UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-24752
Wave Systems Corp.
(Exact name of registrant as specified in its charter)
Delaware |
| 13-3477246 |
(State or other jurisdiction of |
| (I.R.S. Employer |
incorporation or organization) |
| Identification No.) |
480 Pleasant Street |
| 01238 |
Lee, Massachusetts |
| (Zip Code) |
(Address of principal executive offices) |
|
|
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No 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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso No x
As of December 31, 2005 there were 93,341,479 shares of the registrant’s Class A Common Stock and 175,725 shares of the Registrant’s Class B Common Stock outstanding.
The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates as of March 8, 2006, was $63,746,428 (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.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, have been incorporated by reference into Part III of this annual report.
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 PART I, ITEM I OF THIS FORM 10-K. 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 ..
Wave Systems Corp., a development stage company, develops, produces and markets products for hardware-based digital security, including security applications and services that are complementary to and work with the specifications of the Trusted Computing Group, www.trustedcomputinggroup.org (“TCG”). Specifications developed by the TCG are designed to address a broad range of current and evolving digital security issues. These issues include: identity protection, data security, digital signatures, electronic transaction integrity, platform trustworthiness, network security, and regulatory compliance.
The TCG is an industry standards body, comprised of computer and device manufacturers, software vendors and others, whose purpose is to develop, define and promote open industry standard specifications for embedded hardware-enabled computing products, including security technologies across multiple platforms, peripherals and devices. The current TCG specification recommends a hardware-based trusted computing platform, which is a platform that uses an implementation of the TPM specification into a semiconductor device, known as a Trusted Platform Module (“TPM”) that performs protected activities, including protected storage, platform authentication, protected cryptographic processes and attestable state capabilities to provide the first level of trust for the computing platform (a “Trusted Platform”). The TPM is a hardware chip that is separate from the platform’s main CPU(s) that enables secure protection of files and other digital secrets, and performs critical security functions, such as generating, storing and protecting “cryptographic keys,” which are secret codes used to decipher encrypted or coded data. While TPMs provide the anchor for hardware security, known as the “root of trust”, trust is achieved by integrating the TPM within a carefully architected trust infrastructure and supporting the TPM with essential operational and lifecycle services, such as key management and credential authentication.
Prior to the formation of the TCG, Wave developed its pioneering EMBASSY (EMBedded Application Security SYstem) Trust System. The EMBASSY Trust System is a combination of client hardware consisting of the EMBASSY 2100 security chip (the “EMBASSY chip”); and software consisting of the Trust Assurance Network (“TAN”), a back-office infrastructure that manages its security functions. As the market for TPM-enabled products has developed with computing devices being shipped in volume by leaders in the PC industry, Wave has enabled the development work on the EMBASSY Trust System to support security hardware based on the TCG specifications, by repurposing these product assets. Wave has since developed a set of applications known as the EMBASSY Trust Suite, EMBASSY Trust Server products, middleware and software tools to work with various other chip manufacturers’ TCG-enabled TPMs that are now available. Wave’s products are unique in the fact that they support cross platform interoperability for the currently available TPM chips from Winbond Electronics Corporation (“Winbond”), (formerly National Semiconductor Corporation (“NSC”), Atmel, Broadcom, Infineon, and STMicroelectronics and have been verified for usage on TPM platforms shipped by Intel, IBM, HP, Fujitsu, Gateway and Dell.
Wave’s operations to date have consisted primarily of product development, performance under contract to develop products and preliminary marketing to personal computer (“PC”) and Semi-conductor Chip (“Chip”) original equipment manufacturers (“OEMs”), resellers, and enterprises. In addition, Wave has signed distribution contracts for its products with a number of OEMs that have resulted in a marked increase in revenues for the year ended December 31, 2005 versus prior years.
Although Wave was successful in signing distribution contracts with Intel, NSC (now Winbond) and ST Microelectronics, Wave’s total revenue has not grown to a level that is significant in relation to our expenditures. As a result, we have experienced a slow pattern of corporate development. As of December 31, 2005, we had negative working capital of approximately $1.1 million. Considering our current cash balance and Wave’s projected operating cash requirements, we anticipate that we will need a minimum of approximately $12 million of additional cash to satisfy our current forecasted cash flow
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requirements for the year ending December 31, 2006. As discussed above, Wave has begun market introduction of its software products for Trusted Platforms and has signed its first distribution contracts for these applications. However, due to the early stage nature of its market category, Wave is unable to predict with a high enough level of certainty whether enough revenue will be generated in calendar 2006 to fund its cash flow requirements. Given the uncertainty with respect to Wave’s revenue forecast for 2006, it is likely that Wave will be required to raise additional capital through either equity or debt financing in order to adequately fund its capital requirements for the year ending December 31, 2006. Furthermore, in the event that we are successful in executing our business plan for 2006, we will likely still be in a cash shortfall position and 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 2006. Due to our current cash position, our capital needs over the next year and beyond, the fact that we have not secured additional financing at this time and uncertainty as to whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.
Formation of the Trusted Computing Group and introduction of TCG Compliant Products
In April, 2003 the TCG was formed. The Promoting Founders were AMD, HP, IBM, Intel, and Microsoft, and Wave Systems was invited to join the founding group as a Contributing Member. The TCG formally accepted the initial technical specifications developed by the Trusted Computing Platform Alliance (“TCPA”) for Trusted Platform Modules Version 1.1. TCG formally superseded the TCPA organization. The TCG has significantly expanded the industry participation in security hardware standards with membership from industry leaders for important additional platforms including cell phones, PDAs and consumer electronics. During 2003, several manufacturers of semiconductors for the PC industry including National Semiconductor, Atmel and Infineon were offering products that have the capability to function as TPMs that meet the TCG TPM Version 1.1 standard for trusted computing. In addition, PC platforms which included TPMs were announced and/or available from IBM, Intel, and HP. In 2004 the rate of adoption of TPMs accelerated with additional platforms announced by the major OEMs already shipping platforms and an additional OEM, Fujitsu, announced products with TPM’s. In 2005 the rate of adoption of TPMs continued to grow with the availability of TPM-equipped PCs and servers from additional PC OEMs including Dell, Gateway and Lenovo. The overall number of TPM-equipped PC models being offered from the OEMs shipping with TPMs combined with the increased number of OEMs that have introduced TPM-equipped models has continued to accelerate the total rate of TPMs being shipped by the PC industry. In 2005, The TCG released a new version of the TPM specification, Version 1.2 which includes a number of enhancements and extensions over the Version 1.1b. TPM Version 1.2 is fully backwards compatible to Version 1.1b which provides a smoother transition for deployment of the TPM technology and increases the TPM functionality. In addition, vendors such as Atmel announced TPM products targeted to support embedded systems applications beyond the traditional PC market. There are also TCG Working Groups that are developing specifications to extend TCG technologies to other devices such as network products, servers, peripherals and mobile devices.
The offering of products using TCG specifications to the PC market is an important development in the creation of the market for hardware-based computer security. As a result of this development, Wave had begun executing a strategy to put the work it has done in developing the EMBASSY Trust System to use in becoming a leading developer of software, applications and services for this market. Wave formed business relationships with some of these companies as a developer of products that will be essential to the deployment and use of these new products, thereby creating a new revenue opportunity for Wave. Wave is providing solutions in the market that work with all available products using TCG specifications in these commercially available products.
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Client-side Applications
The EMBASSY Trust Suite
The current version of the EMBASSY Trust Suite is a set of applications and services that are designed to bring functionality and user value to TPM-enabled products. Designed to make the TPM easy for users to set up and use, the EMBASSY Trust Suite includes the EMBASSY Security Center (the “ESC”), Document Manager Vault (“Vault”), Private Information Manager (“PIM”), SmartSignature and Key Transfer Manager (“KTM”).
The ESC enables the user to set up and configure the TPM platform. In addition to the basic function of making the TPM operational, ESC is designed to enable the user to manage extended TPM-based security settings and policies, including strong authentication, Windows logon preferences to add biometrics and streamlined password policy management. Wave also announced that it would develop the Trusted Drive Manager functions for ESC to support the newly announced Seagate Full Disc Encryption drives.
Data Protection is addressed by the Vault, which provides document encryption, decryption and client side storage of documents. The Vault, which works with Microsoft Windows, and Microsoft Office, secures documents against unauthorized users and hackers.
Password management is a security challenge due to the increasing number of passwords required and the tendency of users to select easily guessed passwords. To help improve these password issues, PIM uses the TPM to securely store and manage user information such as user names, passwords, credit card numbers and other personal information. It retrieves login information to efficiently fill in applications, web forms and web login information.
Backup and recovery of keys used for logon, signing, and protection of data is an essential requirement for deployment of TPM based systems. KTM is an archive application for the cryptographic keys that is designed to provide a simple, yet fully featured method to securely archive, restore and transfer keys having migratable properties that are secured by the TPM.
SmartSignature is a digital signing application that utilizes the signing keys generated by the TPM.
Additionally, Wave has developed TPM Wizards as part of the EMBASSY Trust Suite which allow users to setup and use the TPM for securing 802.11x wireless networks, the Windows Encrypting File System and encrypting email. The TPM Wizard enhancement was released during the 1st quarter of 2005.
In August 2005, Wave signed an agreement with Seagate Technology LLC (“Seagate”) to develop a trusted drive manager software module for the EMBASSY Trust Suite, which will support the Seagate Momentus 5400 Full Disc Encryption products announced by Seagate (the “Seagate Trusted Drives”). Wave’s support for the Seagate Trusted Drives will also utilize its EMBASSY Trust Suite software for TPM and key management.
Wave plans to continue to develop and enhance the current products being developed within this product group and will develop new applications and services as the trusted computing market continues to evolve. Current planned development costs for this product group are expected to be approximately $2.7 million for the year ending December 31, 2006.
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Middleware and Tools
TCG-Enabled Toolkit
The Wave TCG-Enabled Toolkit is a compilation of software designed to assist application developers writing new applications or modifying existing ones to function on TCG-compliant platforms. Wave provides two versions of the Toolkit, Discovery and Commercial, which enable developers to leverage basic and enhanced TCG services such as integrated key lifecycle management, including key escrow and key recovery. The Discovery Toolkit offers application developers a license for internal evaluation only, whereas the Commercial Toolkit is a license for external redistribution.
Wave TCG-Enabled Cryptographic Service Provider (“CSP”)
Wave offers a TCG-enabled CSP, which allows software developers to utilize the enhanced security of a TCG standards-based platform, facilitating a common user experience independent of the platform. It also enables applications to utilize functionality available on TCG-compliant platforms directly through the Microsoft cryptographic application programming interface, without requiring user knowledge of any specific TCG software stack layer.
Current planned development costs for this product group are expected to be approximately $2.4 million for the year ending December 31, 2006.
EMBASSY Trust Server Applications
EMBASSY Key Management Server (EKMS)
EKMS is a server application that is designed to provide corporate-level backup and transition of the TPM keys, a process known as key migration. Key migration using EKMS is designed to help prevent the risk of serious data loss in the event that a TPM, hard drive or motherboard becomes corrupted, or a user leaves the organization. For instance, an organization may require access to a former employee’s encrypted data or TPM-secured keys for business continuity or disaster recovery purposes. EKMS enables enterprise level key protection services while ensuring proper archive procedures and recovery capabilities.
EMBASSY Authentication Server (EAS)
EAS provides centralized management, provisioning and enforcement of multifactor domain access policies. With EAS, authentication policies can be based on TPM credentials, Smart Card credentials, user passwords and fingerprint templates. With EAS, authentication policies can be provisioned and managed from the domain controller. EAS has an integrated biometric template capability with support for a variety of 3rd-party vendors.
Current planned development costs for this product are expected to be approximately $1.1 million for the year ending December 31, 2006.
Digital Signature and Electronic Document Management
On October 4, 2001, Wave acquired the digital signature and electronic document management technology, SmartSignature and SmartSAFE, from SignOnLine, Inc. (“SignOnLine”), a California-based company. This group of products initially made up our eSign Transaction Management Suite, also known as eTMS (“eTMS”), which consisted 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. In Q4 of 2005, Wave launched SmartSignature Server, a server-side electronic signature application, which
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enables individuals to electronically sign and store virtually any format of document, while connected to a server, as opposed to the signing taking place on the client PC.
To increase the security associated with identity protection and digital signing credentials, Wave’s SmartSignature is currently enabled for the support of TPMs. 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 paper-based documentation methods. SmartSignature Version 3.0 and SmartSAFE Version 3.0 have been completed and Wave commercially released these products in 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, was completed and released in January of 2003. Wave will continue to allocate resources toward marketing and sales to promote these products.
Wave’s eTMS, in addition to being part of the EMBASSY Trust Suite applications and supporting TPMs, is also being independently marketed in the insurance, mortgage, finance, government and other markets which are seeking digital and electronic signature solutions that are compliant with the Electronic Signatures in Global and National Commerce Act (“ESIGN”). In 2005, eTMS’ SmartSignature Server product was licensed to a la mode, Inc., a leading provider of desktop, mobile, and Web tools for the real estate and mortgage industries, to provide digital signature solutions for their XSites product line. Wave also signed a licensing agreement in 2005 with Efficient Forms, LLC, a leading provider of interview-based electronic forms creation, to offer a comprehensive managed-service solution for electronic forms and electronic signatures. In Q4 of 2005, the Wave/Efficient Forms managed service was launched, and deployed at FISERV ISS to automate internal and consumer business processes. Wave has focused on digital signature applications that can make effective use of the stronger security features provided by trusted computing platforms.
Current planned development costs for this product are expected to be approximately $449,000 for the year ending December 31, 2006.
Broadband Media Distribution Services
Wave offers broadband content distribution products and services through Wavexpress, a joint venture between Wave and Sarnoff Corporation. The joint venture was established on October 15, 1999. Under the joint venture agreement, Sarnoff and its affiliates received a 40% equity stake in Wavexpress. Wave received a 53% equity interest and its affiliates, who purchased founders stock in April 1999 for a nominal amount, owned the remaining 7% of the outstanding capital stock. The affiliates of Wave include Peter Sprague, former Chairman of Wave, Steven Sprague, Chief Executive Officer of Wave, certain members of the Board of Directors of Wave and certain Wave employees.
Wavexpress has developed a vertically integrated suite of products designed to enable the optimum broadband distribution of digital programming. The current product offering combines industry standard syndication protocols with proprietary back-end software to create an end-to-end content syndication and monetization platform. This system is offered to content providers looking to deliver high-quality broadband media services using either Wavexpress’ distribution facility or on their own, through Really Simple Syndication (“RSS”). RSS is the standard format for blogs and podcasts and is being increasingly used for open video distribution on the Internet. Content providers connect through the Wavexpress client and backend software to generate advertising revenue or subscription fees for premium services. Wavexpress’ business model intends to derive revenue either from direct fees charged to content providers for the use of Wavexpress software and facilities, or from a share of advertising proceeds collected.
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Wavexpress proprietary client software is integrated and promoted through Microsoft’s Media Center Edition operating system, as well as with Microsoft’s Internet Explorer web browser.
We believe Wavexpress’ products deliver value to content providers by bringing a traditional advertising sales model to the emerging market for cached, syndicated, high-quality video content. By leveraging an open standard, RSS, Wavexpress believes it is in a position to work with any content provider—large or small. Wavexpress’ investment in proprietary backend and distribution technology creates opportunities to differentiate and capitalize on this rapidly growing segment of the content industry.
Planned future development expenditures are expected to approximate $1.1 million for the year ending December 31, 2006. As of December 31, 2005, Wave owned 69% of Wavexpress and Sarnoff owned 25.6%.
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. For the years ended December 31, 2005, 2004, and 2003 Wave incurred losses to common shareholders of approximately $17,562,000, $14,498,000 and $25,292,000, respectively. At December 31, 2005 we had an accumulated deficit of approximately $284,747,000. There can be no assurance that we will ever be successful in achieving commercial acceptance of our products and services.
Our Market
Software has traditionally secured critical information on networks and PCs and allowed for user access to various applications. However, virus attacks and breaches of security have proven that software, on its own, is not capable of completely securing a network or platform. Because of these persistent security concerns, there is now a recognized need in the computer industry for the development and deployment of a more robust and reliable security infrastructure including new security hardware in devices to guard against these persistent security risks. The TCG was formed to develop, define and promote open industry standard specifications for embedded hardware-enabled trusted computing and security technologies, including secure hardware and software interfaces across multiple platforms, peripherals and devices. The underlying premise of the creation of a Trusted Platform that meets the TCG specification is that only when a platform is secured by hardware, in effect creating a root of trust and an authenticatable security environment within the computer itself, will the information stored on the platform be adequately secure. Wave is seeking to become a software, application and services leader in hardware-based digital security and e-commerce products markets. Because Wave has been a pioneer in developing hardware-based computer security systems, it is distinctively positioned to take advantage of its unique knowledge, significant technology assets and trusted computing intellectual properties.
