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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number 0-24752

Wave Systems Corp.
(Exact name of registrant as specified in its charter)

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 ý    No o

        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. o

        Indicatae by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o    No ý

        The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates as of December 31, 2002 was $67,479,663 (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 20, 2003, there were 51,781,918 shares of the registrant's Class A Common Stock and 314,225 shares of the registrant's Class B Common Stock outstanding.

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 WAVE'S ACTUAL RESULTS OR OUTCOMES TO BE MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, WAVE OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND WAVE'S CONTROL. IMPORTANT FACTORS THAT WAVE BELIEVES MIGHT CAUSE SUCH DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN WAVE'S OTHER FILINGS WITH THE COMMISSION DURING THE PAST 12 MONTHS. IN ASSESSING FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY ALL RISK FACTORS AND CAUTIONARY STATEMENTS CONTAINED IN THIS FORM 10-K AND IN THOSE OTHER FILINGS WITH THE COMMISSION.

Table of Contents

PART I

Item 1.    Business

        Wave Systems Corp. develops, produces and markets hardware and software based digital security products for the Internet and e-commerce. Wave's technology involves the use of encryption, which is the process of making data indecipherable. At the heart of Wave's technology is the EMBASSY (EMBedded Application Security SYstem) Trust System (the "ETS"). The ETS is a combination of client hardware and software and a back-office infrastructure that manages its security functions. The client hardware consists of the EMBASSY 2100 security chip (the "EMBASSY chip"). EMBASSY chips may be embedded in such user devices as computer keyboards, smart card readers, PC motherboards, PC and/or cable modems, personal digital assistants, cable set-top boxes and potentially a wide variety of other user devices. The EMBASSY chip is used to securely store the user's personal information such as usernames, passwords, personal identification numbers, credit card information and personal information such as social security number, name and address. In addition, the EMBASSY system stores encrypted software applications that can be called upon to perform a variety of secure functions such as strong authentication, e-commerce and digital rights management, electronic payments, metering of digital content and other functions.

        Wave Systems Corp. is a development stage company. We have not realized any significant revenues since we began our operations in 1988. We do not expect to begin to realize significant revenues until the latter part of 2003, or until we are successful with our strategy which is to achieve broad market acceptance of our technology as a standard platform for hardware based trusted computing. Revenues have been nominal in relation to our expenditures due to the highly complex nature of the technology that we are developing and the early stage nature of the market for products that utilize this technology. As a result, we have experienced a slow pattern of corporate development. As of December 31, 2002, we have working capital of approximately $8.8 million. Considering our current cash balance and Wave's projected operating cash requirements we anticipate that we will need $11 million of additional cash to satisfy our current forecasted cash flow requirements for the twelve-month period ending December 31, 2003. In addition to what we are forecasting in gross margins for fiscal 2003, we estimate having to raise a minimum of approximately $5 million in capital, in order to fund our operations through 2003. However, if we are unable to achieve the revenue targets in our business plan, the amount of capital that we will need to raise will be greater. In order to raise the additional cash required for Wave's operations, Wave has engaged an investment banking firm and is exploring a number of financing alternatives which include debt or equity financing (or a combination of both) or one or more commercial or strategic transactions. In the event that we are successful in executing this business plan for 2003, we will need to begin to generate sufficient sales to fund operations in future years, or we will be required to raise additional capital to continue beyond 2003. Due to our current cash position, our capital needs over the next year and beyond, the fact that we have not at this time secured additional financing and uncertainty as to whether we will achieve our sales forecast of our products and services, substantial doubt exists with respect to our ability to continue as a going concern.

EMBASSY Products and Services

        The ETS has been designed to combine the security strength of hardware, with the flexibility of software, providing a distributed, open and fully programmable platform. Wave believes the flexibility of the ETS positions it to exploit future revenue opportunities as privacy and security requirements evolve and change. This flexibility allows EMBASSY to fulfill developing security requirements, while addressing a broad range of advanced applications such as content protection, user managed privacy, strong authentication of user identities, and distributed e-commerce. While single function security solutions are available, the architecture achieved by EMBASSY provides the capability for multiple entities, such as service providers, content owners and individuals to share a single device while trusting

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that their individual interests have been strongly protected from both local and network sources of attack.

        Products that make up the ETS include hardware and software. The hardware products that make up this product group are the EMBASSY chip and secure user input devices such as EMBASSY Smart Card Readers and EMBASSY Smart Card Reader Keyboards. These devices are being marketed to PC manufacturers as part of Wave's Trusted PC product that combines a smartcard reader or keyboard with security software applications. In addition Wave offers a Hardware Developer's Kit and an Applet Developer's Kit that are used by device manufacturers to develop EMBASSY enabled hardware products and software developers to write EMBASSY enabled software applications. The software products included in this product group are the Trust Assurance Network, which is the back office security infrastructure of the ETS, and Assistant, a client interface that allows the user to securely enter and store, their personal and financial data, personal identification numbers, passwords, digital certificates and other information that requires security. Wave also has several products within this category that are in various stages of development including its Cyber-Comm applet; a secure French banking application that runs on an EMBASSY chip, FINREAD; a JAVA interface for online transactions and Trusted Computing Platform Alliance ("TCPA") Services; security applications that run on other chip manufacturers' security chips known as Trusted Platform Modules ("TPM's"). Expected planned technology development costs to complete these products are approximately $4,500,000. However, we will continue to expend a significant amount of funds in the business development, marketing and sales areas in an effort to promote the market acceptance of these products.

Wave Commerce System

        The Wave Commerce System (the "Commerce System") comprises two main functions: authentication and commerce. Each of these functions provides multiple services enabled by the ETS. The authentication services component positively identifies the person wishing to access protected content. It accomplishes this through a protected applet in conjunction with the EMBASSY device.    The goal of the Commerce System is to provide digital commerce, completely secure from unauthorized access. Web site owners would use authentication services to replace less secure username/password pairs with strong authentication. Content providers use commerce services to distribute digital content. The Commerce System allows flexible purchase models for the sale of digital content including rental, rent-to-own and event-based charges.    This is accomplished using programs that decrypt the encrypted content to allow the user access on a time specific basis. This means that content, goods and services can be consumed with more efficient and flexible pricing, broader distribution opportunities and greater protection against unauthorized usage, with better privacy protection of the consumer's sensitive information.

        The Commerce System consists of the Wavemeter, a chip that performs metering and security functions at the client level and the Wavenet back-office ("Wavenet"). Wavenet is a network of servers that supply full e-commerce functions, customer relationship management tools, security capabilities and digital rights management. Wavenet is transparent to the consumer. All of the account specific commerce functionality occurs at the user's personal computer containing an EMBASSY device. Wavenet provides the back-office capabilities that support the following capabilities: content protection, content use metering, micro-transactions, Internet based communities, Internet based strong authentication and e-commerce. Development of these products is complete with respect to their current versions, although development work for new features and functionality may be required. Presently, no further development work is planned with respect to this product group.

Digital Signature and Electronic Document Management

        On October 4, 2001 Wave acquired digital signature and electronic document management technology, SmartSignature and SmartSAFE from SignOnLine, Inc. ("SignOnLine"), a California-based

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company. This group now consists of four core products: SmartIdentity, SmartSignature, SmartSAFE and SmartConnect. SmartSignature Version 3.0 is a digital signature application that connects signers and institutions—banks, insurance companies, enterprises etc.—through a legally binding digital signature. SmartSAFE Version 3.0 is a web-based document management application where signed documents are archived and tracked. SmartSAFE provides an easy to use environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents. SmartSAFE also supports archival and management of unsigned documents in virtually any format. These products allow a document to be executed, verified, accepted and filed in minutes at a lower cost compared to traditional documentation methods. SmartSignature Version 3.0 and SmartSAFE Version 3.0 have been completed and Wave has commercially released these products in the first quarter of 2003. Additional development work for enhancements to these products has also commenced during the first quarter of 2003. SmartIdentity, an optional service to verify a signer's identity through strong authentication methods, including issuing encrypted digital certificates based on public key infrastructure technology, is substantially complete and ready for release in the second quarter of 2003. Expected costs to complete development of the product enhancements referred to above are approximately $300,000.

Data Broadcast

        Wave offers its data broadcast products through WaveXpress Inc. ("WaveXpress"), a joint venture between Wave and Sarnoff Corporation. WaveXpress' TVTonic software is designed to offer cable television multiple service operators ("MSOs") a complete solution for implementing Internet Protocol Multicast that allows the consumer to experience and manage rich digital content on their PC. TVTonic, which consists of a customized browser that allows a user to view and manage rich digital content, server applications that broadcast this content to the users, and administrative functions used for billing and tracking of usage, is being actively marketed to MSOs. Wave believes the benefits of this product to MSOs include: new incremental revenue streams from dormant, underutilized and off-peak bandwidth, service bundling opportunities, flexible content and pricing offerings, strength of the ETS security products and an advanced consumer experience. The product has been released on a trial basis to Internet users, however significant development is planned for the product to add additional features and functionality. Planned future development expenditures are expected to approximate $1,000,000. As of December 31, 2002, Wave owned 69% of WaveXpress and Sarnoff owned 26%.

        Wave was incorporated in Delaware under the name Indata Corp. on August 12, 1988. We changed our name to Cryptologics International, Inc. on December 4, 1989. We changed our name again to Wave Systems Corp. on January 22, 1993. Our principal executive offices are located at 480 Pleasant Street, Lee, Massachusetts 01238 and our telephone number is (413) 243-1600.

        Wave, as well as WaveXpress, is a development stage company and has realized minimal operating revenues since our inception. Substantially all of Wave's revenues in each of the three years ended December 31, 2002 have been related to the ETS. For the years ended December 31, 2002, 2001, and 2000 Wave incurred losses to common shareholders of approximately $43,467,000, $48,701,000, and $47,656,000, respectively. At December 31, 2002 we had an accumulated deficit of approximately $233,092,000. There can be no assurance that we will ever be successful in achieving commercial acceptance of our products and services.

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Markets and Business Strategy

        Wave is seeking to become a leader in digital security and e-commerce technology. Our objective is to make our EMBASSY Trust System the preferred infrastructure for security in the digital economy.    Key components in achieving this goal include:

Capitalizing on Security Industry Trends

        Wave believes that a key differentiator of the ETS is that it is open and programmable and combines the strong security of hardware with the flexibility of software. Wave believes that ultimately, a truly secure system must include hardware protection. Additionally, Wave foresees that single purpose hardware solutions will not be effective as the hardware will have to support multiple applications to be an effective solution. Therefore, in a business environment of evolving encryption algorithms, multiple digital rights management solutions, multiple platforms needing to be supported; Wave's open and programmable, hardware based solution will have significant advantages over software only, or single purpose hardware device solutions.

