principal Position Year Salary($) Bonus($) Underlying Options(#)
- - --------------------------- ---- --------- -------- ---------------------
Peter J. Sprague(1) 1998 $ 182,917 $ 150,000 895,395
Chairman and Chief 1997 $ 160,000 $ 100,000 10,000
Executive Officer 1996 $ 160,000 $ 50,000 -0-
Steven Sprague(2) 1998 $ 177,500 $ 150,000 954,505
President and 1997 $ 150,000 $ 117,500 -0-
Chief Operating Officer 1996 $ 131,666 $ -0- 150,000
Gerard T. Feeney(3) 1998 $ 90,359 450,000
Senior Vice President, Chief $ 65,000
Financial Officer and
Secretary
- - -------------------
(1) Mr. Peter Sprague received a bonus of $150,000 for 1998; $75,000 was
received in cash and $75,000 was applied to reduce his debt to the Company
(see Item 13).
(2) Mr. Steven Sprague was elected President and Chief Operating Officer on May
23, 1996 and was not previously an executive officer during 1996. Prior to
that, Mr. Steven Sprague was Vice President of Operations of the Company
from April 1994 to June 1995 and employee of the Company in the areas of
operations and strategic planning from November 1992 to April 1994.
(3) Mr. Gerard T. Feeney was hired as Senior Vice President, Finance and
Administration and Chief Financial Officer on June 8, 1998 and was elected
Secretary on February 25, 1999.
Option Grants Table
The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 1998 by the Company to the
Named Executive Officers.
Potential Realizable Value
Number of % of Total at Assumed Annual Rates of
Shares Options Stock Price Appreciation For
Underlying Granted to Exercise Option Term (1)
Options Employees Price Expiration -----------------------------
Name Granted (#) Fiscal Year ($/Share) Date 5% ($) 10% ($)
- - ---- ----------- ----------- --------- ------------ ------ -------
Peter J. Sprague (2) 300,000 5.7% $ 1.15 2/6/08 216,900 548,400
50,005 0.1 1.10 3/11/08 37,854 74,657
545,500 10.4 3.66 5/20/08 1,990,529 4,347,090
Steven Sprague (3) 193,200 3.7 1.15 2/6/08 139,684 353,170
250,005 4.8 1.10 3/11/98 189,254 373,257
511,300 9.7 3.66 5/20/08 1,865,734 4,074,550
Gerard T. Feeney 450,000 8.6 3.50 6/8/08 1,265,400 2,941,200
- - -------------------
-23-
(1) The potential realizable value of the options reported above was calculated
by assuming 5% and 10% compounded annual rates of appreciation of the
common stock from the date of grant of the options until the expiration of
the options, based upon the market price on the date of grant. These
assumed annual rates of appreciation were used in compliance with the rules
of the Securities and Exchange Commission and are not intended to forecast
future price appreciation of the common stock.
(2) Includes an aggregate of 300,000 options repriced on February 6, 1998.
(3) Includes an aggregate of 193,200 options repriced on February 6, 1998.
Fiscal Year End Option Value Table
The following table sets forth information regarding the aggregate
number and value of options held by the Named Executive Officers as at December
31, 1998, and the aggregate number and value of options exercised by the Named
Executive Officers during 1998.
Number of Shares Value of Unexercised
Shares Acquired Underlying Unexercised Options In-The-Money Options
on Exercise Value Received at December 31, 1998(#) at December 31, 1998($)(1)
----------- -------------- ------------------------------ ------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- - ---- ----------- ------------- ----------- -------------
Peter J. Sprague - 0 - - 0 - 31,995 895,505 $ 67 ,715 $ 933,848
Steven Sprague - 0 - - 0 - 1,995 954,505 5,245 1,181,261
Gerard T. Feeney - 0 - - 0 - - 0 - 450,000 - 0 - 98,550
- - -------------------
(1) The last reported bid price for the Company's Class A Common Stock on
the OTC Bulletin Board on December 31, 1998 was $3.719 per share. Value is
calculated on the basis of the difference between the respective option exercise
prices and $3.719, multiplied by the number of shares of common stock underlying
the respective options.
Compensation of Directors
Directors presently receive no cash compensation for serving on the
Board of Directors. Under the Company's Non-Employee Directors Stock Option
Plan, each director who is not an employee of the Company receives an annual
grant of options to purchase 20,000 shares of Class A Common Stock at fair
market value. The options are granted upon re-election after the annual meeting
of the stockholders and vest the day following the grant. Options terminate upon
the earliest to occur of (i) subject to (ii) below, three months after the
optionee ceases to be a director of the Company, (ii) one year after the death
or disability of the optionee, and (iii) ten years after the date of grant. If
there is a change of control of the Company, all outstanding stock options will
become immediately exercisable.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information concerning the
beneficial ownership of the Company's Class A and Class B Common Stock as of
March 5, 1999 (except as otherwise noted) by (i) each stockholder who is known
by the Company to own beneficially more than five percent of the outstanding
Class A or Class B Common Stock, (ii) each director of the Company, (iii) each
of the executive officers of the Company named in the Summary Compensation Table
above, and (iv) all directors and executive officers of the Company as a group.