Because hardware-based trusted computing involves a new approach to conducting business and exchanging information using computer systems, it will require that traditional software-based security be augmented with next generation hardware-based security and an enhanced support infrastructure. Intensive marketing and sales efforts have been and will continue to be necessary, in order to generate demand for products using Wave’s technology, and to ensure that Wave’s solution is accepted in this emerging market. Our objective is to make our EMBASSY branded products and services the preferred applications and infrastructure for Trusted Platforms. Key components in achieving this goal include:
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Capitalizing on Information Security Industry Trends
For 2005 and 2006 security remains one of the top industry priorities across multiple segments of the user and product value chains. This top priority is supported by increased spending budgets and high product adoption rates of new security offerings. Virtually all segments within the security markets are seeing increased focus.
Wave believes that a key differentiator of its EMBASSY Trust Suite is that it is interoperable across all of the currently available TPM-enabled Windows platforms and provides for ease of use. Key industry initiatives and security specifications that will require the addition of trusted hardware are moving forward in a number of platforms including Microsoft’s Next Generation Secure Computing Base (“NGSCB”) now known as Windows Vista operating system, Intel’s LaGrande secure computing program, and AMD’s Secure Execution Mode (“SEM”). Similar programs are under consideration in network devices, and mobile devices such as PDAs and cell phones and consumer electronics devices.
Wave has designed its products with features and functionality that it believes uniquely positions them to capitalize on information security industry issues and trends. Wave sees these issues and trends as follows:
· Requirements to authenticate the identity of both platforms and users for access to protected resources and information
· User managed security features
· Major privacy concerns
· Rapid development of new e-commerce business and distribution models
· Lack of adequate security for e-commerce and vulnerability to attacks
· Convergence of consumer electronics and PC’s
· Legal status of digital identities and digital signatures, including development of next generation web services which require digital signature solutions.
· Increased focus on security and privacy by government entities
· Rampant piracy of digital goods including music, video, software and the need for digital goods providers to securely distribute their content and prevent theft
Wave will continue to pursue strategic relationships with hardware manufacturers, independent software vendors, 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 platform for security solutions and commerce performed in user devices.
Pursue Strategic Marketing and Distribution Alliances
We intend to expand Wave’s strategic alliances with key partners that could distribute our products in enterprise, government and eventually consumer markets, and to build upon our alliances with such industry leaders as Intel, Dell, HP, IBM, Lenovo, Gateway and others in the PC industry. In addition, we are engaged in strategic activities with semi-conductor manufacturers Winbond (formerly NSC), Atmel, STMicroelectronics and Infineon Technologies to support and/or deploy EMBASSY applications with their TPMs designed to the TCG specifications. TCG has expanded its scope to include networking systems, trusted peripherals, data storage devices, mobile wireless products and consumer electronics devices. Wave believes its trusted computing offerings can provide significant value in these new markets and platforms and thus, is working to establish relationships with key partners in each of these markets.
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For example, in 2004 Wave announced a relationship with ARM as part of the ARM Connected Community of technology partners as a important step in pursuing opportunities in these markets.
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 to meet customer requirements and market demand. Planned development efforts that enhance or utilize existing technologies include building upon and enhancing our EMBASSY Trust Suite, eTMS applications and Wavexpress broadband media distribution software applications.
Client and server solutions supporting both the operations and life cycle management of Trusted Platforms is a major focus area for Wave. New products that Wave is planning on developing over the ensuing period will consist primarily of new TCG client and server software services and enabling tools that will expand upon its portfolio of TCG trusted computing applications and services in the following areas:
· Cross platform interoperability: There is TCG hardware coming from multiple suppliers, as well as supporting software from multiple vendors. In order for applications from independent software vendors to work with any of these multiple combinations of products, Wave is developing TCG specific toolkits that provide for this interoperability across platforms. Wave will continue to expand the functions available to systems integrators (“SIs”), independent software vendors (“ISVs”) and independent hardware vendors (“IHVs”) within these enabling toolkits to make it easier to bring new applications to Trusted Platforms.
· Client applications: Wave’s EMBASSY Trust Suite provides important applications for the end user that run on their PCs such as Embassy Security Center, Document Manager, Private Information Manager, Key Transfer Manager and SmartSignature. Wave will continue to add new client applications and enhance the current applications with advanced functions to exploit the strong security of the TCG platforms.
· Server applications: Trusted devices require a number of life cycle management products to address the set up, registration, operations and systems management requirements of the platforms. Wave’s current offering consists of the EKMS and EAS. The server products will be enhanced with future versions and expanded to offer additional trust services.
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, our 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 emerging market opportunities for its products and services. Wave announced major products in 2005, primarily for TPM applications, and is developing significant new client and server based products and product enhancements which are planned to be introduced in 2006. For example: At the RSA Conference, 2006, on February 14th, 2006, Wave presented demonstrations with both Juniper Networks and Nortel Networks, regarding the network security and platform integrity capabilities of TPM-enabled systems.
Marketing, Sales and Customers
Because Wave’s products involve a new approach to conducting business and exchanging information using computer systems, it will require that traditional software-based security be enhanced and/or replaced with next generation products designed using the TCG and related specifications. Intensive marketing and sales efforts have been and will continue to be necessary in order to increase recognition of and generate demand for products using Wave’s technology and to ensure that Wave’s solutions are accepted in this emerging market. The current primary focus is on closing business with chip OEMs, PC
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OEMs, enterprise customers and systems integrators. Wave has also undertaken steps to develop and establish a reseller channel for our products.
Wave’s business model targets revenues from various sources: licensing of our technology including EMBASSY Trust Suite client applications; tools and enabling software; and client/server based trusted software solutions for the lifecycle management of keys and authentication of Trusted Platforms.
Wave has identified five key markets where we believe our products would provide unique benefits:
· PCs—TCG’s standards-based specifications for trusted hardware is leading the industry toward increased deployment of TPM hardware by a growing number of PC OEMs. The current focus for both TCG and Wave is for business PC platforms, but will be extending into consumer PCs over time. Wave anticipates providing enabling tools to SIs, ISVs, and IHVs in order to take advantage of the new trusted computing features of these platforms.
· Network products, Peripherals and Mobile Devices—As TCG based specifications are released and product deployment begins, Wave anticipates extending its products to support these new trusted computing platforms and marketing to the associated OEMs, SI, ISVs, IHVs, and service providers for these devices.
· Banking and Finance—In addition to our European initiatives to be a leader in delivering solutions for European standards, which can provide strong authentication to services, we are aggressively cultivating interest and support from financial institutions for utilizing TCG-compliant platforms. In 2005, Wave upgraded its Liberty Alliance membership to Sponsor Level in order to participate in the new Strong Authentication Expert Group, which is being driven primarily by financial institutions which are looking for new alternatives for strong authentication for electronic transactions.
· Broadband Media—Through our Wavexpress joint venture, we have developed a broadband architecture for the distribution and subsequent management of secured media channels to subscribers in the home and enterprise.
· 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 for both our eTMS as well as Wave’s TCG offerings.
Directly and through our partners, Wave is aggressively targeting opportunities in these markets, as we believe our products provide a wide range of security and trust capabilities not offered in any other single solution.
Wavexpress offers its technology and services on the basis of a per-user fee and/or revenue share with the content owner, with a particular focus on advertising supported entertainment services. In addition, Wavexpress publishes to the installed base of Microsoft Media Center PCs five general interest channels of entertainment programming offered under the TVTonic brand. Wavexpress’ client software and TVTonic channels are pre-installed with one high-end Microsoft Media Center PC OEM. Wavexpress is looking to expand to other manufacturers in 2006.
Wave’s sales for the year ended December 31, 2005 consisted primarily of licensing its software applications, engineering and support services. Of the total revenue realized for the year ended December 31, 2005, 96% was derived from activities related to Wave’s computer security products and services and the remaining 4% was derived from Wavexpress’ broadband media distribution segment. None of the customers from which Wave derived revenue in 2005 in excess of 10%, would have a material adverse effect on Wave’s business if Wave were to lose such customers, because the level of sales during the year overall was not significant to Wave’s level of expenditures. However, Wave’s business plan on a forward-looking basis, will depend heavily on a small number of OEM customers, partners and prospective
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customers, the loss of, or lack of substantial future revenues from any of whom, may have a material adverse effect on our business plan going forward. These include Winbond (formerly NSC), Intel, ST Microelectronics, Dell Computers, Inc. and others.
Competition
Wave EMBASSY Digital Security Products
We operate in the information security market, 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 to leverage, allowing these competitors to gain market share or product acceptance to our detriment. In addition, the rate of market acceptance of trusted computing solutions is still in the formative and early stages. The markets for our products are developing and, while the TCG specifications have provided the basis for the industry to move forward, there remains significant standards work efforts in order for the eco-system supporting trusted computing to move forward. Wave’s potential competitors include security solutions providers such as RSA Security, Inc., Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Utimaco, Safenet and major systems integrators such as IBM, HP and EDS. In addition, Wave competes with other client security applications companies that are developing trusted computer applications including Softex, Phoenix, Infineon and Microsoft. The competitive factors defining these evolving markets include product features, compatibility, standards compliance, quality and reliability, ease of use, performance, customer service and support, distribution and price. Wave believes its products meet the requirements to be successful viable products in these markets. The features of Wave’s products that should allow it to compete favorably through product differentiation include: cross-platform, interoperable solutions; easy-to-use features; and leading edge trusted client/server infrastructure solutions. In addition, Wave continues to have leading solutions with its digital signature products, especially when combined with trusted computing platforms and features.
One of the market challenges facing Wave is the establishment of a newly defined market category within the overall information security market for trusted computing software and services that includes a more complex business model for adoption. While the TCG specifications define a very complex and comprehensive cryptographic system that require significant skills and resources, the market for security solutions that are as complex as those developed by Wave is in a formative stage of development. As a result, commercialization of these technologies has been slow to develop. It is also possible for other competitors to develop similar offerings to compete with our products 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.
Wavexpress Broadband Media Distribution
Wavexpress competes in a market dominated by traditional content delivery methods. Wavexpress prospects rely on traditional broadcast television, Internet streaming and online websites. Wavexpress’ technology augments these services with a higher quality playback experience and more reliable delivery method. Several companies compete for the digital delivery of content over broadband, including CDNs (content delivery networks) such as Akamai, startup caching companies such as Maven Networks and streaming service providers such as The Feedroom.
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Most of our software products 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. With respect to our EMBASSY Trust Suite software applications, we have applied for and received export classifications that allow us to export our products, without a license and with no restrictions, to any country throughout the world with the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria.
We believe the export classifications that we have received for our software products allow us to sell our products internationally in an effective, competitively advantageous manner. Enhancements to existing products may, and new products, including the EMBASSY Trust Server applications, will be subject to reviews by the BXA to determine what export classification they will receive. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license, as we are currently allowed for the products that we’ve received classification, or make it more difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.
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.
Wave has been issued eleven (11) United States patents relating to encryption and to our proprietary EMBASSY and Wave Commerce technology. We also have eight (8) patents pending before the United States Patent Office. In addition, we have two (2) foreign patents and twenty-nine (29) pending foreign patent applications. Our patents are material to protecting some of our technology.
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.
Wave’s products incorporate encryption/decryption, client and server software applications 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 information security applications and services, including the EMBASSY Trust Suite, EMBASSY Server applications, eTMS products, and broadband media distribution products. For the years ended December 31, 2005, 2004 and 2003 we spent
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approximately $6.9 million, $6.9 million and $7.4 million, respectively, on research and development (“R&D”) activities. Planned development expenditures for the year ended December 31, 2006 are expected to be approximately $7.8 million.
As of December 31, 2005, we employed eighty-six (86) full-time employees, thirty-eight (38) of whom were involved in sales, marketing and administration and forty-eight (48) of whom were involved in research and development (including fourteen (14) employed by Wavexpress, five (5) of whom were in sales, marketing and administration and nine (9) of whom were involved in research and development). As of December 31, 2005, we retained the services of nine (9) full-time consultants, three (3) of whom were retained by Wavexpress. We believe our employee relations are satisfactory.
We have a history of net losses and expect net losses will continue. If we continue to operate at a loss, our business will not be financially viable.
We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating profit in any quarter since we began our operations, nor have we generated any significant operating revenue, as our products have not yet attained commercial acceptance. This is due primarily to the early stage nature of the digital security industry in which we operate. As of December 31, 2005, we have a deficit accumulated during the development stage of approximately $284.7 million and negative working capital of approximately $1,112,000. Given the lack of significant sales of our products and services, there is little basis for evaluating the financial viability of our business and our long-term prospects. You should consider our prospects in light of the risks, expenses and difficulties that companies in their early stage of development encounter, particularly companies in new and rapidly evolving markets, such as digital security and online commerce.
To achieve profitability we must, among other things:
· Convince chip, personal computer motherboard, personal computer and computer peripheral manufacturers to license and distribute our products and services and/or make them available to their customers through their sales channels;
· Convince computer end users and enterprise computer users to purchase our upgrade software and server products for trusted computing:
· Convince consumers to choose to order, purchase and accept products using our products and services;
· Continue to maintain the necessary resources, especially talented software programmers;
· Develop relationships with personal computer manufacturers and computer systems integrators to facilitate and to maximize acceptance of our products and services; and
· Generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital to support our operations until we can generate sufficient revenues and cash flows.
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If we do not succeed in these objectives, we will not generate revenues; hence, our business will not be sustainable.
We may not be able to fund our operations and continue as a going concern.
Since we began our operations, we have incurred net losses and experienced significant negative cash flow from operations. 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. Considering our current cash balance and Wave’s projected operating cash requirements, we anticipate that our existing capital resources will be adequate to satisfy our cash flow requirements into May 2006. In order to fund our business through May of 2006 and beyond, it will be necessary for us to generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital. Wave is uncertain as to the availability of financing from other sources to fund any cash deficiencies. Even if we are successful in raising additional capital, uncertainty with respect to Wave’s viability will continue until we are successful in achieving our objectives. Furthermore, although we may be successful at achieving our business objectives, a positive cash flow from operations may not ultimately be realized unless we are able to sell our products and services at a profit. Given the early stage nature of the markets for our products and services, considerable uncertainty exists as to whether or not Wave’s business model is viable.
We may be unable to raise the $12 million of additional cash flow, which is necessary to continue as a going concern for the next twelve months.
Based upon our current expense forecast, we estimate that our current available capital, including net proceeds of approximately $4,247,840 that we received from the sale of 8,348,598 shares of common stock on February 15, 2006, is sufficient to fund Wave into May of 2006. In addition to our efforts to begin to generate revenue sufficient to fund our operations, or complete one or more commercial or strategic transactions, Wave is evaluating additional financing options to generate additional capital in order to continue as a going concern, to capitalize on business opportunities and market conditions and to insure the continued development of our technology, products and services. We estimate, based upon our current forecasts, that we will need to generate approximately $12,000,000, in addition to the $4,247,840 in proceeds referred to above, from a combination of revenue growth, commercial or strategic transactions and/or additional financings, to continue as a going concern for the twelve months ended December 31, 2005. We expect we will be required to generate a significant portion of this cash through additional financings in the form of sales of securities pursuant to a shelf registration statement filed with the SEC on December 16, 2006, which was declared effective on January 13, 2006. We do not know if additional financing will be available or that, if available, it will be available on favorable terms. If we issue additional shares of our stock, our stockholders’ ownership will be diluted, or the shares issued may have rights, preferences or privileges senior to those of our common stock. In addition, if we pursue debt financing we may be required to pay interest costs. The failure to generate sufficient cash flow to fund our forecasted expenditures would require us to reduce our cash burn rate which would in turn impede our ability to achieve our business objectives. Furthermore, if we are not successful in generating sufficient cash flow or obtaining additional funding, we will be unable to continue our operations, develop or enhance our products, take advantage of future opportunities, respond to competitive pressures and continue as a going concern.
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Our market is in the early stage of development so we are unable to accurately ascertain the size and growth potential for revenue in such a market.
The market for our products and services is still developing and is continually evolving. As a result, substantial uncertainty exists with respect to the size of the market for these products and the level of capital that will be required to meet the evolving technical requirements of the marketplace.
Wave’s business model relies on an assumed market of tens of millions of units shipping with built-in security hardware. Because this market remains in the early stage of development, there is significant uncertainty with respect to the validity of the future size of the market. If the market for computer systems that utilize our products and services does not grow to the extent necessary for us to realize our business plan, we may not be successful.
As this early stage market develops and evolves, significant capital will likely be required to fund the resources needed to meet the changing technological demands of the marketplace. There is uncertainty with respect to the level of capital that may be required to meet these changing technological demands. If the amount of capital resources needed exceeds our ability to obtain such capital, we may not be a viable enterprise.
Wave is not established in the industry so we may not be accepted as a supplier or service provider to the market.
Wave’s offering represents a highly complex architecture designed to solve many of the security issues currently present with computer systems, such as identity theft, fraudulent transactions, virus attacks, unauthorized access to restricted networks and other security problems that users of computer systems generally encounter. We are uncertain as to whether the marketplace will accept our solution to these security problems. We will not be successful if the market does not accept the value proposition that we perceive to be present in our products and services.