Capitalizing on E-Commerce Industry Trends

        Wave has designed the ETS with features and functionality that it believes uniquely positions its platform to capitalize on e-commerce issues and trends. Wave sees these issues and trends as follows:

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Rampant piracy of digital goods including music, video, software, and the need for digital goods providers to securely distribute their content and prevent theft



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Mass media broadcast networks merging with the internet



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Rapid development of new business and distribution models



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Lack of adequate security for e-commerce and vulnerability to attacks



•

Major privacy concerns



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Convergence of consumer electronics and PC's



•

Legal status of digital identities and digital signatures



•

Increased focus on security and privacy by government entities

        Wave will continue to pursue strategic relationships with hardware manufacturers, systems integrators and companies involved in the development of commerce in electronic content and services to achieve broad market acceptance of its products as a distributed security platform for commerce performed in user devices.

Pursue Strategic Marketing and Distribution Alliances

        We intend to continue to enter into strategic alliances with key partners that could distribute our products in enterprise, government and consumer markets, and to build upon our alliances with such industry leaders as Samsung Electro-Mechanics Co., Ltd, Maximus, and NEC Computers International. In addition, we are engaged in strategic activities with semi-conductor manufacturers National Semiconductor and Infineon Technologies to deploy EMBASSY services on their TCPA compliant TPMs.

Enhancing our Current Product Offerings and Products in Development

        We intend to continue to develop and extend our existing product offerings to include features and functionality that will satisfy the changing needs in the computer security arena and the computing and e-commerce industries in general. Planned development efforts that enhance or utilize existing

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technologies include building upon and enhancing our Trusted PC product (a product being jointly marketed with NEC Computers International to consumers that bundles an NEC PC with an EMBASSY enabled device such as a smart card reader or smart card reader keyboard to deliver applications to make the PC more secure), the packaging of existing EMBASSY applications in an effort to license these applications to developers of TCPA compliant TPM's and to continue development efforts towards standards-based security platforms (such as the European Transactional IC Card Reader standard, FINREAD). We also intend to continue to develop enhancements to SmartSignature and SmartSAFE products that we acquired (see "Digital Signature and Electronic Document Management" above) and we have initiated development of enhancements to launch WaveXpress' TVTonic as an enterprise application. New products that Wave is planning on developing over the ensuing period will consist primarily of new TCPA software applications for generic non-EMBASSY TPM's. These development efforts will likely be significant, and Wave intends to expend a substantial portion of its research and development resources towards these enhancements as well as significant marketing and corporate development funds to introduce the products and build market demand. As a result, although Wave has reduced its research and development expenditures in 2002, the continued research and development efforts will require substantial capital resources, which will likely necessitate the need for further funding so that Wave may ultimately be able to capitalize on the future market opportunities for its products and services. It is expected that these product enhancements and new product development activities will continue, for at least until the end of calendar year 2003.

Marketing, Sales and Customers

        Wave's business model targets revenues from various sources including: licensing of our technology including EMBASSY and its supporting software infrastructure; fees from entities who use EMBASSY to secure their applets on PCs; and usage and transaction-based fees from content management, e-commerce and other services enabled by EMBASSY. In addition, we derive revenue from outright sales of hardware and development contracts.

        Wave has identified four key markets where we believe the EMBASSY Trust System provides unique benefits:

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Banking and Finance—in addition to our European initiatives to be a leader in delivering FINREAD-standard devices, we are aggressively cultivating interest and support from U.S. financial institutions.



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Broadband Media—through our WaveXpress joint venture, we are developing a broadband architecture for persistent protection of content to the hard disk at home.



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PCs—Wave-sponsored market research strongly confirms the existence of substantial consumer demand for PC trust and security and a willingness to pay for such features. We are aggressively targeting a PC manufacturer deployment opportunity.



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Government and Enterprise—the market for electronic security systems in governmental units and large business enterprises is growing and Wave believes this market represents a key opportunity.

        Directly and through our partners, Wave is aggressively targeting opportunities in these markets, as we believe the ETS provides a wide range of security and trust capabilities not offered in any other single solution.

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        The following is a list of Wave's customers that made up 10% of revenue or greater, including the type of sale and market segment:

        Wave does not anticipate significant recurring sales from the customers identified above. All of our Sales were derived from within our ETS product group.

        Our sales force will focus on business development opportunities in these key markets and others. Within these key markets we will focus on closing business with large systems integrators, financial institutions, Cable MSOs, personal computer manufacturers, and government and enterprise customers.

Backlog

        Wave's backlog as of December 31, 2002 and December 31, 2001 totaled $0 and $243,000, respectively. Wave's backlog as of December 31, 2001 consisted of hardware sales and development contract revenue that was recognized in 2002. Backlog can fluctuate greatly based upon, among other matters, the timing and receipt of orders. Therefore, backlog may not represent a fair indication of future business trends.

Competition

        We operate in a highly competitive and fragmented environment that is characterized by rapidly evolving technology. Many of our competitors and potential competitors have substantially greater financial, technical and marketing resources than us. Also, many current and potential competitors have greater name recognition and more extensive customer bases that could be leveraged, thereby they can gain market share or product acceptance to our detriment. In addition, the rate of market acceptance of content protection solutions has remained slow. The markets for our products are developing and have not yet established clearly defined industry standards. Wave's primary competitors include security solutions providers such as Checkpoint Software Technologies Ltd, Verisign, Inc., RSA Security, Inc., Aladdin Knowledge Systems, Inc. and Baltimore Technologies plc as well as digital certificate authorities including Geotrust, Inc. and Entrust, Inc. In addition we compete with manufacturers of secure input devices including SCM Microsystems, Inc., Covadis SA and SafeNet, Inc.

        The competitive factors defining these evolving markets include product performance, compatibility, standards compliance, quality and reliability, ease of use, client services and support, distribution and price. Wave believes its products meet the requirements to be successful viable products in these markets. Wave's features that should allow its products to compete favorably include product differentiation of a combined software/hardware solution, system integrity, secure communication, fault tolerance, data privacy, and independent customer operation. In addition, Wave may have the opportunity to be "first to market" with its data broadcasting and digital signature products.

        One of the market challenges facing Wave is the establishment of a newly defined market category for multifunction security devices that includes a more complex business model for adoption.    While Wave has developed a very complex cryptographic system that required significant skills and resources, the market for security solutions that are as complex as those developed by Wave has not materialized. As a result, Wave has been unable to commercialize the technology it has developed. It is also possible

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for other competitors to develop similar offerings to compete with the ETS, or new technologies may emerge that could replace existing technology that our products rely on, thereby making our products non-competitive or obsolete. We can offer no assurances that Wave's products will become industry standards or become widely accepted by the marketplace.

International Market

        Most of our products and many components of the ETS are controlled under various United States export control laws and regulations and may require export licenses for certain exports of the products and components outside of the United States and Canada. We have received full export license from the U.S. Department of Commerce for the sale and export of our single-key Data Encryption Standard ("DES") products. We have also received an export license for our triple-key DES chips under the provisions of License Exceptions KMI or ECN, granted by the Bureau of Export Administration of the U.S. Department of Commerce ("BXA"). The remainder of our products and components of the ETS are generally exportable to any end-user in any country throughout the world with the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria.

        We can provide no assurance that we will have patent protection or that we will not infringe patents of other parties in foreign jurisdictions. Because electronic monitoring and the transmission of audited usage and financial information on end users or payment instructions may be subject to varying statutory or regulatory controls in foreign jurisdictions, the use of all portions of the ETS may not be permitted in any particular foreign jurisdiction.

Proprietary Rights and Licenses and Intellectual Property

        Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and foreign patent laws, copyright laws and other intellectual property laws, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Any issued patent owned or licensed by us may not, however, afford adequate protection to us and may be challenged, invalidated, infringed upon or circumvented. Furthermore, you should understand that our activities may infringe upon patents owned by others.

        In addition, we may be required to obtain licenses to patents or other proprietary rights of other parties. Licenses required under any such patents or proprietary rights may not be made available on terms acceptable to us, if at all. If we are required to and do not obtain such licenses, we would be prevented from or encounter delays in the development and marketing of our products and technologies while we attempt to design around such patents or other rights. Such attempts may not be successful. Failure to obtain such licenses or to design around such patents or other rights would have a material adverse effect on us.

        We hold non-exclusive patent rights relating to the metered use of encrypted data in local memory under a limited license from Titan Corporation to a patent jointly held by Titan and a third party (the "Licensed Patent"). This license agreement restricts us from metering information produced and used solely by a government entity or producing products that meter this information. In addition, this license agreement is subject to the rights of the joint owners of this patent, who have the right to exploit, or to license this patent to third parties in a manner that may be competitive with us. The joint owners of this patent may compete with us or license this patent to a competitor of ours, or our business may exceed the scope of this license agreement. Pursuant to this license agreement, we are obligated to pay certain royalties to Titan. Pursuant to this license agreement, we have granted to Titan the exclusive right to use our patents for products distributed to government entities. On February 28, 1997 Wave and Titan executed an addendum to this license agreement whereby we received a sole license to this patent to develop and distribute products to the in-home consumer microcomputer

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market segment. Under this addendum to this license agreement, Titan waived any and all defaults by us under this license agreement occurring prior to February 28, 1997.

        We are aware of four United States patents (the "Third Party Patents") each having some claims that are similar to some of the claims in the Licensed Patent. Based upon information currently known to us, some of the claims of both the Licensed Patent and the Third Party Patents cover certain material aspects of our technology. Therefore, the commercialization of our technology would be subject to the rights of the holder of the Third Party Patents unless we are able to invalidate such claims or license such technology. Also, the holder of the Third Party Patents or a licensee of the Third Party Patents could seek to invalidate such claims of the Licensed Patent and therefore be able to commercialize a technology similar to our technology. In either case, in order to invalidate the other party's patent rights, the party claiming invalidity might need to prove that it invented the claimed subject matter prior to the other party. We cannot provide any assurance that we would be successful in invalidating such claims of the Third Party Patents or that the holder of the Third Party Patents or a licensee of the Third Party Patents would not be successful in invalidating the claims of the Licensed Patent. Furthermore, we cannot provide any assurance that the Third Party Patents could be proven to be invalid on any other basis. Any proceeding involving the validity of the Licensed Patent and the Third Party Patents would be protracted and costly. In any suit contesting the validity of a patent, the patent being contested would be entitled to a presumption of validity and the contesting party would be required to demonstrate invalidity of such patent by clear and convincing evidence.

        If the Third Party Patents are not invalid insofar as their claims relate to our technology, then we would require a license from the holder of the Third Party Patents to commercialize our technology and make, use, or sell products or practice methods, or license others to sell products or use methods, utilizing this technology in the United States. Due to the uncertainty as to whether the Third Party Patents could be proved to be invalid, we engaged in negotiations with the holder of the Third Party Patents to obtain a license under the Third Party Patents. As a result of these negotiations, Wave has entered into a license of limited rights to use the Third Party Patents in connection with certain uses. Wave did not obtain, however, a general license to use such patents in connection with activities not connected with the licensor.