Holders of Class A Common Stock are entitled to one vote per share on all
matters submitted to a vote of the stockholders of the Company. Holders of Class
B Common Stock are entitled to one vote per share on all matters submitted to a
vote of the stockholders, except that holders of Class B Common Stock will have
five votes per share in cases where one or more directors are nominated for
election by persons other than the Company's Board of Directors and where there
is a vote on any merger, consolidation or other similar transaction which is not
recommended by the Company's Board of Directors. In addition, holders of Class B
Common Stock will have five votes per share on all matters submitted to a vote
of the stockholders in the event that any person or group of persons acquires
beneficial ownership of 20% or more of the outstanding voting securities of the
Company. Shares of Class B Common Stock are convertible into shares of Class A
Common Stock on a one-for-one basis at the option of the holder.
-24-
Percent
of All
Number of Shares Number of Shares Percent Outstanding
of Class A Common Percent of of Class B Common of Common
Beneficial Owner(1) Stock Owned(2) Class Stock Owned Class Stock(3)
- - ------------------- ----------------- ---------- ----------------- ------- -----------
Peter J. Sprague(4) 364,486 1.2 1,372,899 49.5 5.4
Steven Sprague(5) 332,163 1.1 189,659 6.8 1.6
John E. Bagalay, Jr.(6) 38,000 * 0 * *
Philippe Bertin(7) 38,000 * 0 * *
George Gilder(8) 67,333 * 2,000 * *
John E. McConnaughy, Jr.(9) 38,000 * 335,000 12.1 1.5
Aladdin Knowledge Sys. (10) 2,531,307 8.0 0 * 7.3
Gerard T. Feeney 0 * 0 * *
All executive officers and
directors as a group
(7 persons)(11) 877,982 2.9 1,899,558 68.6 8.5
- - -------------------
*Less than one percent.
(1) Each individual or entity has sole voting and investment power, except as
otherwise indicated.
(2) Does not include shares of Class A Common Stock issuable upon the
conversion of Class B Common Stock.
(3) In circumstances where the Class B Common Stock has five votes per share,
the percentages of total voting power would be as follows: Peter J.
Sprague, 16.8%; Steven Sprague, 3.0%; John E. Bagalay, Jr., less than 1%;
Philippe Bertin, less than 1%; George Gilder, less than 1%; John E.
McConnaughy, Jr., 4.0%; Aladdin Knowledge Systems, 5.9%; and all Executive
Officers and Directors as a group, 24.1%.
(4) Includes 330,496 shares which are subject to options presently exercisable
or exercisable within 60 days. Also includes 320,000 shares held in trust
for the benefit of Mr. Sprague's adult children, and for which Mr. Sprague
is a trustee.
(5) Includes 320,163 shares which are subject to options presently exercisable
or exercisable within 60 days. Also includes 37,102 shares held in trust
for the benefit of Mr. Sprague's family, and for which Mr. Sprague is a
trustee.
(6) Includes 34,000 shares which are subject to options presently exercisable
or exercisable within 60 days.
(7) Includes 34,000 shares which are subject to options presently exercisable
or exercisable within 60 days.
(8) Includes 67,333 shares which are subject to options presently exercisable
or exercisable within 60 days.
(9) Includes 34,000 shares which are subject to options presently exercisable
or exercisable within 60 days.
(10) Includes 2,531,307 shares which are subject to warrants presently
exercisable or exercisable within 60 days.
(11) Includes 681,043 shares which are subject to options presently exercisable
or exercisable within 60 days.
Item 13. Certain Relationships and Related Transactions
Note Receivable from Director/Officer
On November 16, 1992, the Company made a personal loan to Mr. Peter J.
Sprague, Chairman and Chief Executive Officer of the Company, as evidenced by a
note for $150,000, which sum was due and payable to the Company on January 16,
1993 and which bore interest at the rate of ten percent (10%) per annum. On the
due date, the note was canceled and the total amount owed was "rolled-over" into
a subsequent note, dated May 12, 1993 for $150,000, plus accrued interest. The
note is due on demand by the Company and accrues interest at the rate of 10% per
annum. On April 22, 1993, the Company made an additional loan to Mr. Peter
Sprague for $23,175 as evidenced by a subsequent note, which is due on demand by
the Company and which bears interest at a rate of 10% per annum. All of these
loans were made to Mr. Sprague for personal reasons. As part of Mr. Sprague's
$150,000 bonus for 1998, $75,000 was applied against his indebtedness to the
Company. As of December 31, 1998, Mr. Sprague's aggregate indebtedness
(including accrued interest) to the Company under the notes totaled $149,342. No
demand has been made as of the date hereof. The notes are secured by a pledge of
67,000 shares of Class B Common Stock.