Although Wave has expended considerable resources in developing technology and products that utilize our technology and in business development activities in an attempt to drive the development of the hardware security market, we do not have a track record as a substantial supplier or service provider to consumers of computer systems. Therefore, uncertainty remains as to whether we will be accepted as a supplier to the enterprise and consumer markets, which will likely be necessary for us to be a successful commercial enterprise.
Our products have not been accepted as industry standards, which may slow their sales growth.
We believe platforms adopting integrated hardware security into the PC will become a significant standard feature in the overall PC marketplace. However, our technologies have not been accepted as industry standards. Standards for trusted computing are still evolving. To be successful, we must obtain acceptance of our technologies as industry standards, modify our products and services to meet whatever industry standards ultimately develop, or adapt our products to be complementary to whatever these standards become. If we fail to do any of these, we will not be successful in commercializing our technology; and therefore, we will not generate sales to fund our operations and develop into a self-sustaining, profitable business.
If we do not keep up with technological changes, our product development and business growth will suffer.
Because the market in which we operate is characterized by rapidly changing technology, changes in customer requirements, frequent new products, service introductions and enhancements, and emerging industry standards, our success will depend, among other things, upon our ability to improve our products, develop and introduce new products and services that keep pace with technological developments, remain compatible with changing computer system platforms, respond to evolving customer requirements and
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achieve market acceptance on a timely and cost effective basis. If we do not identify, develop, manufacture, market and support new products and deploy new services effectively and timely, our business will not grow, our financial results will suffer, and we may not have the ability to remain in business.
We encounter risks relating to security, system disruptions and computer infrastructure that could compromise our digital content.
Although we have implemented in our products various security mechanisms, our products and services may nevertheless be vulnerable to break-ins, piracy and similar disruptive problems caused by Internet users. Any of these disruptions would harm our business. Advances in computer capabilities, new discoveries in the field of security, or other developments may result in a compromise or breach of the technology we use to protect products and information in electronic form. Computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through the computer systems of users of our products, which may result in significant liability to us and may also deter potential customers.
A party who is able to circumvent our security measures could misappropriate proprietary electronic content or cause interruptions in our operations and those of our strategic partners. We may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by breaches. Our attempts to implement contracts that limit our liability to our customers, including liability arising from a failure of security features contained in our products and services, may not be enforceable. We currently do not have product liability insurance to protect against these risks.
Competition and competing technologies may render some or all of our products non-competitive or obsolete.
An increasing number of market entrants have introduced or are developing products and services that compete with Wave’s. Our competitors may be able to develop products and services that are more attractive to customers than our products and services. Many of our competitors and potential competitors have substantially greater financial, technical and marketing resources than we have. Also, many current and potential competitors have greater name recognition and larger customer bases that could be leveraged to enable them to gain market share or product acceptance to our detriment. Wave’s potential competitors include security solutions providers such as RSA Security, Inc., Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Ultimaco, Safenet and major systems integrators such as IBM, HP and EDS. In addition, Wave competes with other client security applications companies that are developing are developing trusted computing applications, including Softex, Phoenix, Infineon and Microsoft.
Other companies have developed or are developing technologies that are, or may become, the basis for competitive products in the field of security and electronic content distribution. Some of those technologies may have an approach or means of processing that is entirely different from ours. Existing or new competitors may develop products that are superior to ours or that otherwise achieve greater market acceptance than ours. Due to Wave’s early stage, and lower relative name recognition compared to many of our competitors and potential competitors, our competitive position in the marketplace is vulnerable.
We have a high dependence on relationships with strategic partners that must continue or our ability to successfully produce and market our products will be impaired.
Due in large part to Wave’s early stage and lower name recognition, we depend upon strategic partners such as large, well established personal computer and semiconductor manufacturers and computer systems’ integrators to adopt our products and services within the Trusted Computing marketplace. These companies may choose not to use our products and could develop or market products or technologies that compete directly with us. We cannot predict whether these third parties will commit
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the resources necessary to achieve broad-based commercial acceptance of our technology. Any delay in the use of our technology by these partners could impede or prohibit the commercial acceptance of our products. Although we have established some binding commitments from some of our strategic partners, there can be no assurance that we will be able to enter into additional definitive agreements or that the terms of such agreements will be satisfactory. It will be necessary for Wave to expand upon our current business relationships with our partners, or form new ones, in order to sell more products and services for Wave to become a viable, self-sufficient enterprise.
Product defects or development delays may limit our ability to sell our products.
We may experience delays in the development of our new products and services and the added features and functionality to our existing products and services that our customers and prospective customers are demanding. If we are unable to successfully develop products that contain the features and functionality being demanded by these customers and prospective customers in a timely manner, we may lose business to our competitors. In addition, despite testing by us and potential customers, it is possible that our products may nevertheless contain defects. Development delays or defects could have a material adverse effect on our business if such defects and delays result in our inability to meet the market’s demand.
If we lose our key personnel, or fail to attract and retain additional personnel, we will be unable to continue to develop our products and technology.
We believe that our future success depends upon the continued service of our key technical and management personnel and on our ability to attract and retain highly skilled technical, management, sales and marketing personnel. Our industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or retain qualified technical and managerial personnel in the future, and the failure of us to do so would have a material adverse effect on our business.
We have a limited ability to protect our intellectual property rights and others could infringe on or misappropriate our proprietary rights.
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 and to preserve our trade secrets. We cannot assure you that any patent owned or licensed by us will provide us with adequate protection or will not be challenged, invalidated, infringed or circumvented.
We rely on trade secrets and proprietary know-how, which we protect, in part, by confidentiality agreements with our employees and contract partners. However, our confidentiality agreements may be breached, and we may not have adequate remedies for these breaches. Our trade secrets may also otherwise become known or be independently discovered by competitors. We also rely on intellectual property laws to prevent the unauthorized duplication of our software and hardware products. While we have and will continue to protect our software and our patented technology, intellectual property laws may not adequately protect our technology. We have registered trademark and service mark registrations with the United States Patent and Trademark Office for the marks WaveMeter and WaveNet, EMBASSY, Second Shift (the Wave juggler logo), WaveDirect and Charity Wave. Wave intends to apply for additional name and logo marks in the United States and foreign jurisdictions, as appropriate, but we cannot assure you that federal registration of any of these trademarks will be granted.
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Regulation of international transactions may limit our ability to sell our products in foreign markets.
Most of our software products 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. With respect to our EMBASSY Trust Suite software applications, we have applied for and received export classifications that allow us to export our products, without a license and with no restrictions, to any country throughout the world with the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria.
We believe the export classifications that we have received for our software products allow us to sell our products internationally in an effective, competitively advantageous manner. Enhancements to existing products may, and new products, including the EMBASSY Trust Server applications will, be subject to reviews by the BXA to determine what export classification they will receive. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Currently, we are allowed to export the products for which we’ve received classification, in an unrestricted manner without a license. However, modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license. Such modifications could also make it more difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.
In addition, import and export regulations of encryption/decryption technology vary from country to country. We may be subject to different statutory or regulatory controls in different foreign jurisdictions, and as such, our technology may not be permitted in these foreign jurisdictions. Violations of foreign regulations or regulation of international transactions could prevent us from being able to sell our products in international markets. Our success depends in large part to having access to international markets.
Our stock price is volatile.
The price of our Class A common stock has been and likely will continue to be subject to wide fluctuations in response to a number of events and factors, such as:
· quarterly variations in operating results;
· announcements of technological innovations, new products, acquisitions, capital commitments or strategic alliances by us or our competitors;
· the operating and stock price performance of other companies that investors may deem comparable to us; and
· news reports relating to trends in our markets.
In addition, the stock market in general, and the market prices for technology-related companies in particular, have experienced significant price and volume fluctuations. These broad market fluctuations may adversely affect the market price of our Class A common stock or any of our other securities for which a market develops, regardless of our operating performance. Securities class action litigation has often been instituted against companies that have experienced periods of volatility in the market price for their securities. A Class action lawsuit is currently pending against us (See “Class action lawsuits could affect our operations” below); and it is possible that we could become the target of additional litigation of this kind that would require substantial management attention and expense. The diversion of management’s attention and capital resources could have a material adverse affect on our business. In addition, any negative publicity or perceived negative publicity of any such litigation could have an adverse impact on our business.
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We may be subject to conflicts of interest that could adversely slow our corporate governance process.
Our Board of Directors does not include any representatives of our strategic partners. However, our Board of Directors has included in the past, and may include in the future, representatives of our strategic partners. It is possible that those corporations may be competing against us, or each other, directly or indirectly. A director who also represents another company may voluntarily abstain from voting on matters, where there could be conflicts of interest. Even if such a director does abstain, his presence on the Board could affect the process or the results of the Board’s deliberations. We have adopted no policies or procedures to reduce or avoid such conflicts. If such conflicts of interest arise, they may have a materially adverse effect on our business.
Governmental regulation may slow our growth and decrease our profitability.
There are currently few laws or regulations that apply directly to the Internet. Because our business is dependent in significant respect on the Internet, the adoption of new local, state, national or international laws or regulations may decrease the growth of Internet usage or the acceptance of Internet commerce, which could, in turn, decrease the demand for our products and services and increase our costs or otherwise have a material adverse effect on our business.
Tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New state tax regulations may subject us to additional state sales, use and income taxes.
If we make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.
If appropriate opportunities become available, we may attempt to acquire businesses, technologies, services or products that we believe are a strategic fit with our business. We currently have no commitments or agreements with respect to any material acquisitions. If we do undertake any transaction of this sort, the process of integrating an acquired business, technology, service or product may result in operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition.
A formal investigation by the Securities and Exchange Commission could affect our operations.
The SEC has commenced a formal investigation into certain matters relating to Wave. The SEC investigative order relates to certain public statements made by Wave during and around August 2003, as well as certain trading in Wave’s securities during such time. The SEC has not concluded that there has been any wrongdoing and Wave is cooperating fully with the SEC on this matter. An adverse resolution of the investigation may have a negative effect on our financial condition and operating results.
Class action lawsuits could affect our operations.
A consolidated amended class action complaint is pending in the United States District Court for the District of Massachusetts, naming Wave, its Chief Executive Officer and its Chief Financial Officer as defendants. Brumbaugh et al. v. Wave Systems Corp. et al., Civ. No. 04-30022 (D. Mass.) (MAP). The purported class action has been filed by alleged purchasers of Wave’s Class A Common Stock during the purported class period July 31, 2003 through February 2, 2004. The complaint claims that Wave and the named individuals violated Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), Rule 10(b)-5 promulgated thereunder and Section 20(a) of the 1934 Act by publicly disseminating
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materially false and misleading statements, relating to Wave’s agreements with Intel and IBM. The complaint does not specify the amount of alleged damages plaintiffs seek to recover.
Wave intends to defend the action vigorously. Recently, the Court granted in part and denied in part defendants’ motion to dismiss. The Court dismissed two but let stand seven alleged misrepresentations or omissions. This is not a finding of fault or liability, it is a decision not entirely to dismiss plaintiffs’ pleading. Wave is unable to predict the outcome of this action.
A consolidated, purported derivative action was pending in the United States District Court for the District of Massachusetts, Sachs v. Sprague et al. Civ. No. 04-30032 (D. Mass.) (MAP) The complaint names all of Wave’s directors during the period July 2003 through February 2004 as defendants and alleges claims for breach of fiduciary duties and other claims based on allegations similar to the purported securities class action. Wave is also named as a nominal defendant, although the actions are derivative in nature and purportedly asserted on behalf of Wave. On December 22, 2004, Wave moved to dismiss the complaint. The Court held oral arguments on March 25, 2005. On September 26, 2005, the Court entered an Order stating that the defendants’ motion to dismiss has been allowed. On November 22, 2005 the Court issued a memorandum of decision and entered judgment. The case is terminated in the District Court. However, Plaintiffs have filed a Notice of Appeal. The appeal is proceeding.
At this time, Wave is unable to predict the outcome of this action.
Summarized below is a listing of properties leased by Wave. Our principal research and development activities are conducted at the Princeton and Cupertino facilities.
Facility |
|
|
| Sq. Ft. |
| Annual |
| Lease Expires |
| |||||
Lee, MA |
| 13,048 |
|
| $ | 126,877 |
|
|
| July 2007 |
|
| ||
Princeton, NJ |
| 7,128 |
|
| 157,367 |
|
|
| Dec. 2009 |
|
| |||
Cupertino, CA |
| 10,028 |
|
| 275,916 |
|
|
| Feb. 2008 |
|
| |||
New York, NY |
| 7,169 |
|
| 377,177 |
|
|
| Apr. 2006 |
|
| |||
Orvault, France |
| 1,000 |
|
| 67,260 |
|
|
| Sept. 2007 |
|
| |||
Securities and Exchange Commission Investigation
On December 17, 2003, Wave received an Order by the Securities and Exchange Commission (the “Commission”) regarding a formal investigation. The focus of this investigation is on certain public statements made by Wave during and around August 2003, as well as certain trading in Wave’s securities during such time. Wave is cooperating fully with the Commission in this investigation. Wave is unable to predict the outcome of this investigation at this time.
Purported Class Actions
A consolidated amended class action complaint is pending in the United States District Court for the District of Massachusetts, naming Wave, its Chief Executive Officer and its Chief Financial Officer as defendants. Brumbaugh et al. v. Wave Systems Corp. et al., Civ. No. 04-30022 (D. Mass.) (MAP).
The purported class action has been filed by alleged purchasers of Wave’s Class A Common Stock during the purported class period July 31, 2003 through February 2, 2004. The complaint claims that Wave and the named individuals violated Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), Rule 10(b)-5 promulgated thereunder and Section 20(a) of the 1934 Act by publicly disseminating
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materially false and misleading statements, relating to Wave’s agreements with Intel and IBM. The complaint does not specify the amount of alleged damages plaintiffs seek to recover.
Wave intends to defend the action vigorously. Recently, the Court granted in part and denied in part defendants’ motion to dismiss. The Court dismissed two but let stand seven alleged misrepresentations or omissions. This is not a finding of fault or liability, it is a decision not entirely to dismiss plaintiff’s pleading. Wave is unable to predict the outcome of this action.
Derivative Actions
A consolidated, purported derivative action is pending in the United States District Court for the District of Massachusetts, Sachs v. Sprague et al. Civ. No. 04-30032 (D. Mass.) (MAP). The complaint names all of Wave’s directors during the period July 2003 through February 2004 as defendants and alleges claims for breach of fiduciary duties and other claims based on allegations similar to the purported securities class action. Wave is also named as a nominal defendant, although the actions are derivative in nature and purportedly asserted on behalf of Wave.
On December 22, 2004, Wave moved to dismiss the complaint. The Court held oral argument on March 25, 2005. On September 26, 2005, the Court entered an Order stating that the defendants’ motion to dismiss has been allowed. On November 22, 2005 the Court issued a memorandum of decision and entered judgment. The case terminated in District Court. However, Plaintiffs have filed a Notice of Appeal. The appeal is proceeding. At this time, Wave is unable to predict the outcome of this action.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Market Information & Dividends
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 sales prices per share for the Class A Common Stock. There is no established trading market for our Class B Common Stock.
|
| High |
| Low |
| ||
Year Ended December 31, 2005 |
|
|
|
|
| ||
First Quarter |
| $ | 1.27 |
| $ | 0.88 |
|
Second Quarter |
| 0.99 |
| 0.58 |
| ||
Third Quarter |
| 1.35 |
| 0.76 |
| ||
Fourth Quarter |
| 0.98 |
| 0.65 |
| ||
Year Ended December 31, 2004 |
|
|
|
|
| ||
First Quarter |
| $ | 2.34 |
| $ | 1.03 |
|
Second Quarter |
| 2.29 |
| 1.02 |
| ||
Third Quarter |
| 1.37 |
| 0.71 |
| ||
Fourth Quarter |
| 1.72 |
| 0.78 |
| ||
As of February 24, 2006 there were approximately 28,400 holders of our Class A Common Stock. As of such date, there were 15 holders of our Class B Common Stock.
On February 24, 2006 the last sale price reported on the Nasdaq National Market for the Class A Common Stock was $0.66
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
Securities Authorized for Issuance Under Equity Compensation Plans
The following pertains to Wave’s equity compensation plans as of December 31, 2005:
Plan Category |
|
|
| Number of Securities |
| Weighted Average |
| Number of securities |
| |||||||
Equity compensation plans approved by security holders |
|
| 12,420,897 |
|
|
| $ | 3.81 |
|
|
| 8,324,915 |
|
| ||
Wave equity compensation plans not approved by security holders |
|
| 174,365 |
|
|
| 1.92 |
|
|
| — |
|
| |||
Total Company plans |
|
| 12,595,262 |
|
|
| $ | 3.79 |
|
|
| 8,324,915 |
|
| ||
Wavexpress equity compensation plans not approved by security holders |
|
| 691,896 |
|
|
| $ | 1.23 |
|
|
| 1,780,327 |
|
| ||
22
Wave equity compensation plans not approved by security holders are comprised of the following:
In connection with an agreement that the Company entered into with nClose, Inc., an outside software development firm, on January 2, 2004 the Company issued a warrant to purchase 30,000 shares of Class A Common Stock at an exercise price of $1.00 per share, pursuant to an individual compensation plan with nClose. Also, in connection with the same agreement, on April 30, 2004 an additional warrant was issued to nClose, Inc. to purchase 35,000 shares of Class A Common Stock at an exercise price of $1.00 per share. The warrants are currently exercisable and expire on January 2, 2009 and April 30, 2009, respectively. No additional warrants are required to be granted pursuant to the individual compensation plan for nClose.