        Wave has been issued eleven (11) United States patents relating to encryption and to our proprietary EMBASSY and Wave Commerce technology. We also have six (6) patents pending before the United States Patent Office. In addition, we have filed foreign patent applications for seven patents. Our patents are material to protecting some of our technology.

        Some of our patent rights derive from a license from Wave's former Chairman, Mr. Peter J. Sprague, of his rights in these patents, and several agreements with former officers regarding their rights in these patents. The license agreement with Mr. Sprague requires us to make royalty payments to him and Dr. John R. Michener, a former officer, in a total amount equal to two percent of gross revenues less certain adjustments. This royalty payment is apportioned 75 percent to Mr. Sprague and 25 percent to Dr. Michener. The payment of royalties is secured by a security interest in and to our patents. We believe that these agreements as a whole provide us with exclusive rights under our patents. There can by no assurance that we will enjoy exclusive rights to these patents under such agreements.

        We rely on trade secrets and proprietary know-how, which we protect, in part, by confidentiality agreements with our employees and contract partners. However, we caution you that our confidentiality agreements may be breached and we may not have adequate remedies if such a breach occurs. Furthermore, we can provide no assurance that our trade secrets will not otherwise become known or be independently discovered by competitors.

        We also rely on copyright law to prevent the unauthorized duplication of our software and hardware products. We have and will continue to protect our software and our copyright interest therein through agreements with our consultants. We can provide no assurance that copyright laws will adequately protect our technology.

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        We have registered trademark and service mark registrations with the United States Patent and Trademark Office for the marks WaveMeter and WaveNet, EMBASSY, Great Stuff Network, Second Shift (the Wave juggler logo), WaveCommerce, Wave Interactive Network, WaveDirect, WINPublish, WINPurchase, CablePC, iShopHere and Face/Eye logo (iShopHere.com face logo). We have submitted trademark registrations for, EMBASSY System, Netpass, CharityWave and Trust @ the Edge, Signon-line, Inc., Smartsignature, Smartsafe and others. Wave intends to apply for additional name and logo marks in the United States and foreign jurisdictions as appropriate. No assurance can be given that federal registration of any of these trademarks in the United States will be granted. We have abandoned our prior applications for DataWave, InfoWave, and WaveTrac.

Research and Development

        Wave's products incorporate semiconductor, encryption/decryption, software transaction processing and other technologies in which we have made a substantial investment in research and development. We will likely be required to continue to make substantial investments in the design of trusted computing applications and services, including the EMBASSY trust platform, the Commerce System our SmartSignature and SmartSAFE products, and IP Multicasting products. For the years ended December 31, 2002, 2001, and 2000 we expended approximately $12 million, $17.7 million, and $20.9 million, respectively, on research and development activities. Planned development expenditures for the year ended December 31, 2003 are expected to approximate $9,000,000. A substantial portion of this expenditure will be used to package existing EMBASSY applications and developing new applications in an effort to license these applications to developers of TCPA compliant TPM's that compete with EMBASSY as a standard trust platform for secure computing. In addition, we continue to pursue deployment of EMBASSY in conjunction with the introduction by NEC Computers International of a trusted PC offering that utilizes the EMBASSY Smartcard reader and EMBASSY applications.

Recent Developments

Contract with SSP Solutions, Inc.

        On September 30, 2002, Wave and SSP executed a Termination Agreement and Mutual Release whereby Wave was issued an additional 1,600,000 shares of SSP Class A Common Stock and a $270,000 non-negotiable, non-interest bearing, subordinated convertible promissory note due December 31, 2005 (the "Note") as a fee for the termination by SSP of a software development contract. In exchange, Wave was released from its obligation to provide any further services under the development contract as amended. The contract, entered into October of 2000, was originally for $10 million to integrate Wave's EMBASSY Trusted Client technology into SSP's suite of products for deployment into 5 million digital set top boxes and integrated gateway products such as cable and DSL modems. It was subsequently amended in May of 2001, whereby the parties agreed to a $5 million development services contract pursuant to which Wave agreed to port its EMBASSY platform to run in a Linux environment. In addition, SSP agreed to place with Wave an open $5 million purchase order for EMBASSY products. Wave received $555,556 in cash for payment of services performed pursuant to the contract. The shares that Wave received were recorded on the its balance sheet at estimated fair value of $1,680,000. A termination fee of $1,680,000 was recognized in Wave's statement of operations in connection with this transaction.

        On December 13, 2002 SSP exercised its right to convert the Note into 200,000 shares of SSP common stock. The 200,000 shares that Wave received from the Note conversion were initially recorded on the balance sheet at $0.69 per share, for an aggregate value of $138,000.

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Acquisition of 60% of GlobalWave Ltd

        On July 24, 2002 Wave issued 1,700,000 shares of its Class A Common Stock in exchange for 60% of the remaining assets of GlobalWave Ltd, a joint venture that was previously 40% owned by Wave, for a total purchase price of approximately $2,244,000. The purchase of the 60% of the remaining assets of GlobalWave was accounted for as an acquisition of assets and not considered a business combination, as GlobalWave had effectively ceased operations prior to the acquisition. In exchange for the 1,700,000 shares, Wave received approximately $1,380,000 in cash, tangible fixed assets of approximately $9,000 and the exclusive rights under the licenses that it had previously sold to GlobalWave, which granted GlobalWave the exclusive right to commercialize the Wave Commerce System in Europe, the Middle East and Africa. Wave incurred a charge to operations representing the amount by which the purchase price exceeded the tangible assets that Wave received of approximately $855,000. In addition, GlobalWave forgave its receivable from Wave of $189,000. The net charge of approximately $666,000 has been presented in the statement of operations for the year ended December 31, 2002 as an impairment charge of the acquired license. Wave assumed no liabilities as a result of this transaction.

Introduction of TCPA Compliant Products

        During 2002, several manufacturers of semiconductors for the PC industry announced products that have the capability to function as TPM's that meet the TCPA standard for trusted computing. (Compaq Computer, Hewlett-Packard, IBM, Intel and Microsoft established the TCPA in an effort to define and promote trusted computing. The TCPA has over 170 member companies, from various technology sectors. The TCPA has defined a device known as the Trusted Platform Module (TPM), a device that offers protected storage, platform authentication, protected cryptographic processes and attestable state capabilities to provide the first level of trust for the computing platform.) The offering of these products by major suppliers of semiconductors to the PC market is an important development in the creation of the market for hardware based trusted computing. As a result of this development, Wave has begun executing a strategy to leverage the work it has done in developing a hardware trusted computing platform towards becoming a major developer of services to this market, the development of which is beginning to be driven by some of the major suppliers of semiconductors to the PC industry. Wave is actively pursuing business relationships with these companies in an effort to become a developer of applications that will be essential to the deployment of these new products, thereby creating a substantial new revenue opportunity for Wave. For example, we've engaged in joint promotional activities with both National Semiconductor and Infineon Technologies to promote each other's products and services and we have demonstrated the enabling of Wave's EMBASSY suite of secure services on both the National and Infineon TPM.

Employees

        As of December 31, 2002, we employed 126 full-time employees, 49 of whom were involved in sales, marketing and administration and 77 of whom were involved in research and development (including 21 employed by WaveXpress, 6 of whom were in sales, marketing and administration and 15 of whom were involved in research and development.) As of December 31, 2002 we retained the services of 6 full-time consultants, 1 of whom was retained by WaveXpress. We believe our employee relations are satisfactory.

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Item 2.    Properties

        Summarized below is a listing of properties leased by Wave. Our principal research and development activities are conducted at the Princeton and Cupertino facilities.

Item 3.    Legal Proceedings

        As of December 31, 2002 Wave was not involved in any material litigation, nor, to management's knowledge is any material litigation threatened against them or their properties other than routine litigation arising in the ordinary course of business.

Item 4.    Submission of Matters to a Vote of Security Holders

        None.

PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters

        The Class A Common Stock trades on the Nasdaq National Market under the symbol "WAVX". The following table sets forth, for the periods indicated, the high and low closing sales prices per share for the Class A Common Stock. There is no established trading market for our Class B Common Stock.

        As of March 20, 2003, there were approximately 28,000 holders of our Class A Common Stock. As of such date, there were 30 holders of our Class B Common Stock.

        On March 20, 2003, the last sale price reported on the Nasdaq National Market for the Class A Common Stock was $0.92.

        We have never declared nor paid any cash dividends on our capital stock. We currently anticipate that we will retain all future earnings, if any, to fund the development and growth of our business and do not anticipate paying any cash dividends on our capital stock in the foreseeable future.

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Item 6.    Selected Financial Data

Statement of Operations Data

See Notes to Financial Statements

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Balance Sheet Data

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

        Wave develops, produces and markets hardware and software based digital security products for the Internet and e-commerce. Since our inception in February of 1988, we have devoted substantially all of our efforts and resources to research, feasibility studies, design, development, and market testing of our products and technology. As our research and development activities matured, we have devoted increased resources to the creation of content distribution services, market development and the application of our technology to end-user products and services. However, the market for our products and services is still developing and is continually evolving. Wave's offering represents a highly complex architecture designed to solve many of the security issues currently present with e-commerce and with computer systems in general such as identity theft, fraudulent transactions, virus attacks, unauthorized access to restricted networks and other security problems that users of computer systems generally encounter. Moreover, Wave's technology involves a new approach to conducting business and exchanging information using computer systems and, as a result, intensive marketing and sales efforts have been and will continue to be necessary in order to generate demand for products using Wave's technology. From inception through December 31, 2002, we have realized only minimal operating revenues, and do not anticipate significant revenues until well into the next fiscal year. This is due to the early stage nature of market development for our products and services and the digital security industry as a whole. Wave expects to continue to incur substantial additional expenses associated with continued research and development and business development activities that will be necessary to commercialize our technology. This will likely result in significant losses for the foreseeable future. There are numerous risks that could adversely affect our efforts to achieve profitability.

        For the years ended December 31 2002, 2001 and 2000 we have incurred approximately $19.2 million, $24.2 million, and $26.6 million in selling, general and administrative expenses, respectively. The activities supported by these expenditures include business development, sales, marketing (including product development and product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions. As we have evolved our technology and expanded upon our original product vision, the business development activities and cost of supporting those activities has grown considerably. This growth is attributable to our expansion, as we have branched out into different technologies such as developing data broadcast technology with the investment into WaveXpress, the development of our existing open programmable architecture which was accomplished in large part through our acquisition of N*ABLE Technologies, Inc. ("N*ABLE"), and our expansion into digital signature and electronic document management through our acquisition of SmartSignature and SmartSAFE.    In addition, we have expanded internationally having made a significant investment in GlobalWave in an attempt to exploit overseas markets. The cost associated with supporting this expansion has been substantial and has

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added significantly to our cash requirements over the past three years. Given the early stage nature of the markets for products that use our technology, we have expended and will continue to expend considerable resources, in the sales, marketing, business development and support activities referred to above that will be necessary for us to be successful in developing salable products and markets for our technology.