-25-
Compensation to Steven Sprague
Steven Sprague received aggregate compensation of $327,500, $267,500
and $131,666 for services rendered to the Company in 1998, 1997 and 1996,
respectively. Steven Sprague is the son of Mr. Peter J. Sprague, the Chairman
and Chief Executive Officer of the Company.
Compensation to Michael Sprague
Michael Sprague received aggregate compensation of $112,500 and $27,500
for services rendered to the Company in 1998 and 1997, respectively. Michael
Sprague is the son of Mr. Peter J. Sprague, the Chairman and Chief Executive
Officer of the Company.
Amended and Restated License Agreement and Assignment
Pursuant to an Amended and Restated License Agreement, dated February
14, 1994, and related Patent Assignment and Security Agreement, Mr. Peter J.
Sprague assigned his interest in a patent for the metering and usage of serial
data information to the Company in exchange for a non-terminable royalty
interest. The Company has agreed to payment of royalties to Mr. Sprague of 2% of
the gross revenues (less actual amounts paid to information, database and
content providers, hardware manufacturers and suppliers, search and retrieval
software suppliers, consolidators of information and network providers) derived
from the Company's technology based on the patent. The royalty payments are
allocated 75% to Mr. Sprague and 25% to a former officer of the Company, and are
secured by a security interest in and to the patent.
License and Cross-License Agreement
On May 1, 1992, the Company entered into a Joint Technology Development
Agreement and License and Cross-License Agreement with The Titan Corporation
whereby Titan granted to the Company license rights to the use of certain
patents which are co-owned by Titan. Dr. Gene W. Ray, a director of the Company,
is a director, President and Chief Executive Officer of Titan. The Company
granted to Titan the exclusive right to make for, sell in, and lease in a
"Retained Market," as defined in the agreement, the subject matter described in
any Company patent. The Retained Market is defined generally as the market for
"Government Information," as defined in the agreement, used solely by a
government entity, and the market for products used to access such information.
On February 28, 1997 the Company and Titan executed an addendum to the License
and Cross-License Agreement whereby the Company received a sole license to the
licensed patent to develop and distribute products to the in-home consumer
microcomputer market segment. Under this addendum to the License and
Cross-License Agreement, Titan waived any and all defaults by the Company under
the License and Cross-License Agreement occurring prior to February 28, 1997.
-26-
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K
(a) (1) Financial Statements:
Consolidated Financial Statements
December 31, 1998 and 1997
(With Independent Auditors' Report Thereon)
Page(s)
Index to Consolidated Financial Statements F-1
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for each of the years
ended December 31, 1998, 1997 and 1996 and
for the period from February 12, 1988 (inception) through December 31, 1998 F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for
each of the years ended December 31, 1998, 1997 and 1996 and
for the period from February 12, 1988 (inception) through December 31, 1998
F-5 Consolidated Statements of Cash Flows for each of the years ended
December 31, 1998, 1997 and 1996 and for the period from
February 12, 1988 (inception) through December 31, 1998 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 Registrant (incorporated by reference to Exhibit 3.1 of
the Registrant's Registration Statement on Form S-1, File No. 33-75286)
3.2 -- Bylaws of Registrant (incorporated by reference to Exhibit 3.2 of the Registrant's Registration
Statement on Form S-1, File No. 33-75286)
4.1 -- Form of Stock Certificate of Class A Common Stock (incorporated by reference to Exhibit 4.1 of the
Registrant's Registration Statement on Form S-1, File No. 33-75286)
4.2 -- Form of Representative's Warrant Agreement, including the form of Representative's Warrant
(incorporated by reference to Exhibit 4.2 of the Registrant's Registration Statement on Form S-1,
File No. 33-75286)
4.3 -- Certificate of Designation of Series B Preferred Stock of Wave Systems Corp. as filed with the
Delaware Secretary of State on May 24, 1996 (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on May 30, 1996, File No. 0-24752)
4.4 -- Certificate of Designation of Series C Convertible Preferred Stock of Wave Systems Corp. as filed
with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1
of the Registrant's Current Report on Form 8-K filed on January 8, 1997, File No. 0-24752)
4.5 -- Certificate of Designation of Series D Convertible Preferred Stock of Wave Systems Corp. as filed
with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1
of the Registrant's Current Report on Form 8-K filed on June 3, 1997, File No. 0-24752)
-27-
4.6 -- Certificate of Designation of Series F Convertible Preferred Stock of Wave Systems Corp. as filed
with the Delaware Secretary of State on October 9, 1997 (incorporated by reference to Exhibit 3.1
of the Registrant's Current Report on Form 8-K filed on October 15, 1997, File No. 0-24752)
4.7 -- Certificate of Designation of Series G Convertible Preferred Stock of Wave Systems Corp. as filed
with the Delaware Secretary of State on March 5, 1998 (incorporated by reference to Exhibit 3.1 of
the Registrant's Current Report on Form 8-K filed on March 19, 1998, File No. 0-24752)
+10.1 -- Joint Technology Development Agreement, dated as of May 1, 1992, between The Titan Corporation and
Cryptologics International, Inc. (incorporated by reference to Exhibit 10.2 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)