In connection with an agreement that Wave entered into with an outside sales representative, in 2003 Wave issued warrants to purchase 44,365 shares of Class A Common Stock at prices ranging from $0.95 to $1.45 per share, pursuant to an individual compensation plan with the sales representative. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. These warrants are currently exercisable and expire January 1, 2013 through April 30, 2013.
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 Class A Common Stock at $3.48 per share, pursuant to an individual compensation plan with Archon (the “Archon Plan”). The warrant became exercisable on November 9, 2002, and expires on November 9, 2007. No additional warrants are required to be granted pursuant to the Archon Plan.
As a result of the successful placement of 350 shares of Series B preferred stock, in 1996 a consultant from Digital Media Group, Inc. (“Digital Media”) was issued warrants by Wave to purchase 15,000 shares of Class A Common Stock at a price of $3.09 per share, pursuant to an individual compensation plan with Digital Media (the “Digital Media Plan”). No additional warrants are required to be granted pursuant to the Digital Media Plan. These warrants were exercisable as of December 31, 2005. Warrants for 5,000 shares expired on March 1, 2006. The remaining warrants expire on April 1, 2006 through August 1, 2006.
23
Item 6. Selected Financial Data
Consolidated Statement of Operations Data
|
| For the year-ended December 31, |
| |||||||||||||
|
| 2005 |
| 2004 |
| 2003 |
| 2002 |
| 2001 |
| |||||
Net Revenues |
| $ | 1,018,464 |
| $ | 209,311 |
| $ | 189,363 |
| $ | 446,588 |
| $ | 692,125 |
|
Cost of Sales |
| 726,853 |
| 151,704 |
| 55,179 |
| 202,208 |
| 369,959 |
| |||||
Gross Profit |
| 291,611 |
| 57,607 |
| 134,184 |
| 244,380 |
| 322,166 |
| |||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
| |||||
Selling, general and administrative |
| 11,560,039 |
| 12,255,427 |
| 12,698,682 |
| 19,188,046 |
| 24,184,317 |
| |||||
Research and development |
| 6,937,618 |
| 6,852,754 |
| 7,384,708 |
| 12,009,713 |
| 17,691,051 |
| |||||
Restructuring and other special |
| — |
| — |
| — |
| 726,280 |
| — |
| |||||
Amortization of goodwill |
| — |
| — |
| — |
| — |
| 1,720,632 |
| |||||
Inventory provision |
| — |
| — |
| 1,114,442 |
| — |
| — |
| |||||
Write-off of goodwill |
| — |
| — |
| — |
| — |
| 2,284,570 |
| |||||
Write-off of intangible and other impaired assets |
| — |
| 301,366 |
| — |
| 1,571,031 |
| 1,761,917 |
| |||||
|
| 18,497,657 |
| 19,409,547 |
| 21,197,832 |
| 33,495,070 |
| 47,642,487 |
| |||||
Other income (expense): |
|
|
|
|
|
|
|
|
|
|
| |||||
Equity in net losses of GlobalWave |
| — |
| — |
| — |
| — |
| (2,332,159 | ) | |||||
Loss on other than temporary decline in equity securities |
| — |
| — |
| — |
| (11,513,099 | ) | (1,736,682 | ) | |||||
Liquidated damages |
| — |
| — |
| (155,716 | ) | — |
| — |
| |||||
Gain on decrease in value of warrant liability |
| 490,334 |
| 498,723 |
| 263,097 |
| — |
| — |
| |||||
Gain on termination of development contract |
| — |
| — |
| — |
| 1,818,000 |
| — |
| |||||
Recovery of (Provision for loss on) officer note receivable |
| — |
| — |
| 999,518 |
| (999,518 | ) | — |
| |||||
Gain on sale of marketable securities |
| 80,971 |
| 4,330,248 |
| 234,759 |
| — |
| — |
| |||||
Net interest and other income |
| 72,279 |
| 24,931 |
| 127,192 |
| 477,902 |
| 2,688,105 |
| |||||
Total Other Income / (expense) |
| 643,584 |
| 4,853,902 |
| 1,468,850 |
| (10,216,715 | ) | (1,380,736 | ) | |||||
Net loss |
| (17,562,462 | ) | (14,498,038 | ) | (19,594,798 | ) | (43,467,405 | ) | (48,701,057 | ) | |||||
Accrued dividends on preferred stock (including $5,485,000 of accretion of discount in 2003) |
| — |
| — |
| 5,697,518 |
| — |
| — |
| |||||
Net loss to common stockholders |
| $ | (17,562,462 | ) | $ | (14,498,038 | ) | $ | (25,292,316 | ) | $ | (43,467,405 | ) | $ | (48,701,057 | ) |
Weighted average number of common shares outstanding during the period |
| 83,178,663 |
| 69,040,661 |
| 55,887,384 |
| 51,135,548 |
| 49,949,875 |
| |||||
Loss per common share-basic and diluted |
| $ | (0.21 | ) | $ | (0.21 | ) | $ | (0.45 | ) | $ | (0.85 | ) | $ | (0.97 | ) |
Cash dividends declared per common |
| -0- |
| -0- |
| -0- |
| -0- |
| -0- |
| |||||
Consolidated Balance Sheet Data
|
| As of December 31, |
| |||||||||||||
|
| 2005 |
| 2004 |
| 2003 |
| 2002 |
| 2001 |
| |||||
Working capital |
| $ | (1,112,413 | ) | $ | 3,549,095 |
| $ | 12,406,861 |
| $ | 8,754,620 |
| $ | 36,963,617 |
|
Total assets |
| 3,429,765 |
| 8,454,582 |
| 18,160,430 |
| 18,209,372 |
| 60,234,302 |
| |||||
Long-term liabilities |
| 2,794 |
| 493,128 |
| 991,851 |
| — |
| — |
| |||||
Total liabilities |
| 3,595,574 |
| 3,744,382 |
| 4,145,794 |
| 3,667,533 |
| 6,428,896 |
| |||||
Total stockholders’ equity (deficiency) |
| $ | (165,809 | ) | $ | 4,710,200 |
| $ | 14,014,636 |
| $ | 14,541,839 |
| $ | 53,805,406 |
|
24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In 2003 Wave’s management made a shift in its business focus by devoting less attention and resource to its proprietary EMBASSY Trust System and more attention to developing and marketing TCG-compliant software products known as its EMBASSY Trust Suite and EMBASSY Trust Server Applications. These are products designed and built around the TCG specifications, known as Trusted Platforms, that are being adopted into the Information Security Services marketplace. Wave devoted a substantial amount of its activities and resources during the year ended December 31, 2003 to organizing its business to capitalize on the opportunities presented by the emergence of the TCG specifications.
In 2004 and 2005, Wave continued to pursue a strategy of educating the marketplace on the benefits that trusted computing has to offer, while continuing to develop the basic software applications designed to enable this emerging technology. The market trends and opportunities that management focused the company’s activities during the year ended December 31, 2005 included the following:
· A new study by Infonetics forecasts sharp rises in end-point security. The study predicts that in the coming years, endpoint security will require a range of new types of software and hardware to be effective, including endpoint-security appliances and improved network-infrastructure equipment. Accordingly, the study forecasts the overall network access control (NAC) enforcement market will grow to $3.9 billion by 2008, up from just $323 million last year, a 1101% increase. More information is available from the IT Compliance Institute.
· Adoption of TPMs and Trusted Computing technology is also growing—according to industry analyst, IDC, shipments of TPMs are expected to grow from under 25 million units in 2005 to over 250 million units in 2010.
· The persistence of security threats indicates that hardware is needed to provide more robust security than traditional software solutions.
· Emergence of TPM-enabled PCs being sold into the marketplace—this emergence is complementary to Wave’s business model, which largely relies upon providing services for Trusted Platforms rather than selling the hardware itself.
· Business and security strategies are becoming more closely aligned due to the increasing rate of significant high profile and costly security breaches and the associated risks presented by this phenomenon.
· In-house security expertise remains in short supply—Wave seeks to capitalize on its expertise as awareness of TPM-enabled solutions increases.
· In its Windows Vista Logo Program for Systems, Version 3.0, Draft Revision 0.7, Microsoft has required TPM version 1.2 in its draft operating system hardware requirements specification for logo compliance for “Gold” level business PCs. Wave believes that a significant percentage of the approximately 150 million unit PC market will include TPMs by December 2006, which is Microsoft’s stated launch date for Vista.
· The emergence of additional trusted PC components, such as Seagate’s Momentus 5400 Full Disc Encryption drive which was announced in Q3 of 2005, represent additional opportunities for Wave’s products to support and integrate these devices with the TPM elements in the PC.
· On February 3, 2006, the U.S. Army, in the new Consolidated Buy-2 (CB2) Desktop and Notebook minimum specifications for Army customers as published by the Army Small Computer Program, specifies the requirement for desktop and laptop personal computers to be equipped with new open security chip hardware called the Trusted Platform Module (TPM).
25
In pursuing these opportunities, we recognize many significant challenges that must be overcome, including:
· Tight enterprise IT budgets—industry data appear to show that, while enterprise security will be a priority, it will be challenged by tight budgets
· Long sales cycle due to continued lack of support for enterprise spending on security solutions—information security continues to be viewed as an IT issue versus a business issue
· Need to educate the marketplace of the advantages of utilizing hardware-based trusted platforms as a security solution
· Limited availability of capital resources—Wave continues to rely on financing the development of its business by issuing new equity (See Liquidity and capital resources section for a detailed discussion of financing activities during 2005).
As more PC and chip OEMs have begun introducing their Trusted Platform offerings, management has focused on entering into licensing contracts in which the OEM licenses our applications and bundles them with their offering, paying Wave a royalty for each unit shipped. Wave currently has signed such bundling agreements with three separate OEM partners. For the year ended December 31, 2005, Wave received approximately $865,000 in royalties from these OEM partners pursuant to its license agreements with them. Revenue recognized on these contracts through December 31, 2005 totaled approximately $757,000, while the remaining $108,000 is included in deferred revenue. We continue to pursue OEM business under the royalty model described herein. In addition, we seek to enter into arrangements with resellers that sell to PC OEMs to distribute our applications as a product offering that users may choose when purchasing a TPM-equipped computer from the PC OEM. In February, 2005, Dell Computers Inc began offering Wave’s ETS Software as an option for purchase on select models through their website at Dell.com and in December 2005 Wave signed a distribution license agreement with Dell pursuant to which Dell is permitted to ship a version of Wave’s EMBASSY Trust Suite software with select Dell PC models. Wave is entitled to royalties on each unit that ships with Wave software and a fully featured version of ETS will be offered to Dell customers as an upgrade which will generate additional license revenue for Wave when customers elect to purchase the upgrade. Wave hopes to capitalize on this association with Dell products and the wider distribution of TPM-equipped personal computers that a Dell TPM offering represents. However, there are no minimum royalty or shipped quantity requirements. In addition, we have sought to develop our products such that they operate on all of the major PC OEM Trusted Platforms that are currently shipping product in the marketplace and our applications have been approved to work with the Trusted Platforms of IBM, HP, Atmel, Infineon and others.
Management is also focused on developing the client and server-side applications and tools that will enable enterprises to manage an IT infrastructure that relies on products built using TCG specifications. Wave is devoting a significant portion of its research and development budget to address this opportunity, as this will be a key ingredient for enterprises in successfully implementing a Trusted Platform solution. Wave released these tools and applications in 2004, and has signed a license agreement in 2005 with a small number of enterprise customers to license the Wave TCG-enabled toolkit, EAS and EKMS..
With respect to sales and marketing, management is focused on broadening our distribution strategies to include the direct engagement of our channel partners using their resellers and systems integrators and has hired regional representation in Japan. We have also expanded our targeted presence selling directly to OEMs. We have specifically focused our resources towards solution selling in these channels. An example of building a channel partner relationship is the memorandum of understanding that Wave signed with NTT Data Corporation (“NTT”), a Japanese information technology systems integrator, pursuant to which Wave and NTT envision the formation of a distributor and systems integrator relationship to resell Wave’s products and solutions and to provide support services to NTTs customers in an effort to introduce such products and solutions to the Japanese enterprise market..
26
Management is also focused on opportunities for its eTMS product suite to provide digital signing and document management solutions to the financial services and other vertical markets in which there is a clear and identifiable value proposition in implementing these solutions. Although we have met significant implementation challenges and long sales cycles with this effort, we have also entered into contracts with a la mode, inc. in the real estate industry in 2004 and with Efficient Forms, LLC in the financial services sector in 2005. We continue to pursue additional opportunities for the eTMS product line.
Wavexpress is focused on building a sustainable revenue stream by establishing partnerships with branded content providers to provide paid and advertising supported video entertainment services. Wavexpress’ TVTonic service has recently added new content partners and has been designed to support any video channel distributed via RSS. RSS is the standard format for blogs and podcasts and is being increasingly used for open video distribution on the Internet. It is intended that TVTonic will be an advertising supported service. TVTonic is currently being promoted with all Microsoft Media Center Edition PCs through their Online Spotlight partner program. In addition, Wavexpress is extending its technology so that its subscriber management system can leverage the added security of a TPM and is preparing back-office systems for standalone deployment into enterprise installations.
Wavexpress currently has two active contracts that are generating revenue going into 2006. It is expected that these contracts will generate revenue that is in line with the revenue that Wavexpress has generated in 2005. Management plans to devote increasing development resources towards building its feature set to meet market demand.
While management is primarily focused on the emerging TCG Trusted Platform opportunities, it remains committed to pursuing business opportunities that involve its proprietary EMBASSY Trust System products and services, primarily in the government sector.
Operating Expense Trends
While research and development expenses increased slightly from 2004 to 2005 as shown in Item I—Business; selling, general and administrative expenses (“SG&A”) have been trending downward over the three years ended December 31, 2005. For the years ended December 31, 2005, 2004 and 2003 we have incurred approximately $11.6 million, $12.3 million and $12.7 million, in SG&A expenses, respectively. The activities supported by these expenditures include business development, sales, marketing (including product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions. The downward trend in SG&A expenses and expenses in general, is indicative of Wave’s strict cost-cutting measures, which began during the second half of 2001 and continued through the end of 2003, and have since flattened into 2004 and in 2005 which showed a much lower rate of decrease. Much of these cost reductions were the result of Wave’s abandonment of several lines of business that it had previously been pursuing, including Internet services and consumer e-commerce. In addition, Wave de-emphasized the marketing of its proprietary EMBASSY Trust System platform in 2003 other than to the government security sector. While Wave adjusted its emphasis to focus on the emerging TCG services market segment toward the end of 2002 and into 2003, it drastically reduced several areas within the selling, general and administrative category including product management, sales and marketing, business development and support areas including accounting, human resources, information systems and other corporate overhead, that had supported the higher level of business activity that has now been reduced. The expense reductions being referred to herein came mostly in the form of headcount and outside services expenditure reductions. Now that Wave has begun selling its suite of software applications into the market and has identified and begun developing the next generation of these products that will include key management and infrastructure services, we’ve begun rebuilding our sales force, expanding our distribution channels and implementing a global sales and marketing strategy.
27
Although we’ve reduced our expenditures significantly, given the early stage nature of the markets for products that use our technology, we 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. The outlook over the short-term is for sales and marketing expenditures to remain relatively flat, compared with 2005, with research and development remaining at approximately the same level as 2005 as well. (See Liquidity and capital resources)
The following discussion related to the consolidated financial statements of Wave should be read in conjunction with the financial statements appearing in Item 8.
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 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.
28
“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, 2004, all of Wave’s marketable equity securities were classified as available-for-sale. Wave held no marketable securities as of December 31, 2005.
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, or in the absence of a detail program design, upon completion of a working model of the software as defined in SFAS No. 86. 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.
Revenue Recognition—Wave’s business model targets revenues from various sources including: licensing of EMBASSY Trust Suite, Wavexpress’ broadband media distribution and eTMS software products and development contracts. Many of our sales arrangements include multiple-elements, and/or require significant modification or customization of our software.
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
29
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, delivery has occurred, 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
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, for arrangements that contain multiple elements. Revenue is deferred for undelivered elements for these arrangements. 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 have been met for that element.
Prepaid royalty fees received pursuant to distribution software licenses with OEMs in which Wave earns a royalty, based upon units shipped by the OEM to end customers, are deferred when received, and recognized as revenue as units are shipped by the OEM.
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.
Comparison of the years ended December 31, 2005 and 2004
Results of Operations
Wave had revenues of $1,018,464 and $209,311 for the years ended December 31, 2005 and 2004, respectively, which were primarily derived from license contracts in both periods. The increase was the result of increased shipments of Wave’s OEM customers’ products that include Wave software, for which Wave is paid royalties.