        In June 2000, Wave increased its ownership percentage of GlobalWave, from 25% to 40%.    On October 10, 2000, Wave entered into an agreement with GlobalWave and its Joint Venture partner Redwave, plc., formerly Internet Technology Group, plc. ("ITG"), to subscribe for additional shares to maintain a 40% ownership interest in the venture. As consideration for the additional shares, Wave committed to invest approximately $5.7 million in cash and development services. Wave accounted for its investment in GlobalWave using the equity method of accounting, and accordingly recognized its share (40%) of GlobalWave's results of operations in the accompanying consolidated statement of operations, to the extent of its investment in GlobalWave of $5.7 million. On July 24, 2002 Wave acquired the remaining 60% of Global Wave in exchange for 1,700,000 shares of its Class A Common Stock for a total purchase price of approximately $2,244,000. The purchase of the 60% of the remaining assets of GlobalWave was accounted for as an acquisition of assets and not considered a business combination, as GlobalWave had effectively ceased operations prior to the acquisition. In exchange for the 1,700,000 shares, Wave received approximately $1,380,000 in cash, tangible fixed assets of approximately $9,000 and the exclusive rights under the licenses that it had previously sold to GlobalWave, which granted GlobalWave the exclusive right to commercialize the Wave Commerce System in Europe; the Middle East and Africa. Wave incurred a charge to operations representing the amount by which the purchase price exceeded the tangible assets that Wave received of approximately $855,000. In addition, GlobalWave forgave its receivable from Wave of $189,000. The net charge of approximately $666,000 has been presented in the statement of operations for the quarter and year ended December 31, 2002 as an impairment charge of the acquired license. Wave assumed no liabilities as a result of this transaction.

        On July 27, 1999, Wave completed the acquisition of N*ABLE, a security solutions company that produced hardware-based security solutions for the protection of sensitive user data within network client systems, including a hardware-based security co-processor that manages the secure transfer of payment or sensitive personal information to and from desktop computers. Wave paid the shareholders of N*ABLE total consideration of 2,280,821 shares of our Class A Common Stock (subject to certain post closing adjustments). The closing price per share as of the closing date was $10.38. Founded in 1996, N*ABLE was located in Danvers, Massachusetts, with offices in Cupertino, California and Bouguenais, France. The transaction was accounted for under the pooling-of-interests method of accounting and the financial data in the Selected Financial Data table above and in the discussion below has been restated for all periods assuming the acquisition occurred on the first day of the first period presented.

        In April 1999, WaveXpress, a joint venture between Wave and Sarnoff was established. For technology licensed to WaveXpress, Sarnoff and affiliates received a 40% equity stake in WaveXpress. Wave and its affiliates who purchased, for a nominal amount, founders stock in April 1999 owned the remaining 60% of the outstanding capital stock. The affiliates of Wave include Peter Sprague; Wave's former Chairman and Steven Sprague; Wave's Chief Executive Officer, certain members of the Board of Directors of Wave and certain employees of Wave. This affiliate group owned, in the aggregate, 7% of the outstanding capital stock of WaveXpress. As of December 31, 2002, Wave owned 69% of WaveXpress while Sarnoff owned 26%. The equity interests of Wave, Sarnoff and all other shareholders including the employee stock option pool, assuming all of Wave's and Sarnoff's convertible securities are converted and warrants are exercised, would be approximately 83%, 7%, and 9%, respectively. Wave is also funding WaveXpress through a series of convertible notes and expects to continue to provide funding until an external round of funding can be attained. These notes can be converted into

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equity by Wave. Through December 31, 2002, Wave has loaned approximately $29.0 million in funds under these notes, of which $9.5 million had been converted to shares of WaveXpress common stock as of December 31, 2002.

        The financial statements of WaveXpress have been consolidated with those of Wave for the years ended December 31, 2002, 2001 and 2000. As the joint venture minority partners, Sarnoff and the Wave affiliates, have not contributed any cash and are not required to fund the operations of the joint venture, Wave has not recorded a minority interest in WaveXpress in the consolidated financial statements and therefore, has reflected 100% of WaveXpress' operating results in these consolidated financial statements.

        The following discussion related to the consolidated financial statements of Wave should be read in conjunction with the financial statements appearing in Item 8.

Critical Accounting Policies

        Wave's discussion and analysis of its financial condition and results of operations are based on the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, accounts receivable reserves, marketable securities, valuation of long-lived and intangible assets accounting for joint ventures and software development. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        The following accounting policies are deemed critical to the understanding of the consolidated financial statements included under Item 8—Financial Statements and Supplementary Data.

        Method of Accounting for Joint Ventures—Wave accounts for its investments in joint ventures using the equity method of accounting when its ownership interest in the joint venture is less than fifty percent and it is determined that Wave has the ability to exercise significant influence over the joint venture's operating and financial policies. The financial statements of joint ventures in which Wave owns greater than a fifty percent interest are consolidated with Wave's financial statements pursuant to Accounting Principles Board ("APB") Opinion No. 18.

        Marketable Securities—Investments, which consist solely of equity securities, are accounted for under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" issued by the Financial Accounting Standards Board (FASB). Pursuant to the provisions of SFAS No. 115, investments are classified as "trading", "available-for sale" or "held to maturity". "Trading" securities are bought and held principally for the purpose of selling them in the near term and are recorded at fair value. Fair value is based upon quoted market prices. Unrealized gains and losses on trading securities are included in the determination of net earnings. "Available-for-sale" securities are being held for an unspecified period of time and may be used for liquidity or other corporate purposes and are recorded at fair value. Unrealized gains and losses on available-for-sale securities are reported as a separate component of comprehensive income (loss) in stockholders' equity. Unrealized losses that are determined to be other than temporary are recognized as charges against earnings. Factors considered when determining if an other than temporary decline has occurred include: whether a decline in market value is related to specific concerns of the issuer of the securities as opposed to general market conditions, the length of

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time of the decline in market price, the financial condition and near-term prospects of the issuer and other factors that may indicate that the value of the securities will not recover. "Held to maturity" securities are debt securities that are intended to be held to maturity and are recorded at amortized cost. As of December 31, 2002, all of Wave's investments have been classified as available-for-sale.

        Inventories—Inventories, which are stated at the lower of cost or net realizable value, consist of inventory held for resale to customers. Cost is determined on the first-in, first-out basis and includes freight and other incidental costs incurred. Judgment is involved in evaluating backlog and in assessing the recoverability of inventory held at the balance sheet date. Wave provides inventory allowances based on the determination of excess and obsolete inventories as determined through the evaluation of future sales and changes in technology.

        Research and Development and Software Development Costs—Research and development costs are expensed as incurred. Software development costs are accounted for pursuant to Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" ("SFAS No. 86"). SFAS No. 86 specifies that costs incurred internally in creating a computer software product should be charged to expense when incurred as research and development costs until technological feasibility has been established for the product. Once technological feasibility is established and the product has achieved commercial marketability, all development costs should be capitalized until the product is available for general release to customers. We consider technological feasibility to be established upon completion of a detail program design for our SmartSignature and SmartSAFE product development. Judgment is required in determining when the technological feasibility of a product is established, if the product has achieved commercial marketability and in estimating the life of the product for which the capitalized costs will be amortized.

        Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of—Wave reviews the valuation of long-lived assets, including property and equipment and capitalized software, under the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and SFAS No.86. Wave is required to assess the recoverability of long-lived assets and capitalized software costs whenever events and circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include the following:

•

significant underperformance relative to expected historical or projected future operating results;



•

significant changes in the manner of our use of the acquired assets or the strategy of our overall business;



•

significant negative industry or economic trends; and



•

significant decline in our stock price for a sustained period.

        In accordance with SFAS No. 144, when we determine that the carrying value of applicable long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we evaluate whether the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of that asset. If such a circumstance exists, we would measure an impairment loss to the extent the carrying amount of the particular long-lived asset or group exceeds its fair value. We would determine the fair value based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. In accordance with SFAS No. 86, when we determine that the carrying value of certain other types of long-lived assets may not be recoverable we evaluate whether the unamortized cost exceeds the expected future net realizable value of the products. If the unamortized costs exceed the expected future net realizable value of the products, the excess amount is written off. Changes in judgments on any of these factors could impact the value of the asset being evaluated.

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        Wave adopted SFAS No. 144 during the first quarter of fiscal year2002 without a material impact on its financial position or results of operations.

        Revenue Recognition—Wave's business model targets revenues from various sources including: licensing of our technology including EMBASSY and its supporting software infrastructure; fees from entities who use EMBASSY to secure their applets on PCs; and usage and transaction-based fees from content management, e-commerce and other services enabled by EMBASSY. In addition, we derive revenue from sales of hardware and from development contracts. To date, our sales arrangements have not included multiple-elements, nor have our arrangements required significant modification or customization of the software except for our contract with SSP Solutions for which we used the percentage of completion method of accounting that is described below.

        Wave follows the provisions of statement of position "SOP" 97-2, Software Revenue Recognition as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Generally, Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable and collectibility is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales rebates when such amounts can be estimated. When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements that have significant customizations and modification of the software product is deferred and recognized in a manner that approximates the percentage of completion method. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

        PRODUCTS—SOFTWARE AND HARDWARE

        Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term, provided Wave has vendor-specific objective evidence of the fair value of each undelivered element. Revenue is deferred for undelivered elements. Revenue is also deferred for the entire arrangement if vendor-specific objective evidence does not exist for each undelivered contract element. Examples of undelivered elements in which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any contract element is recognized when all of the revenue recognition criteria has been met for that element. However, it has not been our practice to provide periodic updates or maintenance to maintain system performance.

        Revenue from the sale of hardware components is recognized when persuasive evidence of an arrangement exists, the product has been shipped to the customer, the sales price is fixed and determinable and collectivity is reasonably assured. All product is shipped with ownership passing to the buyer upon leaving our premises and payment terms are generally net 30.

        SERVICES

        Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized over the contract term based on the percentage of services that are provided during the period compared with the total estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Payment terms vary by contract.

