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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