The table below sets forth the components that make up the revenue for the years ended December 31, 2005 and 2004:
|
| 2005 |
| 2004 |
| Increase/ |
| Change |
| |||||
Licensing |
| 974,058 |
| 183,318 |
| 790,740 |
|
| 431 | % |
| |||
Services |
| 44,406 |
| 18,833 |
| 25,573 |
|
| 136 | % |
| |||
Hardware Products |
| — |
| 7,160 |
| $ | (7,160 | ) |
| (100 | )% |
| ||
Total Net Revenues |
| $ | 1,018,464 |
| $ | 209,311 |
| $ | 809,153 |
|
| 387 | % |
|
30
Cost of sales for the year ended December 31, 2005, was $726,853 compared with $151,704 for the same period in 2004. The increase in costs of sales was due primarily to additional amortization of capitalized software associated with products licensed during the year ended December 31, 2005 versus the prior year. In addition, service and licensing costs increased resulting from the increase in revenues for these line items.
SG&A expenses on a consolidated basis for the year ended December 31, 2005 were $11,560,039, as compared to $12,255,427 for the comparable period of 2004, a decrease of approximately 6%. The decrease was due in large part to decreases in salary and benefit costs totaling approximately $363,000 on a consolidated basis, associated with headcount reductions of four S&GA positions at Wavexpress which were made in the fourth quarter of 2004. In addition, depreciation and amortization expense was lower by approximately $637,000, because amortization that was previously included in SG&A for the year ended December 31, 2004, related to revenue and was therefore included in cost of sales for the year ended December 31, 2005. These expense decreases were offset by increases in travel & entertainment expenses of $107,200 at Wave; due to increased international sales and marketing activities; and increases in bonuses and commissions of $167,200 in connection with the higher sales volume for the year ended December 31, 2004 versus the prior year. Included in the consolidated SG&A expense totals listed above are Wavexpress’ SG&A expenses, which were $1,096,335 and $1,789,997 for the years ended December 31, 2005 and 2004, respectively. This 39% decrease was due primarily to decreased salary, benefit, travel and other employee-related expenses which accounted for approximately $481,000 of the decrease in the consolidated salary and benefit expenses referred to above. In addition, Wavexpress’ facility, broadband and telecommunications expenses were reduced by approximately $50,000, consultant and professional fees were reduced by approximately $33,000, depreciation expenses decreased by approximately $43,000, and general office and supplies expenses were reduced by $35,000.
The activities supported by Wave’s SG&A expenditures include business development, sales, marketing (including product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions. 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 products and markets for our technology. We expect SG&A expenses to remain approximately at the same level as the year December 31, 2005 for the foreseeable future, although actual expenditures may vary depending upon the future business needs of Wave.
R&D expenses for the year ended December 31, 2005 were $6,937,618, as compared to $6,852,754, for year ended December 31, 2004, an increase of 1%. This change was primarily attributable to increased salary, fringe and benefit expenditures of approximately $311,000 at Wave where R&D headcount was greater by an average of three positions in the year ended December 31, 2005 versus 2004. In addition, outside consulting and development expenses increased by approximately $291,000 at Wave as Wave increased the use of outsourced engineering services primarily in connection with its eTMS products and services. Wavexpress’ total R&D expenditures included in the above consolidated R&D expenses were $1,127,004 and $1,657,376, for the year ended December 31, 2005 and 2004, respectively, for a decrease of approximately 32% This decrease related primarily to salary and fringe benefit cost reductions of approximately $475,000 due to a reduction in headcount of six positions on average, for the year ended December 31, 2005 versus the prior year.
In the year ended December 31, 2004, Wave took a charge of $301,366 to write-off developed software that had been capitalized. The software that was written off was developed for a distribution agreement that was entered into with NSC, whereby NSC was to distribute it with its trusted platform model chip. The write-off was the result of the termination of the agreement and because the version of the software that was written off was discontinued and superseded by a new version. Consequently, the
31
value of the software became impaired because it had no alternative uses. No such impairment charges were incurred in the year ended December 31, 2005. Wave continues to maintain a license agreement with NSC’s successor, Winbond, whereby Wave is paid royalties based on Wave intellectual property that is included in Winbond’s chip design.
Other Income and Expenses
Interest income for the years ended December 31, 2005 was $70,779 as compared to $24,931, for the comparable period of 2004. The increase in interest income is primarily attributable to an increase in interest rates earned on Wave’s money market accounts for the year ended December 31, 2005 compared with the same period in 2004.
Wave sold the remaining 259,670 shares of its holdings of Saflink common stock during the year ended December 31, 2005 for total proceeds of $336,309, recording a realized gain of $80,971 on the sales. Wave sold 2,507,300 shares of its holdings of SSP Solutions, Inc., common stock and 966,300 shares of Saflink common stock during the year ended December 31, 2004, for total proceeds of $6,759,751, recording a realized gain of $4,330,248 on the sales. (In August 2004, SSP Solutions, Inc. merged with and became a wholly-owned subsidiary of Saflink Corporation.)
For the year ended December 31, 2005, Wave recorded a gain, representing the decrease in the value of the liability for outstanding warrants containing net cash settlement features, of $490,334, versus a gain of $498,723 for the twelve-month period ended December 31, 2004. These warrants were granted in connection with a private placement of Wave’s Class A Common Stock completed on November 18, 2003. The liability, calculated using the Black-Scholes option pricing model, was valued at $493,128 as of December 31, 2004, and $2,794 as of December 31, 2005. The decrease was primarily the result of the decrease in the quoted closing price on the Nasdaq National Exchange of Wave’s Class A Common Stock from December 31, 2004 to December 31, 2005. Because the price of Wave’s Class A Common Stock declined, the fair value of the warrant liability decreased as well, resulting in the gain.
Due to the reasons set forth above, our net loss to common stockholders for the year December 31, 2005 was $17,562,462 as compared to $14,498,038, for the comparable period of 2004.
Comparison of the years ended December 31, 2004 and 2003
Results of Operations
For the year December 31, 2004 and December 31, 2003, revenues were $209,311 and $189,363, respectively. The increase in revenue is attributable to increases in product, and licensing revenue offset by a decrease in service revenues, as set forth in the following table:
|
| 2004 |
| 2003 |
| Increase/ |
| % Change |
| |||||||
Licensing |
| $ | 183,318 |
| $ | 120,670 |
|
| $ | 62,648 |
|
|
| 51.9 | % |
|
Services |
| 18,833 |
| 65,343 |
|
| (46,510 | ) |
|
| (71.2 | )% |
| |||
Hardware products |
| 7,160 |
| 3,350 |
|
| 3,810 |
|
|
| 113.7 | % |
| |||
Total Net Revenues |
| $ | 209,311 |
| $ | 189,363 |
|
| $ | 19,948 |
|
|
| 10.5 | % |
|
Cost of sales for the year ended December 31, 2004 was $151,704 compared with $55,179 same period in 2003.Gross profit was $57,607 representing a gross profit margin of 28% for the year ended December 31, 2004 while $134,184 represented a gross profit margin of 71% for the year ended December 31, 2003. The decrease in gross profit margin was the result of the higher margins on service contracts in 2003 versus 2004, and higher costs of license revenues in 2004 versus 2003 resulting from the amortization expense of capitalized software costs.
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SG&A expenses for the year December 31, 2004 were $12,255,427 as compared to $12,698,682 for the comparable period of 2003. The 3% decrease in selling, general and administrative expenses was attributable primarily to headcount reductions at both Wave and Wavexpress. Wavexpress incurred SG&A expenses of $1,789,997 in 2004, compared to $2,014,828 for 2003, for a decrease of 11%. The reasons set forth above encompass Wavexpress, as well as Wave as a whole.
Research and development expenses for the year ended December 31, 2004 were $6,852,754 as compared to $7,384,708 for the comparable period of 2003. This 7% decrease in research and development expenses was primarily attributable to headcount reductions of employees and consultants, which decreased expenses by a total of $640,928 including salary and consultant compensation. Wavexpress’ research and development expenses were $1,657,376 for the year ended December 31, 2004 versus $1,873,463, for a reduction of 12%. The amounts set forth for Wavexpress are included in the consolidated amounts referred to above. Also, the reasons for the reduction in expenditures set forth above pertain to both Wave as a whole and Wavexpress.
For the year ended December 31, 2004, Wave took a charge of $301,366 to write-off developed software that had been capitalized. The software that was written off was developed for a distribution agreement that was entered into with NSC, whereby NSC was to distribute it with their trusted platform module chip. The write-off was the result of the termination of the agreement and because the version of the software that was written off has been discontinued and superseded by a new version. Consequently, the value of the software became impaired because it had no alternative uses. No such impairment charges were incurred in the year ended December 31, 2003. Wave continues to maintain a license agreement with NSC, whereby Wave is paid royalties based on Wave technology that is included in NSC’s chip design.
For the year ended December 31, 2003, Wave recorded a write down of approximately $1,114,000, representing the value of its EMBASSY 2100 chips held in inventory. This charge was taken because of the amount of time that continued to elapse without any substantial sales of this inventory coupled with the emergence within the trusted computing market towards TCG-compliant chips that have less functionality than the EMBASSY 2100 chips, but for which the marketplace is more readily accepting at this stage in the development of the trusted computing market.
Other Income and Expenses
Interest income for the year ended December 31, 2004 was $24,931 versus December 31, 2003 of $74,822 for a decrease of 67%. The decrease in interest income is primarily attributable to interest income having been recognized on the officer loan recovery referred to below for the year ended Deceember 31, 2003, and from a decrease in interest-bearing assets during 2004
Wave sold 2,507,300 shares of its holdings of SSP Solutions, Inc., common stock and 966,300 shares of Saflink Corporation common stock during the year ended December 31, 2004, for total proceeds of $6,759,751, recording a realized gain of $4,330,248 on the sales. In August, 2004, SSP Solutions, Inc. merged with and became a wholly-owned subsidiary of Saflink Corporation. For the year ended December 31, 2003, Wave sold 332,500 shares of SSP for proceeds of $430,934, realizing an aggregate gain from the sales of $234,759.
During the fourth quarter of 2003, Wave incurred $155,716 in liquidated damages in connection with the issuance of 3,725,263 shares of its Class A Common Stock at a price of $1.90 per share and warrants to purchase 931,309 shares of Class A Common Stock at an exercise price of $2.62 per share in a private placement to a group of accredited investors for proceeds of approximately $6,562,000, net of issuance costs of approximately $516,000. The shares were issued pursuant to a securities purchase agreement dated November 18, 2003 between Wave and certain purchasers. Pursuant to a related registration rights agreement, if Wave did not file a registration statement for the shares within 30 days from the date of the closing of the securities purchase agreement, Wave would be required to pay liquidated damages to each
33
purchaser equal to 2% of each purchaser’s subscription amount, for each month elapsed beyond the 30 day deadline. Because Wave was not able to file the registration statement until one month and three days after the 30 day deadline, Wave incurred an aggregate of $155,716 in liquidated damages in the fourth quarter of 2003. No such charges were incurred in 2004.
For the year ended December 31, 2004, Wave recorded income of $498,723 representing the decrease in the value of the liability for outstanding warrants containing net cash settlement features. These warrants were granted in connection with a private placement of Class A Common Stock completed on November 18, 2003. The liability, calculated using the Black Scholes option pricing model, was valued at $991,851 as December 31, 2003, versus $493,128 as of December 31, 2004. The decrease was the result of the decrease in the quoted closing price on the Nasdaq National Exchange of Wave’s Class A Common Stock from December 31, 2003 to December 31, 2004. Because the price of Wave’s Class A Common Stock declined, the fair value of the warrants declined as well resulting in the gain. A gain of $263,097 was recognized for the year ended December 31, 2003 due to the decrease in the fair market value of the warrant from the inception of the warrant through December 31, 2003.
Wave reversed the reserve previously established with respect to notes receivable from Peter J. Sprague, Wave’s former Chairman of the Board, of $999,518 during the year ended December 31, 2003, because the notes were collected in the third quarter of 2003. These loans were previously reserved for during the fourth quarter of 2002, because at the time there was substantial doubt about the ability of the borrower to repay these loans. In the third quarter of 2003, Mr. Sprague sold 500,000 shares of Wave Class A Common Stock, and was therefore able to repay the loans and all accrued interest thereon with the proceeds from such sales of Wave’s Class A Common Stock. Mr. Sprague resigned as Chairman of the Board of Wave as of March 31, 2003. Mr. Sprague was subsequently appointed Chairman of the Board and Chief Executive Officer of Wavexpress. No such charges were incurred in 2004. Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a written policy prohibiting future loans to officers and directors.
For the year ended December 31, 2003, Wave received other income of $52,370, primarily from the settlement of a dispute with a former vendor. No such other income was received for the year ended December 31, 2004
For the year ended December 31, 2003, Wave recorded accrued dividends on its Series H Stock in the amount of $212,518 plus accretion of discount on such preferred stock of $5,485,000 for total dividends on preferred stock of $5,697,518. There was no preferred stock outstanding in 2004, therefore, no preferred stock dividend expense was recorded in 2004. (See Note 8 to the Financial Statements).
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Liquidity and capital resources
We have experienced net losses and negative cash flow from operations since our inception and, as of December 31, 2005, had a deficit accumulated during the development stage of $284,746,826. Total stockholders’ equity as of December 31, 2005 was negative $165,809. We have financed our operations since inception principally through the issuance of Class A and B Common Stock and various series of preferred stock, for total proceeds since inception of approximately $246,281,191.
Sources and Uses of Cash
At December 31, 2005, we had $2,006,022 in cash and cash equivalents versus $5,805,912 as of December 31, 2004, resulting in a net decrease in cash of $3,799,890 for the year ended December 31, 2005. The table below shows the year-to-year comparison of the significant elements of cash used in operating, investing and financing activities and a reconciliation of each year’s operating results reported in the statement of operations to the total decrease in cash in each of the three years ended December 31, 2005.
As shown below, the total net decrease in cash over the last three years has changed significantly from a net cash decrease for the year ended December 31, 2003 of $1,402,819 to a net cash decrease for the year ended December 31, 2004 of $3,012,393 to a net cash decrease for the year ended December 31, 2005 of $3,799,890.
35
Consolidated Statement of Cash Flow Data
|
| For the years ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
Cash used in operating activities: |
|
|
|
|
|
|
| |||
Net loss |
| $ | (17,562,462 | ) | $ | (14,498,038 | ) | $ | (19,594,798 | ) |
(Recovery of) provision for note receivable from officers |
| — |
| — |
| (999,518 | ) | |||
Realized gain from the sale of marketable securities |
| (80,971 | ) | (4,330,248 | ) | (234,759 | ) | |||
Gain on decrease in value of warrant liability |
| (490,334 | ) | (498,723 | ) | (263,097 | ) | |||
Write off intangible and other assets that became impaired |
| — |
| 301,366 |
| — |
| |||
Inventory provision |
| — |
| — |
| 1,114,442 |
| |||
Depreciation and amortization |
| 841,729 |
| 854,629 |
| 1,241,035 |
| |||
Compensation paid in the form of stock options & warrants |
| 7,294 |
| 80,609 |
| 189,565 |
| |||
Total adjustments to reconcile net loss to cash used in operating activities |
| 277,718 |
| (3,592,367 | ) | 1,047,668 |
| |||
Proceeds from liquidation of other assets |
| 23,935 |
| 93,570 |
| 50,688 |
| |||
(Increase) decrease in prepaid expenses and receivables |
| (201,788 | ) | (67,085 | ) | 368,844 |
| |||
(Reduction) increase in deferred revenue |
| 152,440 |
| 276,968 |
| 74,222 |
| |||
(Reduction) increase in accounts payable and accrued expenses |
| 189,086 |
| 63,540 |
| (567,853 | ) | |||
Changes in assets & liabilities |
| 163,673 |
| 366,993 |
| (74,099 | ) | |||
Other accrual to cash adjustments, net |
| — |
| (31,480 | ) | 144,793 |
| |||
Cash used in operating activities |
| (17,121,071 | ) | (17,754,892 | ) | (18,476,436 | ) | |||
Cash flows from investing activities: |
|
|
|
|
|
|
| |||
Disbursements for capital expenditures |
| (160,829 | ) | (304,172 | ) | (985,146 | ) | |||
Proceeds provided by sales of marketable equity securities |
| 336,309 |
| 6,759,751 |
| 430,934 |
| |||
Net cash provided by (used in) investing activities |
| 175,480 |
| 6,455,579 |
| (554,212 | ) | |||
Cash flows from financing activities: |
|
|
|
|
|
|
| |||
Proceeds from sale of common stock |
| 10,622,054 |
| 8,252,625 |
| 6,562,180 |
| |||
Proceeds from sale and conversion of preferred stock |
| — |
| — |
| 4,780,540 |
| |||
Proceeds from exercise of employee stock options |
| 354,047 |
| 34,295 |
| 2,868,916 |
| |||
Proceeds from the exercise of warrants |
| 2,169,600 |
| — |
| 2,493,390 |
| |||
Total proceeds from issuance of newly issued equity |
| 13,145,701 |
| 8,286,920 |
| 16,705,026 |
| |||
Proceeds from repayment of officer notes receivable |
| — |
| — |
| 1,135,320 |
| |||
Payment of dividends on preferred stock |
| — |
| — |
| (212,517 | ) | |||
Total cash provided by financing activities |
| 13,145,701 |
| 8,286,920 |
| 17,627,829 |
| |||
Net decrease in cash |
| $ | (3,799,890 | ) | $ | (3,012,393 | ) | $ | (1,402,819 | ) |
Cash used in operations
The amount of cash used in operations decreased to $17,121,071 for the year ended December 31, 2005 from $17,754,892 used for the year ended December 31, 2004, which decreased from $18,476,436 used for the year ended December 31, 2003. As shown above, the decreases in cash used in operations were the result of the changes in the Net Losses in each of the three years ended December 31, 2005, as discussed in detail in the previous Results of Operations section, adjusted for non-cash items of the net losses such as book realized gains on sales of marketable securities and changes to assets and liabilities for
36
net cash outlays and/or receipts which under generally accepted accounting principles, are not reported in the Statement of Operations.