        In October 2000, we entered into a $10 million comprehensive development agreement with SSP Solutions to integrate Wave's EMBASSY Trusted Client technology into the SSP Secure Service Provider™ Suite to be deployed in 5 million digital set top boxes and integrated gateway products such as cable and DSL modems. In May 2001 the agreement was amended whereby under the amended

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terms of the agreement, the parties agreed to a $5 million development services contract whereby Wave agreed to port its EMBASSY platform to run in a Linux environment. In addition, SSP Solutions agreed to place with Wave an open $5,000,000 purchase order for EMBASSY products. Payment terms of the agreement provide that SSP Solutions make payments of $277,778 per month for eighteen months. In addition, the parties agreed that in the event that SSP Solutions fails to pay any monthly installment, within 30 days of receiving written notice by Wave that it is in default, the unpaid portion of the installment shall automatically convert into a stock acquisition right allowing Wave to acquire a number of shares in SSP Solutions to be determined by dividing the unpaid amount by the fair market value of SSP Solutions common stock. As the contract was for a discrete project to integrate our technology with the SSP platform, revenue under the development services agreement has been recognized on a percentage of completion basis in accordance with SOP 97-2 as it relates to contract accounting under SOP 81-1. Percentage complete is determined based upon the actual costs incurred compared to the total estimated costs to complete, subject to cash received and milestones accomplished. Milestones include specific software development objectives that must be completed and accepted by SSP Solutions. As of December 31, 2002 Wave had received $555,556 in cash and has not exercised any stock appreciation rights. We have recognized approximately $198,000 and $358,000 in revenue under the development agreement for the years ended December 31, 2002 and 2001, respectively.

Comparison of the years ended December 31, 2002 and 2001

Results of Operations

        For the twelve months ended December 31, 2002 and December 31, 2001, revenues were $446,588 and $692,125, respectively. The decrease in revenue is attributable to decreases in hardware, services, and licensing revenues, as set forth in the following table:

        The service contract revenue was derived primarily from a development contract with SSP Solutions, a shareholder of Wave. Wave also owns 19.80% of SSP Solutions. The service contract revenue derived from this development contract for the year ended December 31, 2002 was $197,965, or 64% of the total service contract revenue versus $357,591, or 83% of the total service contract revenue for the year ended December 31, 2001. Revenue on the contract was recognized on a percentage of completion basis limited to cash received and milestones accomplished. In February 2002, SSP formally requested that Wave suspend work on the development contract referred to above and that their remaining commitment and payments be applied toward alternative projects. Work under this contract was suspended during the first quarter of 2002, and the contract was formerly terminated pursuant to a settlement that was reached on September 30, 2002.

        Cost of sales for the twelve months ended December 31, 2002, was $202,208 compared with $369,959 for the same period in 2001. Gross profit was $244,380, representing a gross profit margin of 55% for the year ended December 31, 2002 versus gross profit of $322,166 representing a gross profit margin of 47% for the year ended December 31, 2001. The $77,786 decrease in gross profit was primarily the result of the overall decrease in sales, offset in part with a higher gross profit margin for the year ended December 31, 2002.

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        Revenue and gross margins during the year ended December 31, 2002 versus the same period in 2001 is indicative of a downward trend, with neither period showing significant revenues. The amount of revenues in both years has not reached a level that would contribute significantly to Wave's operations and has been sporadic. Wave does not foresee that it will achieve significant revenues at least until the latter part of 2003. Our sales forecast for the year ended December 31, 2003 approximates $5 million in gross margin contribution. However, this forecast is not supported by a backlog of orders at this time, but rather the anticipation that various deals that we are currently pursuing will close. Wave continues to work towards solidifying strategic alliances with the major personal computer manufacturers to forge collaborative efforts to distribute its products to consumers, while also endeavoring to find markets for its products in the government and enterprise sectors by targeting large systems integrators. We are also actively pursuing agreements with manufacturers of non-EMBASSY TCPA compliant TPM's to provide services to run on these platforms. In order for Wave to achieve significant revenues it will have to be successful in these efforts, and while significant progress has been made, we are not in a position of a significant backlog of orders at this time, hence we expect to continue to experience this trend at least over the next two to three fiscal quarters. (See further discussion under "Liquidity and Capital Resources")

        Research and development expenses for the twelve months ended December 31, 2002 were $12,009,713, as compared to $17,691,051 for the comparable period of 2001. This 32% decrease in research and development expenses was primarily attributable to lower consultant costs, which decreased by $1,696,000 and salary and fringe cost reductions of approximately $1,569,000 associated with headcount reductions, due to less design and development activities in 2002. In addition, Wave reduced product development expenses by $1,302,000 and depreciation expense was reduced by $512,000, due to assets becoming fully depreciated. WaveXpress' research and development expenses were $2,331,080 for the year ended December 31, 2002 versus $3,916,845 for the year ended December 31, 2001. The amounts set forth for WaveXpress are included in the consolidated amounts referred to herein. Also, the reasons for the reduction in expenditures set forth above pertain to both Wave as a whole and WaveXpress.

        Selling, general and administrative expenses for the twelve months ended December 31, 2002 were $19,188,046 as compared to $24,184,317 for the comparable period of 2001. The 21% decrease in selling, general and administrative expenses was attributable to several factors. Wave reduced employee compensation and fringe expenses by approximately $3,500,000 by reducing its selling, general and administrative headcount by an average of thirty-three positions. Bonuses of approximately $936,000 and $1,570,000 were paid to employees for the years ended December 31, 2002 and 2001, respectively, accounting for $634,000 of the overall reduction in compensation costs. Wave also reduced professional fees expense by approximately $358,000 by eliminating three consultant positions. Additionally, during 2002 Wave undertook an aggressive cost cutting program that resulted in reductions in travel and entertainment expenses of $478,000 and reductions to telecommunications expenses totaling $163,000. In addition, Wave reduced office rent expense by approximately $296,000 as a result of the termination of its WaveXpress lease, and its move into smaller, less costly office space. WaveXpress incurred selling, general and administrative expenses of $2,506,768 in 2002, compared to $4,800,927 for 2001, for a decrease of 48%. The reasons set forth above encompass WaveXpress as well as Wave as a whole.

        During the year ended December 31, 2002, Wave completed a restructuring and cost reduction program to prioritize its initiatives, reduce expenses and improve efficiency. This program included a workforce reduction, the relocation of its WaveXpress office and restructuring of certain business functions. As a result of this program, Wave recorded restructuring costs and other charges of $726,280 consisting of $229,000 in severance benefits associated with the workforce reduction, $426,000 for lease termination fees and brokerage fees and $71,000 for moving expenses related to the WaveXpress office relocation. All of these costs were incurred or paid by March 31, 2002. In connection with this program, Wave reduced its workforce by a total of thirty-six employees, nineteen of which were in research and development and seventeen that were in selling, general and administrative departments.

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All employees were notified of the work force reduction during the three months ended March 31, 2002. In addition, Wave recorded an impairment charge of $905,390 for abandoned leasehold improvements and other tangible fixed assets that were disposed of or removed from operations. In the third quarter of 2002, Wave recorded an additional impairment charge which was associated with a license that was acquired in connection with its purchase of 60% of GlobalWave Group plc of $665,641. As a result of these two impairment events, total asset impairment charges for the twelve months ended December 31, 2002 were $1,571,031. For the year ended December 31, 2001, Wave took a charge of $1,562,500 to write-off a technology license that it had purchased in connection with the development of the WaveXpress data broadcast system, and wrote off $199,417 for hardware, also part of the WaveXpress terrestrial data casting system. These write-offs totaling $1,761,917 were the result of modifications to WaveXpress' business model; consequently, the value of these assets became impaired because they were no longer needed in the business and had no alternative uses.

        Goodwill amortization associated with the acquisition of the assets of Indigo Networks, LLC, for the year ended December 31, 2002 was $0 versus $1,720,632 in the year ended December 31, 2001. Due to the decline in Internet related business conditions, Wave wrote off the remainder of the unamortized goodwill and purchased intangible assets totaling $2,284,570 associated with this acquisition in the fourth quarter of 2001. Accordingly, no intangible assets were subject to amortization expense for the year ended December 31, 2002.

Other Income and Expenses

        Interest income for the year ended December 31, 2002 was $477,902 versus $2,688,105 for the year ended December 31, 2001, for a decrease of 82%. This decrease resulted from a decrease in interest bearing assets during 2002 and lower rates earned on those interest-bearing assets.

        Equity in losses of GlobalWave were $0 and $2,332,159 for the year ended December 31, 2002 and 2001, respectively. Wave recognized its share in GlobalWave's losses to the extent of its committed investment in GlobalWave of $5.7 million. Because Wave recognized losses equal to its committed investment as of December 31, 2001, no further losses were recognized in 2002 in connection with GlobalWave's operations.

        For the year ended December 31, 2002, Wave took a charge for an "other than temporary decline" in the value of its investment in SSP of $11,513,099. This charge was taken because it was determined that an other than temporary decline in SSP's share price had occurred due to concerns about SSP's financial condition and near-term prospects. The amount was calculated as the difference between the previously adjusted cost basis of Wave's 4,883,083 shares of SSP, 3,083,083 of which were acquired in February 2001 and 1,800,000 were acquired as settlement for termination of a development agreement (discussed below), versus the fair value of the shares based on the closing price of SSP as of December 31, 2002 on the Nasdaq national exchange, or $0.59 per share. As a result of this charge and a similar charge that was taken in the fourth quarter of 2001 for $1,736,682, the cost basis of the investment as of December 31, 2002 has been adjusted to $2,881,019 from its original cost basis of $16,130,800. The investment is presented on the December 31, 2001 balance sheet at $11,160,758, which represents the closing value of the shares on the Nasdaq national exchange on that date. The difference between the value and the adjusted cost basis is presented as an unrealized loss in stockholders' equity. Additionally, while this block of SSP shares are registered, the number of shares we hold, including those received in the termination agreement (discussed below), exceed the average daily trading volume of SSP shares and therefore our ability to sell the shares in the open market is somewhat limited. Therefore, the value of these shares may be subject to further declines in value prior to our ability to sell the shares.

        On September 30, 2002 Wave and SSP executed the Termination Agreement and Mutual Release in connection with a development agreement previously entered into between the parties whereby Wave was issued an additional 1,600,000 shares of SSP Class A Common Stock and a non-negotiable,

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non-interest bearing, subordinated convertible promissory note due December 31, 2005 in the principal amount of $270,000 (the "Note"). The Note was convertible into SSP Class A common stock at the conversion rate of $1.35, subject to adjustments for anti-dilution stock splits, stock dividends, reclassifications, reorganizations and the like. In exchange, Wave was released from its obligation to provide any further services under the development contract as amended. The shares that Wave received were recorded on its balance sheet at estimated fair value based on the average closing price of the shares on the Nasdaq national exchange for the period from the two trading days before to the two trading days after the date of issuance of the shares, or $1.05 per share, for an aggregate value of $1,680,000. On December 31, 2002, SSP exercised its right to convert the Note and issue to Wave 200,000 shares of SSP common stock at the conversion rate of $1.35. The shares that Wave received from the Note conversion were recorded at a value per share of $0.69, for an aggregate value of $138,000. In connection with the Termination Agreement and the Note conversion, a gain of $1,818,000 was recognized in Wave's statement of earnings for the year ended December 31, 2002. SSP is required to register the shares issued to Wave from this transaction by April 1, 2003. The shares are currently not registered and our ability to sell the shares is restricted. Therefore, these shares may be subject to declines in value prior to our ability to sell the shares.