Adjustments to reconcile net loss to cash used in operating activities
These amounts represent items reported in Wave’s Consolidated Statement of Operations, that do not represent an outlay or receipt of cash in the year that they are reported, under generally accepted accounting principals. These items in the aggregate make up a significant portion of the differences between the reductions in Wave’s reported Net Loss year over year, versus the differences in the amount of cash used by Wave’s operations over each of the periods. These items resulted in a net add-back to net loss of $277,718 for the year ended December 31, 2005 versus a net subtraction of $3,592,367 for the year ended December 31, 2004 compared with a net add-back of $1,047,668 for the year ended December 31, 2003. The individual items that make up these adjustments are listed in the table above and described in greater detail in the Results of Operations and Other Income and Expense sections above. In addition, changes in asset and liability accounts, as shown above, represent additional sources or uses of cash in each of the three years. Accordingly, while the overall net loss increased by $3,064,424 (to $17,562,462 from $14,498,038 ) for the year ended December 31, 2005 versus the year ended December 31, 2004, cash used in operating activities decreased by $633,821 (to $17,121,071 from $17,754,892.) This was due in large part to the gain realized on the sales of available-for-sale securities of $80,971 in 2005 versus $4,330,248 in 2004. The gains are subtracted from the reported net loss to arrive at cash used by operating activities because sales of marketable securities are an investing activity, therefore the gross proceeds from these sales are shown in Cash Flows from Investing Activities. In comparing the year ended December 31, 2004 to 2003, while the overall Net Loss decreased by $5,096,760 (to $14,498,038 from $19,594,798) for the year ended December 31, 2004 versus the year ended December 31, 2003, cash used in operating activities decreased by the lesser amount of $730,544 (to $17,745,892 from $18,476,436.) This difference was in large part due to the gain realized on the sales of available-for-sale securities of $4,330,248 in 2004 versus $234,759 in 2003 coupled with the differences between the other adjustments listed above.
Cash Flows from investing activities
As displayed in the table above, cash used in investing activities consisted of funds used to acquire and develop capital assets totaling $160,829, $304,172 and $985,146 for the years ended December 31, 2005, 2004 and 2003, respectively. Such amounts included the cost of internally developed capitalized software in the amount of $0, $73,000, and $580,543 for each of the three years ended December 31, 2005, 2004 and 2003, respectively. Wave expects to continue to acquire fixed assets primarily to replace computer equipment to be used internally. These expenditures are expected to continue at approximately the same level as the 2005 expenditures.
During the year ended December 31, 2005, Wave sold 259,670 shares of Saflink, in a series of separate sales, for total proceeds of $336,309. For the year ended December 31, 2004, Wave sold 2,507,300 shares of the common stock of SSP and 966,330 shares of Saflink for total proceeds of $6,759,751. For the year ended December 31, 2003, Wave sold 332,500 shares of SSP common stock for proceeds of $430,934. Wave holds no shares of Saflink as of December 31, 2005.
Net cash generated from investing activities decreased by $6,280,099 for the year ended December 31, 2005 versus the year ended December 31, 2004 and increased by $7,009,791 for the year ended December 31, 2004 versus the year ended December 31, 2003. The cash generated from the sale of marketable securities was a much more significant source of cash for Wave in 2004, versus the years ended December 31 2005 and 2003, which made up for much of the differences described herein, combined with lower capital expenditures in each of the two years ended December 31, 2005 and 2004 versus 2003.
37
Cash Flows from financing activities
Because Wave did not have sufficient cash on hand, nor did it generate sufficient revenues to fund the amount of cash used for operations and acquisition and development of capital assets for the years ended December 31, 2005 and 2004, we needed to finance much of our operations through the sale of newly issued common stock as described below. In addition, during 2003, Wave received funds from the repayment of notes receivable with an officer and a former officer of Wave that totaled $1,135,320, including $281,000 that was repaid with the proceeds of a bonus that was awarded to the officer to repay his loan.
Proceeds from Issuance of Newly Issued Equity Securities
Sales of Common Stock
On December 5, 2005, Wave sold and issued 5,982,906 shares of Class A Common Stock for $0.585 per share, for gross proceeds of $3,500,000, for which it received net proceeds of $3,340,890 after paying underwriter and other fees, which totaled $159,110. The purchasers were also issued warrants to purchase 1,093,750 shares of Common Shares within six months at an exercise price of $0.80 per share. If exercised in their entirety, the warrants would generate an additional $875,000 in gross proceeds to Wave.
On August 5, 2005, Wave sold and issued 4,000,000 shares of Class A Common Stock for $0.90 per share, for gross proceeds of $3,600,000, for which it received net proceeds of $3,389,205 after paying underwriter and other fees, which totaled $210,795.
On March 15, 2005, Wave sold 4,659,090 shares of Class A Common Stock for $0.88 per share, for gross proceeds of $4,100,000, for which it received $3,891,959, after paying underwriter and other fees.
On December 16, 2004, Wave sold and issued 5,484,790 shares of Class A Common Stock for an aggregate purchase price of $5,759,030. The Common Shares were priced at $1.05. Wave realized net proceeds of $5,474,728 after deducting placement agent and other fees associated with the issuance of these securities.
On July 30, 2004, Wave entered sold and issued 3,529,412 shares of Class A Common Stock for an aggregate purchase price of $3,000,000. The shares of Class A Common Stock were priced at $0.85. Wave realized net proceeds of $2,777,897 after deducting placement agent and other fees associated with the issuance of these securities. In addition, a total of 3,529,412 shares were offered in connection with this sale and issuance of these shares, in the form of an additional investment right with an exercise price of $1.00 per share and warrants for 4,411,765 shares at exercise prices currently ranging from $1.1428 to $1.2820 per share. The additional investment right expired on November 2, 2004. The warrants are exercisable during the period January 30, 2005 through January 30, 2006.
All shares issued in connection with the above described sales of common stock were drawn-down off of a shelf registration statement which was filed by Wave on April 15, 2004 and declared effective by the Securities and Exchange Commission (the “SEC”) on May 10, 2004.
On November 18, 2003, Wave issued 3,725,263 shares of its Class A Common Stock at a price of $1.90 per share and granted warrants to purchase 931,309 shares of Class A Common Stock at a an exercise price of $2.62 per share in a private placement to a group of accredited investors for proceeds of approximately $6,562,000, net of issuance costs of approximately $516,000. The warrants have a three (3) year term. In addition, in connection with the transaction, Wave incurred commissions of $218,000 for the fair market value of warrants granted to placement agents to purchase approximately 161,595 shares of Wave’s Class A Common Stock. The warrants granted to the placement agents are also exercisable at a price of $2.62 per share and have a three- (3) year life as well. If exercised in full, the warrants granted in connection with this financing will generate up to an additional $2,864,000, at the exercise price. Pursuant to a registration
38
rights agreement entered into with the accredited investors for the sales of these shares, Wave agreed to file a registration statement with the Securities and Exchange Commission covering the resale of the Class A Common Shares sold and those underlying the warrants, and bear all expenses therefrom. Wave filed the registration statement on Form S-3 covering the resale of the shares on January 20, 2004. On February 12, 2004 the registration statement was declared effective by the Commission.
Series H Preferred Stock and Warrant
On April 30, 2003, Wave completed a private placement of 548.5 shares of its Series H Convertible Preferred Stock (the “Series H Stock”) and warrants to purchase Wave’s Class A Common Stock for an aggregate purchase price of $5,485,000, with a group of institutional and accredited investors. Wave realized aggregate proceeds of $4,780,540 net of commissions and other cash fees of $704,460, in connection with the transaction. In addition, Wave incurred commissions of $315,969 for the fair market value of warrants granted to placement agents to purchase 322,270 shares of Wave’s Class A Common Stock at $0.01. All of the warrants granted to the placement agents have been exercised as of December 31, 2003 for proceeds of $3,223. As of December 31, 2003 all 548.5 shares of Series H Stock were converted at a conversion price of $0.76 into 7,217,105 shares of Class A Common Stock.
The Series H Warrants were initially exercisable for a total of 3,608,556 shares of Class A Common Stock on the trading day following the date of Wave’s 2003 annual meeting of stockholders, had an initial exercise price of $1.13 per share and a five-(5) year life. During September 2003 the terms of the Series H Purchase Agreement and other documents governing the Series H Stock and the Series H Warrants were modified, pursuant to a letter agreement and waiver (collectively the “Waiver”) whereby, each holder that executed the Waiver was required to convert their Series H Stock on the effective date of the Waiver and agreed to allow Wave to reduce their Series H Warrant shares by the holders’ proportion of a 900,000 reduction in the total number of Series H Warrant shares. Also, pursuant to the Waiver, the exercise price of the Series H Warrants was reduced from $1.13 to $1.00 for the holders that signed the Waiver. Dividends on the Series H Stock accrued on the initial liquidation preference amount of each share ($10,000) at an annual rate of 10%, and would have increased to 12% on April 30, 2004. Dividends were payable out of any assets legally available to pay dividends when and if declared by the board of Directors of Wave, upon liquidation of the Series H Stock or upon conversion of the Series H Stock. Dividends paid for the year ended December 31, 2003 totaled $212,517.
Exercise of Warrants to Purchase Class A Common Stock
On August 1, 2005, Wave received gross proceeds of $2,260,000 less placement agent fees of $90,400 for net proceeds of $2,169,600, for the issuance of 2,000,000 shares of Class A Common Stock upon partial exercise of a warrant that was granted to an accredited investor as part of a securities purchase agreement with the accredited investor, dated July 30, 2004. The warrants were exercised at a price of $1.13 per share.
During 2003, 2,632,311 shares of Class A Common Stock were issued in connection with the exercise of Series H Warrants for net proceeds of $2,490,167. Series H Warrants to acquire 65,789 shares of Class A Common Stock remain outstanding as of March 1, 2004.
Exercise of employee stock options
On November 1, 2005 Wave issued 238,666 shares of Class A Common Stock to Wave and Wavexpress employees for $0.68 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $162,293, from the sale of these shares.
On June 1, 2005 Wave issued 253,475 shares of Class A Common Stock to Wave and Wavexpress employees for $0.765 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $191,754, from the sale of these shares.
39
During 2004, employees exercised stock options resulting in the issuance of 35,309 shares of Wave Class A Common Stock for proceeds of $34,295, at an average price of $0.97 per share.
During 2003, employees exercised stock options resulting in the issuance of 1,340,739 shares of Wave Class A Common Stock for proceeds of $2,868,916, at an average price per share of $2.14 per share.
Proceeds from repayment of officer notes receivable
Prior to the enactment of the Sarbanes-Oxley Act of 2002, Wave had made loans to certain of its officers. Some of the loans were extended beyond their original terms by one year. These loans and the 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 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. All loans to officers were paid in full as of December 31, 2003. Wave received proceeds of $1,135,320 from the repayment of these loans.
Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a written policy prohibiting future loans to officers and directors.
Summary analysis of historical cash flows and future outlook
It is evident from the table above that Wave’s use of cash to fund operations has fluctuated significantly over the three-year period presented. The detailed discussion of this trend is presented in the analysis of the results of operations above. In addition, Wave needed to raise a significant amount of additional funds primarily from issuing new shares of common stock as detailed in the above discussion of cash flows from financing activities.
Liquidity Requirements and Future Sources of Capital
Wave estimates that its total expenditures to fund operations for the year ending December 31, 2006 will be approximately $19,100,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.
Expected sources of capital include the following:
· cash on hand of $2,006,022 as of December 31, 2005
· gross margin contribution from sales and licensing of products
· additional financings including the sale on February 16, 2006 of 8,348,598 shares of common stock for gross proceeds of $4,466,500 for which we received approximately $4,247,000 after subtracting underwriter and other fees. In addition, in connection with this sale of common stock we granted warrants to purchase up to 1,550,868 shares of common stock at an exercise price of $0.72 per share which will yield approximately $1,072,000 in net proceeds if exercised in full.
Given Wave’s capital requirements for the year ending December 31, 2006 as indicated above, and our cash balance as of December 31, 2005, Wave will be required to raise additional capital to continue to fund its operations.
40
We plan to obtain additional funding from further sales of newly issued shares of Class A Common Stock including the sale of Class A Common Stock under the remaining availability of two $25,000,000 shelf registration statements; one that we filed on April 15, 2004 that the Securities and Exchange Commission declared effective on May 10, 2004 and one that we filed on December 16, 2005 that the Securities and Exchange Commission declared effective on January 13, 2006. Since that time, we have completed several sales of Class A Common Stock under these registration statements, which are discussed above.
The remaining availability under this Shelf Registration, after subtracting the $26,685,530 in gross proceeds from the financings referred to above (including the February 16, 2006 financing), is approximately $23,314,470, of which $1,991,625 is reserved for the unexercised warrants which expire June 3, 2006 through August 15, 2006.
Revenue outlook
During 2003, Wave began licensing its EMBASSY Trust Suite software through bundling arrangements with OEMs with whom it signed contracts with during the year. In addition, Wave received revenues from software development and other services. Total cash received from all revenue sources in 2005 was approximately $961,000 versus approximately $335,000 for 2004.
In November of 2005, Wave signed a new OEM distribution agreement with Dell that permits Dell to distribute Wave software on certain Dell TPM-equipped business PCs. Wave will be paid a per unit royalty fee for each Dell product shipment which includes Wave’s software. In addition, pursuant to this same agreement, it is expected that Dell will offer an upgrade package of Wave’s software that purchasers of certain models of TPM-equipped computers may buy. Wave will be paid a license fee, for each copy of the upgrade package that is purchased. We are working with Dell to market our products, in an effort to drive volume of purchases of the upgrade package. However, we have no reliable basis to predict how many upgrade packages will be purchased, and what the resultant revenue to Wave might be from this program. There are no minimum royalty or shipped quantity requirements.
In January of 2006, Wave signed a distribution agreement with Gateway, that permits Gateway to distribute Wave software on Gateway TPM-equipped models. Wave will be paid a per unit royalty fee for each Gateway shipment which includes Wave’s software. In addition, pursuant to this same agreement, it is expected that Gateway will offer an upgrade package of Wave’s software that purchasers of certain models of TPM-equipped computers may buy. Wave will be paid a license fee, for each copy of the upgrade package that is purchased. We are working with Gateway to market our products, in an effort to drive volume of purchases of the upgrade package. However, we have no reliable basis to predict how many upgrade packages will be purchased, and what the resultant revenue to Wave might be from this program. There are no minimum royalty or shipped quantity requirements.
Wave also continues to work with all of its partners and customers to introduce and promote its existing software products and new software products which are under development, in an effort to expand the market for TPM-based secure computing and thereby increase its market share and revenues. However, it should be noted that because of the early stage of Wave’s market and other factors, a high level of uncertainty exists with respect to the ability to forecast future revenues. Although there has been a substantial increase in the volume of shipments of TPM chips, TPM hardware security that meets the TCG industry standard, which our business model depends upon, is still a new, developing category within the computer security market, the ultimate size of this market and the timeframe for its development are unknown and difficult to predict.
We believe the recent distribution agreements that were signed with Dell and Gateway should generate royalty revenue beginning in the second quarter of 2006. The aggregate amount of royalty revenue from these arrangements for 2006 may be material. We expect to begin to receive any payments of these additional royalties in the third quarter of 2006.
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Wave will also continue to pursue hardware sales and licensing of its proprietary EMBASSY Trust System, primarily in government-related security markets.
As stated previously, Wavexpress currently has two active contracts with customers for its broadband media distribution services. Under these contracts Wavexpress shares subscription and/or advertising revenue generated by the client’s website in addition to bandwidth fees. Given that this is a new type of service, it is difficult to predict the subscription levels and therefore the revenue that will be generated from these contracts. In addition, Wavexpress has a number of additional customer prospects with whom it may close business in 2006; however, it is also difficult to predict the number of contracts that it will enter into during the year.
Known Trends and Uncertainties affecting future cash flows
Because Wave does not have sufficient cash to fund operations for the year ending December 31, 2006; and given the uncertainties described above with respect to Wave’s revenue outlook for 2006, Wave has been and will continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending December 31, 2006. These activities include the filing of a second $25,000,000 S-3 shelf registration with the SEC on December 16, 2005 which was declared effective on January 13, 2006; and the closing of an initial round of financing under this shelf registration on February 16, 2006, upon which we received approximately $4,247,000 in net proceeds, for the sale of 8,348,598 shares of common stock at $0.535 per share. It is likely that we will be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional capital to continue to fund our operations for the year ending December 31, 2006. The availability and amount of any such financings are unknown at this time. Wave may also be required to reduce expenses which may significantly impede its ability to meet its sales, marketing and development objectives. Given the available cash currently on hand and our expenditure forecast for the year ending December 31, 2006, we estimate that we will need to generate at least $12,000,000, over and above the $4,247,000 that we received from the February 16, 2006 sale of common stock, from a combination of revenue growth and additional financing activities, in order to continue as a going concern for the year ending December 31, 2006.
Other uncertainties that may impact the future business outlook
Uncertainty exists with respect to the legal matters that are currently pending including the formal SEC investigation and the class action securities and derivative shareholder lawsuits that have been commenced against Wave. There is uncertainty as to the amount of legal costs that Wave may incur in addressing these matters. In addition, the extent of any impact due to negative publicity or perceived negative publicity is unknown.
Because the information security services market and the TCG hardware security category in particular are in early stages of development, customer requirements may change or new competitive pressures can emerge which could require a shift in product development and/or market strategy. Should such shifts occur, it may require development, marketing and sales strategies to re-start or expand, which would likely increase operating costs, requiring additional capital. Such shifts have occurred several times throughout Wave’s history, requiring significant changes in strategy and business plan.
Furthermore, the achievement of sufficient revenue is dependent upon continued significant expenditures, which will likely be required for research and development and sales and marketing to increase market awareness, beyond December 31, 2006, to increase market awareness. Therefore, if Wave is not able to begin to generate significant revenues by December 31, 2006 to cover its operating costs, it will need to generate capital from other sources, and the likelihood is Wave will need to raise funds through either issuing additional common stock, preferred stock and/or debt to fund its operations beyond December 31, 2006.
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Commitments
Wave has no significant long-term contractual obligations other than with respect to operating leases for its facilities, which are listed below:
|
| Within one |
| Years two and |
| Years four and |
| Total |
| ||||||||||
Operating leases commitments |
|
| $ | 766,430 |
|
|
| $ | 751,855 |
|
|
| $ | 171,623 |
|
| $ | 1,689,908 |
|
Net Operating and Capital Loss Carryforwards
As of December 31, 2005, Wave had available net operating and capital loss carryforwards for Federal income tax purposes of approximately $252 million, which expire beginning in 2006 through 2025. Because of the “change in ownership” provisions of the Tax Reform Act of 1986, our net operating and capital 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 have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred. However, in considering Section 382 of the Internal Revenue Code, 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 and, potentially, in periods following. As a result, all of the utilization of our net operating losses is likely to be subject to annual limitations.
Going Concern Opinion
Wave’s consolidated financial statements as of December 31, 2005 have been prepared under the assumption that we will continue as a going concern. Wave’s independent registered public accounting firm, KPMG LLP, have issued a report dated March 9, 2006, that includes an explanatory paragraph referring to our significant operating losses and substantial doubt of our ability to continue as a going concern. (See Note 2 to Wave’s consolidated financial statements.)
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued its final standard on accounting for share-based payments, Statement of Financial Accounting Standard No. 123(R)—Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires companies to expense the fair value of employee stock options and similar equity compensation, also known as share-based payment (“SBP”) awards. The statement applies to all outstanding and unvested SBP awards as of a company’s adoption date. The Securities and Exchange Commission delayed implementation of SFAS 123(R) to fiscal years beginning after June 15, 2005. Therefore, we implemented SFAS 123(R) effective January 1, 2006 using the modified prospective method, which requires the recognition of expense for SBP awards over their remaining vesting period. The portion of these SBPs’ fair value attributable to awards that vested prior to the adoption of SFAS 123(R) is never recognized under this method. We estimate that the impact of the adoption of SFAS 123(R), to Wave for the year ending December 31, 2006, will be an expense of approximately $1.4 million, or $0.01 to $0.02 per share. However, our assessment of the estimated compensation charges is dependent upon assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the volatility of our stock price, interest rates, the level and type of SBPs that Wave awards and employee stock option exercise behaviors. As such, our actual share-based compensation expense may differ from this estimated amount.
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Item 7A. Quantitative and Qualitative Disclosure about Market Risk
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.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
Our CEO and CFO have evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2005. Based on their evaluation, our CEO and CFO have concluded, as of the date of such evaluation, that our disclosure controls and procedures are effective.
Management’s Report on Internal Control Over Financial Reporting
Wave’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act. Wave’s internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Wave’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2005. In making its assessment, Wave’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control Integrated Framework”. Based on this assessment, Wave’s management concluded that, as of December 31, 2005, its internal control over financial reporting is effective based on those criteria. Wave’s Independent Registered Public Accounting Firm, KPMG LLP, has issued an attestation report on management’s assessment of Wave’s internal control over financial reporting, which is included following this report.
Dated: March 9, 2006
WAVE SYSTEMS CORP.
By: |
| /s/ STEVEN K. SPRAGUE |
| By: |
| /s/ GERARD T. FEENEY |
| ||||
|
| Name: |
| Steven K. Sprague |
|
|
| Name: |
| Gerard T. Feeney |
|
|
| Title: |
| President and Chief Executive Officer |
|
|
| Title: |
| Senior Vice President of Finance and Administration, Chief Financial Officer |
|
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Wave Systems Corp. and subsidiaries (a development stage corporation) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Wave Systems Corp. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also, in our opinion, Wave Systems Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission .
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We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Wave Systems Corp. and subsidiaries (a development stage corporation) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficiency) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005, and the period from February 12, 1988 (date of inception) to December 31, 2005 and our report dated March 9, 2006 expressed an unqualified opinion on those consolidated financial statements. Our report dated March 9, 2006 contains an explanatory paragraph that states that 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. The consolidated financial statements do not include any adjustments that might result from the outcome of that uncertainty.
KPMG LLP
Boston, Massachusetts
March 9, 2006
Changes in internal controls
There have been no changes in Wave’s internal controls over financial reporting that occurred during Wave’s fourth fiscal quarter that have materially affected, or are reasonably likely to affect, Wave’s internal control over financial reporting.
Not Applicable.
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Item 10. Directors and Executive Officers of the Registrant
Information concerning Wave’s directors and executive officers will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Election of Directors.” Such information is incorporated herein by reference.
Information concerning compliance with Section 16(a) of the Securities Exchange Act will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Compliance with Section 16(a) of the Exchange Act.” Such information is incorporated herein by reference.
Information concerning Wave’s Audit Committee will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “The Board of Directors and its Committees” Such information is incorporated herein by reference.
Wave’s Board of Directors has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer (the “Code of Ethics”). The Code of Ethics has been posted on Wave’s Internet website at www.wave.com. Wave intends to satisfy the disclosure requirements under Item 10 of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Ethics that relates to a substantive amendment or material departure from a provision of the Code of Ethics by posting such information on its internet website at www.wave.com.
Item 11. Executive Compensation
Information regarding executive compensation will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Executive Compensation.” Such information is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Security Ownership of Certain Beneficial Owners and Management.” Such information is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Certain Relationships and Related Transactions.” Such information is incorporated herein by reference.
Item 14. Principal Accountant’s Fees
Information regarding Wave’s principle accountant’s fees will appear in Wave’s Proxy Statement for the 2006 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2006, under the caption “Certain Relationships and Related Transactions.” Such information is incorporated herein by reference.
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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:
Exhibit No. |
| Description of Exhibit |
3.1* | — | Restated Certificate of Incorporation of Wave (incorporated by reference to Exhibit 3.1 of Wave’s Registration Statement on Form S-1, File No. 33-75286) |
3.2* | — | Bylaws of Wave (incorporated by reference to Exhibit 3.2 of Wave’s Registration Statement on Form S-1, File No. 33-75286) |
4.1* | — | Form of Stock Certificate of Class A Common Stock (incorporated by reference to Exhibit 4.1 of Wave’s Registration Statement on Form S-1, File No. 33-75286) |
4.2* | — | Form of Representative’s Warrant Agreement, including the form of Representative’s Warrant (incorporated by reference to Exhibit 4.2 of Wave’s Registration Statement on Form S-1, File No. 33-75286). |
4.3* | — | Certificate of Designation of Series B Preferred Stock of Wave as filed with the Delaware Secretary of State on May 24, 1996 (incorporated by reference to Exhibit 3.1 of Wave’s Current Report on Form 8-K, filed on June 6, 1996, File No. 0-24752) |
4.4* | — | Certificate of Designation of Series C Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave’s Current Report on Form 8-K, filed on January 8, 1997, File No. 0-24752) |
4.5* | — | Certificate of Designation of Series D Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave’s Current Report on Form 8-K, filed on June 3, 1997, File No. 0-24752) |
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4.6* | — | Certificate of Designation of Series F Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 9, 1997 (incorporated by reference to Exhibit 3.1 of Wave’s Current Report on Form 8-K, filed on October 15, 1997, File No. 0-24752) |
4.7* | — | Certificate of Designation of Series G Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on March 5, 1998 (incorporated by reference to Exhibit 3.1 of Wave’s Current Report on Form 8-K, filed on March 19, 1998, File No. 0-24752) |
4.8* | — | Certificate of Designation of Series H Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on April 30, 2003 (incorporated by reference to Exhibit 4.1 of Wave’s Current Report on Form 8-K, filed on May 5, 2003, File No. 0-24752) |
†10.1* | — | Wave Systems Corp. 2004 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 of Wave’s Form S-8 Registration Statement, filed on May 24,2005) |
10.2* | — | Securities Purchase Agreement dated as of December 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on December 7, 2005, File # 0-24752) |
10.3* | — | Securities Purchase Agreement dated as of August 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on August 8, 2005, File # 0-24752) |
10.4* | — | Securities Purchase Agreement dated as of March 15, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on March 17, 2005, File # 0-24752) |
†10.5* | — | Wave’s Amended and Restated 1994 Stock Option Plan (incorporated by reference to Wave’s Notice of Annual Meeting of Stockholders on Schedule 14A filed on April 29, 2004,) |
†10.6* | — | Wave Non-Employee Directors Stock Option Plan (incorporated by reference to Wave’s Notice of Annual Meeting of Stockholders on Schedule 14A filed on April 29, 2004) |
†10.7* | — | Wave 1996 Performance Stock Option Plan (incorporated by reference to Exhibit 10.12 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
10.8 | — | Reserved |
†10.9* | — | Employment Contract, dated June 8, 1998, between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 10.18 of Wave’s Annual Report on Form 10-K, filed on April 1, 1999, File No. 0-24752). |
†10.10* | — | Employment Contract, dated November 10, 1998, between Steven Sprague and Wave (incorporated by reference to Exhibit 10.19 of Wave’s Annual Report on Form 10-K, filed on April 1, 1999, File No. 0-24752). |
10.11* | — | Asset Purchase Agreement dated August 13, 2000, by and among Wave and Indigo Networks, LLC (incorporated by reference to Exhibit 99.1 of Wave’s Current Report on Form 8-K, filed on September 15, 2000, File #0-24752) |
10.12* | — | Office Building Lease dated October 20, 2002 between Stevens Creek Investors, LLC and Wave (incorporated by reference to Exhibit 10.13 of Wave’s Annual Report on Form 10-K, filed on March 31, 2003, File #0-24752) |
10.13* | — | Form of Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.15 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
10.14* | — | First Amendment to Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.16 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
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10.15* | — | Termination Agreement and Mutual Release between Wave Systems Corp. and SSP Solutions, Inc. date September 30, 2002 (Incorporated herein by referenced to Exhibit 10.1 of Wave’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752) |
10.16* | — | Subordinated Convertible Promissory Note between Wave Systems Corp. and SSP Solutions, Inc. dated September 30, 2002 (Incorporated herein by referenced to Exhibit 10.2 of Wave’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752) |
10.17* | — | Share Purchase Agreement between Redwave plc, GlobalWave Group plc and Wave Systems Corp. dated June 19, 2002 (Incorporated herein by referenced to Exhibit 10.3 of Wave’s Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752) |
10.18* | — | GlobalWave Group plc Notice of Extraordinary General Meeting dated June 20, 2002 (Incorporated herein by referenced to Exhibit 10.4 of Wave’s Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752) |
10.19* | — | Joint Venture Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.20 of Wave’s Annual Report on Form 10-K/A, filed on June 27, 2003, File #0-24752) |
10.20* | — | Stockholder Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.21 of Wave’s Annual Report on Form 10-K/A, filed on June 27, 2003, File #0-24752) |
10.21* | — | Securities Purchase Agreement dated as of July 30, 2004 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on August 3, 2004, File #0-24752) |
10.22* | — | Additional Investment Right to Purchase 3,529,412 Shares of Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.2 of Wave’s Current Report on Form 8-K, filed on August 3, 2004, File #0-24752) |
10.23* | — | Series A Common Stock Purchase Warrant to Purchase 3,529,412 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.3 of Wave’s Current Report on Form 8-K, filed on August 3, 2004, File #0-24752) |
10.24* | — | Series B Common Stock Purchase Warrant to Purchase 882,353 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.4 of Wave’s Current Report on Form 8-K, filed on August 3, 2004, File # 0-24752) |
10.25* | — | Placement Agency Agreement between Corpfin Inc. and Wave (incorporated by reference to Exhibit 10.5 of Wave’s Current Report on Form 8-K, filed on August 3, 2004, File # 0-24752) |
10.26* | — | Securities Purchase Agreement dated as of December 16, 2004 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on December 17, 2004, File # 0-24752) |
10.27* | — | Form of Addendum No. 1 to Authorized Distributor Agreement between Wave and Envoy Data Inc. dated December 14, 2004 |
10.28* | — | Securities Purchase Agreement dated as of February 15, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave’s Current Report on Form 8-K, filed on February 21, 2006, File # 0-24752) |
21.1* | — | Subsidiaries of Registrant (incorporated by reference to Exhibit 10.12 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
23.1 | — | Consent of Independent Registered Public Accounting Firm—KPMG LLP |
31.1 | — | Section 302 Certification by Steven K. Sprague, President and Chief Executive Officer |
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31.2 | — | Section 302 Certification by Gerard T. Feeney, Chief Financial Officer |
32.1 | — | Section 906 Certification |
99.1* | — | Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the “First Purchase Agreement”), by and among Wave and the purchasers of the Series H Convertible Preferred Stock (Incorporated by reference to Wave’s Form 8-K filed on May 5, 2003). |
99.2* | — | Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the “Second Purchase Agreement”), by and between Wave and an individual purchaser (Incorporated by reference to Wave’s Form 8-K filed on May 5, 2003). |
99.3* | — | Form of Registration Rights Agreement by and among Wave and the purchasers of the Series H Convertible Preferred Stock, dated as of April 30, 2003 (Incorporated by reference to Wave’s Form 8-K filed on May 5, 2003). |
99.4* | — | Form of Warrant issued by Wave pursuant to the First Purchase Agreement to each of the purchasers of the Series H Convertible Preferred Stock, dated as of April 30, 2003 (Incorporated by reference to Wave’s Form 8-K filed on May 5, 2003). |
99.5* | — | Form of Warrant issued by Wave pursuant to the Second Purchase Agreement to the individual purchaser, dated as of April 30, 2003 (Incorporated by reference to Wave’s Form 8-K filed on May 5, 2003). |
99.6* | — | Form of Warrant issued by Wave to the placement agent and sub-placement agents, dated as of April 30, 2003 (Incorporated by reference to Wave’s Form S-3 filed on May 14, 2003 (Registration No. 333-99469)). |
99.7* | — | Letter Amendment to First Purchase Agreement and Second Purchase Agreement effected on August 11, 2003 (Incorporated by reference to Wave’s Form 8-K filed on August 12, 2003). |
99.8* | — | Form of Letter Agreement to the Series H Convertible Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave’s Form 8-K filed on September 16, 2003). |
99.9* | — | Form of Waiver to the Series H Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave’s Form 8-K filed on September 16, 2003). |
99.10* | — | Securities Purchase Agreement, dated as of November 18, 2003, by and among Wave and purchasers of the Class A common stock. (Incorporated by reference to Wave’s registration statement filed on Form S-3/A filed on February 12, 2004. (Registration No. 333-112017.)) |
99.11* | — | Form of Warrant issued by Wave to each of the purchasers of the Class A Common Stock and the placement agents, dated as of November 18, 2003 with the schedule of holders attached thereto. (Incorporated by reference to Wave’s Form 8-K/A filed on February 13, 2004). |
99.12* | — | Registration Rights Agreement by and among Wave and the purchasers of the Class A Common Stock, dated as of November 18, 2003. (Incorporated by reference to Wave’s Form 8-K/A filed on February 13, 2004). |
99.13* | — | Demand Note, dated March 26, 2001 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.1 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
99.14* | — | Demand Note, dated February 27, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.2 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
51
99.15* | — | Demand Note, dated July 25, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.3 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
99.16* | — | Demand Note, dated September 5, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.4 of Wave’s Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752) |
99.17* | — | Allonge to Demand Promissory Note, dated March 26, 2002 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.6 of Wave’s Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752) |
99.18* | — | Allonge to Demand Promissory Note, dated February 27, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.7 of Wave’s Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752) |
99.19* | — | Allonge to Demand Promissory Note, dated July 25, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.8 of Wave’s Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752) |
* 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
52
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 16, 2006
WAVE SYSTEMS CORP. | ||
| By: | /s/ STEVEN K SPRAGUE |
|
| Name: Steven K. Sprague |
|
| Title: President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature |
|
| Title |
|
| Date |
| |
/s/ STEVEN K. SPRAGUE | President, Chief Executive Officer | March 16, 2006 | ||||||
Steven K. Sprague | and Director |
| ||||||
/s/ JOHN E. BAGALAY, JR. | Chairman | March 16, 2006 | ||||||
John E. Bagalay, Jr. |
|
| ||||||
/s/ GEORGE GILDER | Director | March 16, 2006 | ||||||
George Gilder |
|
| ||||||
/s/ JOHN E. MCCONNAUGHY, JR. | Director | March 16, 2006 | ||||||
John E. McConnaughy, Jr. |
|
| ||||||
/s/ NOLAN BUSHNELL | Director | March 16, 2006 | ||||||
Nolan Bushnell |
|
| ||||||
/s/ GERARD T. FEENEY | Senior Vice President, Finance and Administration, Chief Financial | March 16, 2006 | ||||||
Gerard T. Feeney |
| |||||||
53
Index to Consolidated Financial Statements
| Page(s) |
| |||
|
| F-2 |
|
| |
Consolidated Balance Sheets as of December 31, 2005 and 2004 |
|
| F-3 |
|
|
|
| F-4 |
|
| |
|
| F-5 |
|
| |
|
| F-12 |
|
| |
|
| F-14 |
|
| |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited the accompanying consolidated balance sheets of Wave Systems Corp. and subsidiaries (a development stage corporation) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficiency) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005 and for the period from February 12, 1988 (date of inception) to December 31, 2005. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005 and for the period from February 12, 1988 (date of inception) to December 31, 2005 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 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We also have audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Wave Systems Corp. internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 9, 2006, expressed an unqualified opinion on management’s assessment of, and the effective operation of internal control over financial reporting.