        In the quarter ended December 31, 2002, Wave has recorded a reserve for uncollectibility of $999,518 in respect of certain notes receivable from Peter J. Sprague, Wave's former Chairman. One of the loans with a balance of approximately $799,000 was due on February 29, 2003. The Company has determined that Mr. Sprague is unable to repay the loan promptly. Mr. Sprague resigned as Chairman of Wave as of March 31, 2003. Wave intends to engage Mr. Sprague as Chairman and Chief Executive Officer of WaveXpress. Wave intends to diligently pursue collection of Mr. Sprague's loan.

        Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a policy prohibiting future loans to officers and directors.

Comparison of the years ended December 31, 2001 and 2000

Results of Operations

        For the twelve months ended December 31, 2001 and December 31, 2000, revenues were $692,125 and $332,522 respectively. Revenue growth can be primarily attributed to a significant increase in hardware sales and service contract revenues, offset by a decrease in licensing and other revenue, as set forth in the following table:

        The service contract revenue was derived primarily from a development contract with SSP. At December 31, 2001, Wave owned 14.95% of SSP. The service contract revenue derived from this development contract for the year ended December 31, 2001 was $357,591, or 83% of the total service contract revenue. Revenue on the contract was recognized on a percentage of completion basis limited to cash received and milestones accomplished. Cost of sales for the twelve months ended December 31, 2001, was $369,959 compared with $58,864 for the same period in 2000. Cost of sales in 2001 was not comparable to costs of sales for 2000, as the sales mix differed substantially in 2001 versus 2000. Sales in the year-ended 2001 from contracts and hardware produced profit margins of 45% versus sales for the year ended 2000 that consisted largely of license revenues, producing a much higher overall profit margin of 82%.

        Research and development expenses for the twelve months ended December 31, 2001 were $17,691,051, as compared to $20,866,055 for the comparable period of 2000. This 15% decrease in

22

research and development expenses was primarily attributable to lower consultant costs, which decreased by $2,669,000, associated with a lessened design and development effort with respect to our proprietary integrated circuit technology and software. Significant development initiatives undertaken during the year ended December 31, 2000 included major enhancements to Wavenet, the development of EMBASSY II, the development of the EMBASSY applet developers kit, the creation of the "Trust Assurance Network" and the development of core EMBASSY applets. Many of these projects were substantially completed near the end of the first quarter of 2001. Accordingly, as the development of these projects were substantially complete, Wave reduced its consultant work force early in 2001 resulting in significantly less research and development costs incurred during the year. WaveXpress' research and development expenses were $3,916,845 for the year ended December 31, 2001 versus $5,188,098 for the year ended December 31, 2000. The amounts set forth above include the WaveXpress amounts referred to herein. Also, the reasons for the reduction in expenditures set forth above pertain to both Wave as a whole and WaveXpress.

        Selling, general and administrative expenses for the twelve months ended December 31, 2001 were $24,184,317 as compared to $26,553,634 for the comparable period of 2000. The 9% decrease in selling, general and administrative expenses was attributable to several factors. A number of consultant positions were eliminated during 2001 and were either not replaced or were converted to in-house employees, reducing the overall cost per headcount. Consultants that supported products and/or lines of business that Wave had been developing during the year ended December 31, 2000, but later de-emphasized, or abandoned in 2001 were eliminated. These included our Internet related businesses; MyPublish.com; a service that allows individual publishers to offer digital content for sale via the MyPublish.com website, CharityWave.com; an on-line charitable donation service, Wave Direct; a website offering digital content that could be consumed using a Wave hardware device and iShopHere.com; an internet shopping portal, and products that relied upon legacy hardware technology, that became obsolete. These products and services never reached full scale production as the demand never reached a level that would have warranted a full scale production launch. Reductions of consultant and professional fees accounted for cost reductions of approximately $895,000. The consultant services that were eliminated primarily involved the process of content preparation (that is, the process of encrypting digital content to be consumed using the Commerce System). Wave also reduced trade show costs by $320,000 and advertising and marketing expenses by $362,000. These savings were achieved by attending fewer trade shows and by bringing the corporate marketing function in-house and using fewer outside marketing consultants. Additionally, during 2001 Wave undertook an aggressive cost cutting program that resulted in reductions in travel and entertainment expenses of $681,000 and reductions of office supplies expenses totaling $357,000. Finally, substantial savings were achieved by eliminating recruiting expenses of $1,044,000 as Wave stabilized its work force late in the year-ended 2000 and into 2001. Offsetting these reductions were increases to employee compensation and fringe expenses totaling $898,000 and litigation settlements of $410,000. Bonuses of approximately $1,570,000 and $1,616,000 were paid to employees for the years ended December 31, 2001 and 2000, respectively. WaveXpress incurred selling, general and administrative expenses of $4,800,927 in 2001, compared to $4,992,285 for 2000, for a decrease of 4%. The reasons set forth above encompass WaveXpress as well as Wave as a whole.

        Goodwill amortization associated with the acquisition of iShopHere.com, for the year ended December 31, 2001 was $1,720,632 versus $573,544 in the year ended December 31, 2000. This is the result of a full year's amortization having been taken for the year-ended December 31, 2001, while only four months' expense was taken in the year ended December 31, 2000, as the acquisition took place on August 31, 2000.

        In the first quarter of 2001, we took a charge of $1,562,500 to write off a technology license that was purchased in connection with the development of the WaveXpress data broadcast system. Additionally in the fourth quarter of 2001, Wave wrote off $199,417 for hardware; also part of the WaveXpress terrestrial data casting system. These write-offs totaling $1,761,917 were the result of

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modifications to WaveXpress' business model; consequently, the value of these assets became impaired because they were no longer needed in the business and had no alternative uses.

        As a result of the decline in current business conditions, and our realignment of resources to focus on what it considers high-growth markets and core opportunities, Wave recorded in the fourth quarter of 2001, a charge of $2,284,570 related to the impairment of goodwill and purchased intangible assets associated with the purchase of Indigo Networks. This amount is equal to the carrying amount of the assets prior to the impairment charge. Accordingly, the carrying amount of the goodwill and purchased intangible assets as of December 31, 2001 was $0.

        We recorded a provision for inventory obsolescence totaling $933,304 in 2001. This charge related to chips based on legacy technology that Wave was no longer actively marketing, and therefore became impaired.

        The in-process research and development ("IPRD") expense incurred in the year-ended December 31, 2000 was related to the acquisition of Indigo and its e-commerce shopping network, iShopHere.com. The portion of the purchase price allocated to in-process research and development for this acquisition was approximately 29% of the total purchase price of $7,445,000. The IPRD was valued using an income approach. The cash flows were discounted to present value at an appropriate rate. The discount rate was determined by an analysis of the risks associated with each of the identified intangible assets. The resulting net cash flows to which the discount rate of 27% was applied were based on management's estimates of revenues, operating expenses and income taxes from such acquired in-process technology.

Other Income and Expenses

        Interest income for the year ended December 31, 2001 was $2,688,105 versus $5,103,716 for the year ended December 31, 2000, for a decrease of 47%. This decrease resulted from a decrease in interest bearing assets during 2001 and lower rates earned on those interest-bearing assets. Equity in losses of GlobalWave were $2,332,159 and $3,406,491 for the year ended December 31, 2001 and 2000, respectively. The decrease resulted from a reduction in GlobalWave's net loss, and Wave's portion being limited to Wave's investment in GlobalWave of $5.7 million, which was reached in the fourth quarter of 2001.

        As of December 31, 2001 Wave took a charge for an "other than temporary decline" in the value of its investment in SSP Solutions of $1,736,682. This charge was taken because a decline in SSP Solutions' share price had occurred due to concerns about SSP Solutions' financial condition and near-term prospects. As a result of this charge the cost basis of the investment as of December 31, 2001 has been adjusted to $12,576,118.

        The Gain on Sale of marketable equity securities in the year ended December 31, 2000 resulted from the acquisition of ITG. Wave recognized the gain as the amount of cash received in the transaction over the book basis of the 1,000,000 shares.

Liquidity and capital resources

        We have experienced net losses and negative cash flow from operations since our inception, and, as of December 31, 2002, had a deficit accumulated during the development stage of $233,091,528. Total stockholders' equity as of December 31, 2002 was $14,541,839. We have financed our operations principally through the issuance of Class A and B Common Stock and various series of preferred stock, for total proceeds since inception of approximately $204,819,000.

        At December 31, 2002, we had $10,221,124 in unrestricted cash and cash equivalents. At December 31, 2001, we had $40,437,119 in cash and cash equivalents. We held non-current marketable equity securities with a value of $2,881,016 as of December 31, 2002 versus $11,171,124 ($11,160,758 of which was classified as non-current) in marketable securities at December 31, 2001. The decrease in cash and cash equivalents resulted from $29,096,904 used in operating activities. Investing activities

24

used $1,327,509 for the purchase of property and equipment totaling approximately $1,149,000, which amount included development of capitalized software of approximately $800,000. Also included in investing activities was approximately $1,559,000 used to meet our final funding commitment to GlobalWave. This was offset by $1,380,000 in cash that we received when we subsequently purchased the 60% of GlobalWave that we had previously not owned. In addition, $208,418 was provided in financing activities that consisted of repayment of a loan granted an officer for $164,319, and proceeds from the issuance of Common Stock from exercises of employee stock options and warrants totaling $44,099.

        Wave's significant commitments with respect to leases, inventory purchases and software development contracts are as follows:

        WaveXpress has been funded entirely by Wave through a series of convertible promissory notes (the "Notes"). Through December 31, 2002 Wave had provided approximately $32.6 million in funds under the Notes, including accrued interest of $3.6 million. Wave expects to continue funding WaveXpress through the Notes and similar notes at least through the first quarter of 2003. Presently, Wave has committed to funding WaveXpress up to an additional $1.0 million under the Notes.

        As of December 31, 2002, we had available net operating loss carryforwards for Federal income tax purposes of approximately $179 million. Because of the "change in ownership" provisions of the Tax Reform Act of 1986, our net operating loss carryforwards may be subject to an annual limitation on the utilization of these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50 percent of Wave occurs within any three-year period. We have made no determination concerning whether there has been such a cumulative change in ownership. However, we believe that it is likely that such a change in ownership occurred prior to or following the completion of our initial public offering in September 1994.

        Wave had outstanding loans receivable from officers totaling $1,277,860 less a reserve for uncollectibility of $999,518 for a net balance of $278,342 as of December 31, 2002. Some of the loans, as indicated below were extended beyond their original terms by one year, prior to the enactment of the Sarbanes-Oxley Act of 2002. These loans and the extensions thereon were granted to the officers to allow them to satisfy certain personal financial obligations that would otherwise have required them to liquidate some of their holdings of Wave shares. The loans were granted and extended as a means to mitigate a potential unfavorable impact to Wave's share price as a result of the officers selling large blocks of shares. The officer loans consist of the following:

        On March 26, 2001 Wave made a personal loan to Mr. Gerard T. Feeney, Senior Vice President, Chief Financial Officer and Secretary of Wave as evidenced by a demand note for $250,000, which sum was due and payable to Wave on March 26, 2002 and bears interest at a rate per annum equal to 1% over the prime interest rate. The due date of the demand note was subsequently extended until March 26, 2003. On March 27, 2003, the Compensation Committee approved an extraordinary bonus in an amount equal to Mr. Feeney's obligations with respect to such loan and accrued interest. Proceeds of this extraordinary bonus will be used to repay the loan and all interest accrued on such loan. Wave intends to take this extraordinary bonus into account when considering future bonus awards to Mr. Feeney.

        Also during 2001, Wave made personal loans to Mr. Peter J. Sprague, former Chairman of Wave totaling approximately $1,062,000. The loans were evidenced by demand notes for $713,000 dated February 27, 2001, $185,000 dated July 25, 2001 and $164,000 dated September 5, 2001. These notes

25

carry terms of one year and bear interest at a rate per annum equal to 1% over the prime rate of interest. The loan that was due dated September 5, 2001 having an original face value of $165,000, the balance of which was approximately $174,000 including accrued interest as of September 30, 2002 came due in September 2002. On November 12, 2002, the Compensation Committee approved the payment of an extraordinary bonus to Mr. Sprague, which he used to repay the loan in full. Accordingly, Wave has recognized approximately $174,000 as bonus expense in selling, general and administrative expense in its statements of operations for the year ended December 31, 2002. The remaining demand notes in the amount of $713,000 and $185,000 plus accrued interest came due on February 27, 2002 and July 25, 2002, respectively and were extended for an additional year beyond their original due dates, prior to the enactment of the Sarbanes-Oxley Act of 2002. As of December 31, 2002, the balances of these two notes including accrued interest were approximately $799,000 and $201,000, respectively for a total of approximately $1,000,000, in notes that are due in 2003. It should be noted that the note that was due on February 27, 2003 is still outstanding as of March 20, 2003. In the quarter ended December 31, 2002, Wave has recorded a reserve for uncollectibility of approximately $1,000,000 in respect to these notes. The Company has determined that Mr. Sprague is unable to repay the loan promptly. Mr. Sprague resigned as Chairman of Wave as of March 31, 2003. Wave intends to engage Mr. Sprague as Chairman and Chief Executive Officer of WaveXpress. Wave intends to diligently pursue collection of Mr. Sprague's loan.

        Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a policy prohibiting future loans to officers and directors.

        At December 31, 2002, we had working capital of $8,754,620, including the loans receivable from officers referred to above, totaling $1,277,860 less the uncollectibility reserve of $999,518 for a balance of $278,342. If the loans are not repaid, we will not be able to use these loans as a source of funds for operations and the amount of capital we will need to raise will be greater.

        Wave's consolidated financial statements as of December 31, 2002 have been prepared under the assumption that we will continue as a going concern. Wave's independent auditors, KPMG LLP, have issued a report dated March 31, 2003, that included an explanatory paragraph referring to our significant operating losses and substantial doubt of our ability to continue as a going concern beyond the second quarter of 2003. (See Note 2 to Wave's consolidated financial statements.)

        Wave has incurred substantial operating losses since its inception, and as of December 31, 2002 has an accumulated deficit of approximately $233 million. We also expect we will incur an operating loss for the calendar year 2003. Considering our current cash balance and Wave's projected operating cash requirements, we anticipate that we will need $11 million of additional cash to satisfy our current forecasted cash flow requirements for the twelve month period ending December 31, 2003. In addition to what we are forecasting for gross margins for fiscal 2003, we estimate having to raise a minimum of approximately $5 million in capital in order to fund our operations through 2003. In the event we are unable to raise additional capital, we anticipate that our existing capital resources will be adequate to satisfy our cash flow requirements into the second quarter of 2003, at our current expenditure rate. In order to raise the additional cash required for Wave's operations, Wave has engaged an investment banking firm and is exploring a number of financing alternatives which include debt or equity financing (or a combination of both) or one or more commercial or strategic transactions.

        As Wave has not yet attained commercial acceptance of its products and has not generated any significant operating revenue, considerable uncertainty currently exists with respect to the adequacy of current funds to support our activities beyond the second quarter of 2003. If Wave is not successful in raising sufficient capital, it will not be able to continue as a going concern.

Recent Accounting Pronouncements

        In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing

26

guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. Earlier application of these provisions is encouraged. The provisions of the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 is not expected to have a material effect on Wave's financial statements.

        In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 is not expected to have a material effect on Wave's financial statements.

        In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to have a material effect on Wave's financial statements. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002.

        In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to these consolidated financial statements.

        In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of this Interpretation is not expected to have a material effect on Wave's financial statements.

Item 7A.    Quantitative and Qualitative Disclosure about Market Risk

        Wave's investment portfolio consists of minority equity investments in publicly traded companies. Most predominantly, we hold 4,883,083 shares of common stock, representing a 19.80% equity interest in SSP Solutions. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. These investments are inherently risky because the markets for the technologies or products they have under development are typically in the early stages and may never materialize. We recorded charges against earnings associated

27

with losses in value on our investment in SSP Solutions that were considered to be "other than temporary" of $11.5 million and $1.7 million for the years ended December 31, 2002 and 2001, respectively. Also, our ability to sell these securities is limited as 1,800,000 of these shares are not registered and the average daily trading volume of SSP's shares is so low that our ability to effectively sell shares in the market is limited. Consequently, our investment in these shares is subject to further potential significant declines in value. The following table presents the hypothetical change in fair values of Wave's investments in marketable equity securities of publicly traded entities using the high and low closing prices of the securities from January 1, 2001 through March 20, 2003:

        Assuming hypothetical future changes in the market prices of these investments based on the historical data presented above, the potential loss in future values resulting from such changes could range from between 8% and 87% of the fair market value of these investments as of December 31, 2002. The amount of such hypothetical future losses in fair market value would be equal to $230,000, $2,500,000 and $2,500,000, using hypothetical losses of 8%, 86% and 87%, respectively.

        The exposure to market risk associated with interest rate-sensitive instruments is not material. Wave's cash and cash equivalents consist primarily of money market funds that meet high credit quality standards and the amount of credit exposure to any one issue is limited.

Item 8.    Financial Statements and Supplementary Data

        The consolidated financial statements, the notes thereto, and the independent auditors' report thereon are presented beginning at page F-1 of this Form 10-K and are hereby incorporated by reference into this Item 8. The quarterly financial information required by this Item 8 is included in the Notes to Consolidated Financial Statements.

Item 9.    Changes in and Disagreements with Accountant on Accounting and Financial Disclosure

        Not Applicable.

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PART III

Item 10.    Directors and Executive Officers of the Registrant

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Biographical Information Regarding Executive Officer Who Is Not A Director

(1)

Member of Nominating Committee.

(2)

Member of Compensation Committee.

(3)

Member of Audit Committee.

(4)

Member of Executive Committee.

(5)

Independent Audit Committee financial expert.

Involvement in Certain Legal Proceedings

        Mr. McConnaughy was the Chairman of the Board of the Excellence Group, LLC, which filed a petition for Bankruptcy under Chapter 11 of the U.S. Federal bankruptcy laws in January 1999. The Excellence Group's subsidiaries produced labels for a variety of customer.

        Mr. Peter J. Sprague is President of KWI, Inc., which filed a petition for Bankruptcy under Chapter 11 of the U.S. Federal bankruptcy laws in December 2001. KWI is a water treatment company.

Item 11.    Executive Compensation

Summary Compensation Table

        The following table sets forth information with respect to the compensation paid or awarded by Wave to the Chief Executive Officer and the other executive officers whose cash compensation

30

exceeded $100,000. (collectively, the "Named Executive Officers") for services rendered in all capacities during 2002, 2001 and 2000.

(1)

Mr. Peter Sprague was awarded a bonus of $150,000 that was paid in 2000 and was fully applied to his outstanding loans with Wave. In 2002 Mr. Sprague was awarded an extraordinary bonus of approximately $174,000 that was applied in full to his outstanding loan with Wave. Mr. Sprague has resigned as an officer and director of Wave, effective March 31, 2003.

(2)

Mr. Steven Sprague was elected President and Chief Executive Officer of Wave on June 26, 2000. Previously, Mr. Sprague was President and Chief Operating Officer of Wave from May 23, 1996 until he was elected Chief Executive Officer.

(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 in Last Fiscal Year

        The following table sets forth certain information regarding options granted during the fiscal year ended December 31, 2002 by Wave to the Named Executive Officers.

(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.

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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 of December 31, 2002, and the aggregate number and value of options exercised by the Named Executive Officers during 2002.

(1)

The last reported bid price for Wave's Class A Common Stock on December 31, 2002 was $1.33 per share. Value is calculated on the basis of the difference between the respective option exercise prices and $1.33, multiplied by the number of shares of common stock underlying the respective options.

Employment Contracts

        Wave has an employment agreement with Steven Sprague that provides that Mr. Sprague shall serve as President and Chief Executive Officer of Wave for consecutive one year terms unless either party provides written notice to the other of its/his intention not to renew the contract not less than sixty (60) days prior to the expiration of the then current term. The employment agreement provides that Mr. Sprague will be paid a minimum base salary of $185,000 per year subject to increase from time to time as determined by action of the Board of Directors. The employment agreement also provides that Mr. Sprague will be entitled to operational bonuses based on performance. In the event that Mr. Sprague's employment is terminated without cause or in certain other circumstances, Mr. Sprague will be paid a lump sum in an amount equal to three (3) year's annual base salary then in effect, and continue health insurance and other benefits for a period equal to the remaining Term of Employment then in effect. This employment agreement also contains a two year post termination covenant not to compete.

        Wave also has an employment agreement with Gerard T. Feeney that provides that Mr. Feeney shall serve as Senior Vice President, Finance and Administration and Chief Financial Officer of Wave for consecutive one year terms unless either party provides written notice to the other of its/his intention not to renew the contract not less than sixty (60) days prior to the expiration of the then current term. The employment agreement provides that Mr. Feeney will be paid a minimum base salary of $160,000 per year subject to increase from time to time as determined by action of the Board of Directors. The employment agreement also provides that Mr. Feeney will be entitled to operational bonuses based on performance. In the event that Mr. Feeney's employment is terminated without cause or in certain other circumstances, Mr. Feeney will be paid a lump sum in an amount equal to one year's annual base salary then in effect, and a guaranteed portion of bonus, benefits and similar relocation package. However in the event Mr. Feeney secures employment elsewhere during the one year period subsequent to termination, severance pay will stop once employment has begun with the new employer. In addition, Mr. Feeney's options will continue to vest for at least one year from the termination date and for the portion of time greater than one year and up to his next anniversary vesting period. This employment agreement also contains a two year post termination covenant not to compete.

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Compensation Interlocks and Insider Participation

        None of the members of the Compensation Committee of Wave were officers or employees of Wave, nor was any executive officer of Wave a director or member of the compensation committee of any entity, of which an executive officer or director served on the Compensation Committee of Wave.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The following table provides information about securities authorized for issuance under Wave's equity compensation plans.

        Equity compensation plans not approved by security holders are comprised of the following:

        In connection with a software development agreement that Wave entered into with Archon Technologies, Inc. ("Archon"), Wave issued to Archon a warrant to purchase 50,000 shares of Wave Class A Common Stock at $3.48 per share. The warrant became on exercisable November 9, 2002, and expires on November 9, 2007.

        A director of WaveXpress was granted a warrant to purchase 10,000 shares of Wave Class A Common Stock at $10.00 per share, upon acceptance of an offer to serve on WaveXpress' board. This warrant is currently exercisable and expires on August 24, 2004.

        As a result of the successful placement of 350 shares of Series B Preferred Stock, a consultant from Digital Media Group, Inc. was issued warrants by Wave to purchase 15,000 Class A Common shares at a price of $3.09 per share. These warrants are currently exercisable and expires on March 1, 2006.

        In connection with a consulting agreement that Wave entered into with the William Morris Agency, Inc. ("William Morris"), Wave issued William Morris a warrant to purchase 10,000 shares of Wave Class A Common Stock at $14.73 per share. This warrant is currently exercisable and expires on March 31, 2004.

        The following table sets forth certain information concerning the beneficial ownership of Wave's Class A and Class B Common Stock as of March 20, 2003 (except as otherwise noted) by (i) each stockholder who is known by Wave to own beneficially more than five percent of the outstanding Class A or Class B Common Stock, (ii) each director of Wave, (iii) each of the executive officers of Wave named in the Summary Compensation Table below, and (iv) all directors and executive officers of Wave 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 Wave. 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

33

Common Stock will have five votes per share in cases where one or more directors are nominated for election by persons other than Wave's Board of Directors and where there is a vote on any merger, consolidation or other similar transaction which is not recommended by Wave'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 Wave. 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.

*

Less than one percent.

(1)

Each individual or entity has sole voting and investment power, except as otherwise indicated.

(2)

Includes shares of Class A Common Stock issuable upon the conversion of the number of shares of Class B Common Stock indicated for the beneficial owner.

(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, 4.5%; John E. Bagalay, Jr., less than 1%; Nolan Bushnell, less than 1%; George Gilder, less than 1%; John E. McConnaughy, Jr., less than 1%; Steven Sprague, 3.6%; Gerard T. Feeney, 1.4%; and all Executive Officers and directors as a group, 10.0%.

(4)

Includes 1,122,500 shares, of Class A Common Stock that are subject to options presently exercisable or exercisable within 60 days.

(5)

Includes 122,000 shares of Class A Common Stock that are subject to options presently exercisable.

(6)

Includes 52,000 shares of Class A Common Stock that are subject to options presently exercisable.

(7)

Includes 202,000 shares of Class A Common Stock that are subject to options presently exercisable.

(8)

Includes 40,000 shares of Class A Common Stock that are subject to options presently exercisable.

(9)

Includes 1,586,173 shares of Class A Common Stock that are subject to options presently exercisable or exercisable within 60 days. Also includes 37,102 shares of Class B Common Stock held in trust for the benefit of Mr. Steven Sprague's family, and for which Mr. Steven Sprague is a trustee.

(10)

Includes 600,000 shares of Class A Common Stock that are subject to options presently exercisable or exercisable within 60 days.

34

(11)

Includes 3,724,673 shares of Class A Common Stock that are subject to options presently exercisable or exercisable within 60 days.

(12)

Includes 223,500 shares beneficially owned by Mr. Steven Sprague and Mr. Peter J. Sprague in which voting and investment rights are shared.

Item 13.    Certain Relationships and Related Transactions

Note Receivable from Director/Officers

        Wave had outstanding loans receivable from officers totaling $1,277,860 less a reserve for uncollectibility of $999,518 for a net balance of $278,342 as of December 31, 2002. Some of the loans, as indicated below were extended beyond their original terms by one year. These loans and extensions thereon, were granted to the officers, prior to the enactment of the Sarbanes-Oxley Act of 2002, to allow them to satisfy certain personal financial obligations that would otherwise have required them to liquidate some of their holdings of Wave shares. The loans were granted and extended as a means to mitigate a potential unfavorable impact to Wave's share price as a result of the officers selling large blocks of shares. The officer loans consist of the following:

        On March 26, 2001 Wave made a personal loan to Mr. Gerard T. Feeney, Senior Vice President, Chief Financial Officer and Secretary of Wave as evidenced by a demand note for $250,000, which sum was due and payable to Wave on March 26, 2002 and bears interest at a rate per annum equal to 1% over the prime interest rate. Interest on the loan accrues monthly and is payable at maturity. The due date of the demand note was subsequently extended until March 26, 2003. On March 27, 2003, the Compensation Committee approved an extraordinary bonus in an amount equal to Mr. Feeney's obligations with respect to such loan and accrued interest. Proceeds of this extraordinary bonus will be used to repay the loan and all interest accrued on such loan. Wave intends to take this extraordinary bonus into account when considering future bonus awards to Mr. Feeney. The largest aggregate amount outstanding with respect to indebtedness of Mr. Feeney during 2002 was $278,000.

        Also during 2001, Wave made personal loans to Mr. Peter J. Sprague, former Chairman of Wave totaling approximately $1,062,000. The loans were evidenced by demand notes for $713,000 dated February 27, 2001, $185,000 dated July 25, 2001 and $164,000 dated September 5, 2001. These notes carry terms of one year and bear interest at a rate per annum equal to 1% over the prime rate of interest. Interest on the loans accrues monthly and is payable at maturity. Two of the demand notes in the amount of $713,000 and $185,000 plus accrued interest came due on February 27, 2002 and July 25, 2002, respectively and were extended for an additional year beyond their original due dates, prior to the enactment of the Sarbanes-Oxley Act of 2002. As of December 31, 2002, the balances of these two notes including accrued interest were approximately $799,000 and approximately $201,000, respectively for a total of $1,000,000, in notes that are due in 2003. The remaining loan, which had an original face value of $165,000 and a balance of approximately $174,000 including accrued interest, came due in September 2002. On November 12, 2002, the Compensation Committee approved the payment of an extraordinary bonus that Mr. Sprague used to repay the $165,000 balance of the note plus accrued interest of $9,000. The remaining loans, one of which having a balance of $799,000 which came due on February 27, 2003, remain outstanding. In the quarter ended December 31, 2002, Wave has recorded a reserve for uncollectibility of approximately $1,000,000 in respect to these notes. The Company has determined that Mr. Sprague is unable to repay the loan promptly. Mr. Sprague resigned as Chairman of Wave as of March 31, 2003. Wave intends to engage Mr. Sprague as Chairman and Chief Executive Officer of WaveXpress. Wave intends to diligently pursue collection of Mr. Sprague's loan. The largest aggregate amount outstanding with respect to indebtedness of Mr. Sprague during 2002 was $1,162,000.

        Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a policy prohibiting future loans to officers and directors.

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Specialty Broadcast Networks

        In August 2001, Wave loaned $150,000 to Specialty Broadcast Networks ("SBN") pursuant to an unsecured convertible term note. SBN's business is to create new video and Internet content networks and aggregate this content into commercially viable web sites and interactive networks. The loan was made to SBN to fund initial operations. The largest aggregate amount due Wave under the note during 2002 was $159,879, including accrued interest of $9,879. Wave also entered into a stockholder agreement pursuant to which Wave acquired a 50% stake in SBN, for a nominal amount. Steven Sprague is a director and Executive Officer of SBN. The note bears interest at a rate per annum equal to the prime rate and is convertible into shares of SBN common stock. Interest on the note accrues monthly. As of March 20, 2003 the loan balance, including accrued interest thereon was approximately $161,000. The note together with accrued interest is due and payable no later than April 30, 2004. Wave's commitment to make further loans to SBN pursuant to the note expired on February 3, 2002, and Wave has made no further loans to SBN.

Compensation to Michael Sprague

        During 2002, Michael Sprague, son of Mr. Peter J. Sprague, the former Chairman and former Chief Executive Officer of Wave, served as Vice President of Services Development of WaveXpress and was paid compensation of $125,619 for serving in this capacity.

Item 14.    Controls and Procedures

(a)

Evaluation of disclosure controls and procedures. Under new Securities and Exchange Commission regulations implementing portions of the Sarbanes-Oxley Act of 2002, our CEO and CFO are required to certify in this annual report their responsibility for establishing and maintaining disclosure controls and procedures designed to ensure that material information in relation to Wave is made known to them. Our CEO and CFO are also required to certify that they have evaluated the effectiveness of our disclosure controls and procedures as of a date within 90 days prior to the filing of this report, and that they have presented in this report their conclusions about the effectiveness of the disclosure controls and procedures as a result of the evaluation. Based on their evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective, providing them with material information relating to Wave as required to be disclosed in the reports we file with the Commission on a timely basis.

(b)

Changes in internal controls. There were no significant changes in Wave's internal controls or in other factors that could significantly affect these disclosure controls subsequent to the date of the CEO and CFO's evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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PART IV

Item 15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)

(1)    Financial Statements:

(a)

(2)    Financial Statement Schedules:

All schedules have been omitted since they are either not required or not applicable.

(a)

(3)    Exhibits:

37

38

*

Incorporated herein by reference.

+

Confidential treatment has been granted as to portions of this exhibit.

†

Management contract or compensatory plan.

(b)

Reports on Form 8-K

        There have been no reports on Form 8-K filed during the quarter-ended December 31, 2002.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: March 30, 2003

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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CERTIFICATIONS

I, Steven K. Sprague, certify that:

1.

I have reviewed this annual report on Form 10-K of Wave Systems Corp.

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)

Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a)

All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

41

I, Gerard T. Feeney, certify that:

1.

I have reviewed this annual report on Form 10-K of Wave Systems Corp.

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)

Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a)

All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

42

Index to Consolidated Financial Statements

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
Wave Systems Corp.:

        We have audited the consolidated financial statements of Wave Systems Corp. and subsidiaries (a development stage corporation) as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wave Systems Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 and for the period from February 12, 1988 (date of inception) to December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

        The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has an accumulated deficit that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

KPMG LLP

Boston, Massachusetts
March 31, 2003

F-2

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)

Consolidated Balance Sheets

December 31, 2002 and 2001

See accompanying notes to consolidated financial statements.

F-3

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)

Consolidated Statements of Operations

Years ended December 31, 2002, 2001, 2000, and
period from February 12, 1988 (date of inception)
through December 31, 2002