Boston, Massachusetts | /s/ KPMG LLP |
March 9, 2006 |
|
F-2
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
December 31, 2005 and 2004
|
| 2005 |
| 2004 |
| ||
Assets |
|
|
|
|
| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 2,006,022 |
| $ | 5,805,912 |
|
Marketable securities |
| — |
| 721,880 |
| ||
Accounts Receivable |
| 334,659 |
| 98,641 |
| ||
Prepaid expenses |
| 139,686 |
| 173,916 |
| ||
Total current assets |
| 2,480,367 |
| 6,800,349 |
| ||
Property and equipment, net |
| 754,153 |
| 1,435,053 |
| ||
Other assets |
| 195,245 |
| 219,180 |
| ||
Total Assets |
| 3,429,765 |
| 8,454,582 |
| ||
Liabilities and Stockholders’ Equity (Deficiency) |
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Accounts payable and accrued expenses |
| 3,089,150 |
| 2,900,064 |
| ||
Deferred revenue |
| 503,630 |
| 351,190 |
| ||
Total current liabilities |
| 3,592,780 |
| 3,251,254 |
| ||
Liability for warrants containing cash settlement provisions |
| 2,794 |
| 493,128 |
| ||
Total liabilities |
| 3,595,574 |
| 3,744,382 |
| ||
Stockholders’ Equity (Deficiency): |
|
|
|
|
| ||
Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 93,341,754 shares issued and outstanding in 2005 and 76,177,617 in 2004 |
| 933,418 |
| 761,776 |
| ||
Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 175,725 shares issued and outstanding in 2005 and 205,725 in 2004 |
| 1,757 |
| 2,057 |
| ||
Capital in excess of par value |
| 283,645,842 |
| 270,664,189 |
| ||
Deficit accumulated during the development stage |
| (284,746,826 | ) | (267,184,364 | ) | ||
Accumulated other comprehensive income—unrealized gain on marketable securities |
| — |
| 466,542 |
| ||
Total Stockholders’ Equity (Deficiency) |
| (165,809 | ) | 4,710,200 |
| ||
Total Liabilities and Stockholders’ Equity (Deficiency) |
| $ | 3,429,765 |
| $ | 8,454,582 |
|
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, 2005, 2004, 2003 and the
period from February 12, 1988 (date of inception)
through December 31, 2005
|
| 2005 |
| 2004 |
| 2003 |
| Period from |
| ||||||
Net Revenues: |
|
|
|
|
|
|
|
|
|
|
| ||||
Licensing |
| $ | 974,058 |
| $ | 183,318 |
| $ | 120,670 |
|
| $ | 1,783,945 |
|
|
Services |
| 44,406 |
| 18,833 |
| 65,343 |
|
| 869,879 |
|
| ||||
Hardware products |
| — |
| 7,160 |
| 3,350 |
|
| 496,624 |
|
| ||||
Total Net Revenues |
| 1,018,464 |
| 209,311 |
| 189,363 |
|
| 3,150,448 |
|
| ||||
Cost of sales: |
|
|
|
|
|
|
|
|
|
|
| ||||
Licensing |
| 682,179 |
| 133,468 |
| 39,361 |
|
| 990,645 |
|
| ||||
Services |
| 44,674 |
| 13,589 |
| 12,948 |
|
| 430,917 |
|
| ||||
Hardware Products |
| — |
| 4,647 |
| 2,870 |
|
| 288,572 |
|
| ||||
Total Cost of Sales |
| 726,853 |
| 151,704 |
| 55,179 |
|
| 1,710,134 |
|
| ||||
Gross profit |
| 291,611 |
| 57,607 |
| 134,184 |
|
| 1,440,314 |
|
| ||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
| ||||
Selling, general and administrative |
| 11,560,039 |
| 12,255,427 |
| 12,698,682 |
|
| 164,174,108 |
|
| ||||
Research and development |
| 6,937,618 |
| 6,852,754 |
| 7,384,708 |
|
| 105,137,768 |
|
| ||||
Inventory provision |
| — |
| — |
| 1,114,442 |
|
| 1,114,442 |
|
| ||||
Amortization of goodwill |
| — |
| — |
| — |
|
| 2,294,176 |
|
| ||||
Write-off of intangibles and other impaired assets |
| — |
| 301,366 |
| — |
|
| 3,634,314 |
|
| ||||
Restructuring costs and other special charges |
| — |
| — |
| — |
|
| 726,280 |
|
| ||||
Write-off of goodwill |
| — |
| — |
| — |
|
| 3,054,456 |
|
| ||||
In-process research and development expense |
| — |
| — |
| — |
|
| 2,176,000 |
|
| ||||
Acquisition costs |
| — |
| — |
| — |
|
| 1,494,000 |
|
| ||||
Aladdin license expense |
| — |
| — |
| — |
|
| 3,889,000 |
|
| ||||
|
| 18,497,657 |
| 19,409,547 |
| 21,197,832 |
|
| 287,694,544 |
|
| ||||
Other income (expense): |
|
|
|
|
|
|
|
|
|
|
| ||||
Interest income |
| 70,779 |
| 24,931 |
| 74,822 |
|
| 10,361,833 |
|
| ||||
Interest expense |
| — |
| — |
| — |
|
| (1,695,461 | ) |
| ||||
Equity in net losses of GlobalWave |
| — |
| — |
| — |
|
| (5,738,650 | ) |
| ||||
Loss on other than temporary decline in marketable equity securities |
| — |
| — |
| — |
|
| (13,249,781 | ) |
| ||||
Gain on sale of marketable securities |
| 80,971 |
| 4,330,248 |
| 234,759 |
|
| 5,188,435 |
|
| ||||
Gain on termination of development contract |
| — |
| — |
| — |
|
| 1,818,000 |
|
| ||||
Liquidated damages |
| — |
| — |
| (155,716 | ) |
| (155,716 | ) |
| ||||
Unrealized gain on decrease in value of warrant liability |
| 490,334 |
| 498,723 |
| 263,097 |
|
| 1,252,154 |
|
| ||||
Recovery of officer note receivable |
| — |
| — |
| 999,518 |
|
| — |
|
| ||||
License fee |
| — |
| — |
| — |
|
| 5,000,000 |
|
| ||||
License warrant cost |
| — |
| — |
| — |
|
| (1,100,000 | ) |
| ||||
Other income (expense) |
| 1,500 |
| — |
| 52,370 |
|
| (173,410 | ) |
| ||||
|
| 643,584 |
| 4,853,902 |
| 1,468,850 |
|
| 1,507,404 |
|
| ||||
Net loss |
| (17,562,462 | ) | (14,498,038 | ) | (19,594,798 | ) |
| (284,746,826 | ) |
| ||||
Accrued dividends on preferred Stock (including $5,485,000 of accretion of discount in 2003) |
| — |
| — |
| 5,697,518 |
|
| 10,048,115 |
|
| ||||
Net loss to common stockholders |
| (17,562,462 | ) | (14,498,038 | ) | $ | (25,292,316 | ) |
| $ | (294,794,941 | ) |
| ||
Loss per common share—basic and diluted |
| $ | (0.21 | ) | $ | (0.21 | ) | $ | (0.45 | ) |
| $ | (10.05 | ) |
|
Weighted average number of common shares |
| 83,178,663 |
| 69,040,661 |
| 55,887,384 |
|
| 29,323,741 |
|
| ||||
See accompanying notes to consolidated financial statements.
F-4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)
|
|
|
|
|
|
|
|
|
|
| Deficit |
|
|
| Note |
|
|
| ||||||||||||||||||||||
|
| Class A |
| Class B |
| Capital |
| during the |
|
|
| receivable |
|
|
| |||||||||||||||||||||||||
|
| Common Stock |
| Common Stock |
| in excess of |
| development |
| Deferred |
| from |
|
|
| |||||||||||||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| compensation |
| stockholder |
| Total |
| |||||||||||||||||||||
Shares issued to founders at $.003 per share |
|
| — |
|
|
| $ | — |
|
| 4,680,000 |
|
| $ | 46,800 |
|
|
| $ | (31,200 | ) |
|
| $ | — |
|
|
| $ | — |
|
|
| $ | — |
|
| $ | 15,600 |
|
Shares issued at $1.25 per share, net of expenses of $36,574 from September through November 1988 |
|
| — |
|
|
| — |
|
| 300,000 |
|
| 3,000 |
|
|
| 335,426 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 338,426 |
| |||||||
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (326,832 | ) |
|
| — |
|
|
| — |
|
| (326,832 | ) | |||||||
Balance at December 31, 1988 |
|
| — |
|
|
| — |
|
| 4,980,000 |
|
| 49,800 |
|
|
| 304,226 |
|
|
| (326,832 | ) |
|
| — |
|
|
| — |
|
| 27,194 |
| |||||||
Shares issued at $1.25 per share, net of expenses of $68,750, from January through December 1989 |
|
| — |
|
|
| — |
|
| 270,000 |
|
| 2,700 |
|
|
| 266,050 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 268,750 |
| |||||||
Shares issued at $1.25 per share in July 1989 as compensation for services rendered |
|
| — |
|
|
| — |
|
| 1,920 |
|
| 19 |
|
|
| 2,381 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 2,400 |
| |||||||
Shares issued by principal stockholders at $1.25 per share in December 1989 as compensation for services rendered |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 374,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 374,000 |
| |||||||
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (982,186 | ) |
|
| — |
|
|
| — |
|
| (982,186 | ) | |||||||
Balance at December 31, 1989 |
|
| — |
|
|
| — |
|
| 5,251,920 |
|
| 52,519 |
|
|
| 946,657 |
|
|
| (1,309,018 | ) |
|
| — |
|
|
| — |
|
| (309,842 | ) | |||||||
Shares issued by principal stockholder at $1.25 per share in March 1990 as compensation for services rendered |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 56,250 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 56,250 |
| |||||||
Shares issued by principal stockholder at $.50 per share in March 1990 as compensation for services rendered |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 60,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 60,000 |
| |||||||
Shares issued at $1.67 per share in May 1990 as compensation for services rendered |
|
| — |
|
|
| — |
|
| 6,000 |
|
| 60 |
|
|
| 9,940 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 10,000 |
| |||||||
Shares issued at $1.67 per share, net of expenses of $5,000 in March, April, November and December 1990 |
|
| — |
|
|
| — |
|
| 390,000 |
|
| 3,900 |
|
|
| 641,100 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 645,000 |
| |||||||
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (1,178,129 | ) |
|
| — |
|
|
| — |
|
| (1,178,129 | ) | |||||||
Balance at December 31, 1990 |
|
| — |
|
|
| — |
|
| 5,647,920 |
|
| 56,479 |
|
|
| 1,713,947 |
|
|
| (2,487,147 | ) |
|
| — |
|
|
| — |
|
| (716,721 | ) | |||||||
Shares issued at $1.67 per share from March through November 1991 |
|
| — |
|
|
| — |
|
| 315,000 |
|
| 3,150 |
|
|
| 521,850 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 525,000 |
| |||||||
Shares issued at $1.67 per share in November 1991 as compensation for services rendered |
|
| — |
|
|
| — |
|
| 19,800 |
|
| 198 |
|
|
| 32,802 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 33,000 |
| |||||||
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (1,009,368 | ) |
|
| — |
|
|
| — |
|
| (1,009,368 | ) | |||||||
Balance at December 31, 1991 |
|
| — |
|
|
| — |
|
| 5,982,720 |
|
| 59,827 |
|
|
| 2,268,599 |
|
|
| (3,496,515 | ) |
|
| — |
|
|
| — |
|
| (1,168,089 | ) | |||||||
See accompanying notes to consolidated financial statements.
F-5
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
|
| Class A |
| Class B |
| Capital |
| Deficit |
| Deferred |
| Note |
|
|
| ||||||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| compensation |
| stockholder |
| Total |
| ||||||||||||||
Balance at December 31, 1991 |
|
| — |
|
|
| — |
|
| 5,982,720 |
|
| 59,827 |
|
|
| 2,268,599 |
|
|
| (3,496,515 | ) |
|
| — |
|
|
| — |
|
| (1,168,089 | ) |
Shares issued at $1.67 per share from January through October 1992 |
|
| — |
|
|
| — |
|
| 708,000 |
|
| 7,080 |
|
|
| 1,172,920 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 1,180,000 |
|
Shares issued at $1.67 per share in May 1992 in connection with License and Cross-License Agreement | �� |
| — |
|
|
| — |
|
| 674,976 |
|
| 6,750 |
|
|
| 1,118,210 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 1,124,960 |
|
Shares issued at $1.67 per share in May 1992 as compensation for services rendered |
|
| — |
|
|
| — |
|
| 18,000 |
|
| 180 |
|
|
| 29,820 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 30,000 |
|
Shares issued at $2.50 per share in May and November 1992 as compensation for services rendered |
|
| — |
|
|
| — |
|
| 771,000 |
|
| 7,710 |
|
|
| 1,919,790 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 1,927,500 |
|
Shares issued at $2.50 per share, net of expenses of $7,500, in November and December 1992 |
|
| — |
|
|
| — |
|
| 323,001 |
|
| 3,230 |
|
|
| 796,773 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 800,003 |
|
Shares issued by principal stockholder in December 1992 at $2.50 per share as compensation for services rendered |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 75,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 75,000 |
|
Shares canceled in October and December 1992 |
|
| — |
|
|
| — |
|
| (75,000 | ) |
| (750 | ) |
|
| 750 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
|
Issuance of stock options at $.003 exercise price per share in June 1992 |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 798,400 |
|
|
| — |
|
|
| (398,660 | ) |
|
| — |
|
| 399,740 |
|
Amortization of deferred compensation |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 155,455 |
|
|
| — |
|
| 155,455 |
|
Accrued dividends on preferred stock |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| (6,383 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| (6,383 | ) |
Note receivable and accrued interest from stockholder |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (152,974 | ) |
| (152,974 | ) |
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (4,182,638 | ) |
|
| — |
|
|
| — |
|
| (4,182,638 | ) |
Balance at December 31, 1992 |
|
| — |
|
|
| — |
|
| 8,402,697 |
|
| 84,027 |
|
|
| 8,173,879 |
|
|
| (7,679,153 | ) |
|
| (243,205 | ) |
|
| (152,974 | ) |
| 182,574 |
|
Shares issued at $1.67 per share in February 1993 |
|
| — |
|
|
| — |
|
| 30,000 |
|
| 300 |
|
|
| 49,800 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 50,100 |
|
Shares issued at $3.50 per share, net of expenses of $82,427, from April through December 1993 |
|
| — |
|
|
| — |
|
| 550,359 |
|
| 5,504 |
|
|
| 1,838,294 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 1,843,798 |
|
Shares issued at $3.50 per share from May to December 1993 as compensation for services rendered, for the acquisition of property and equipment and as additional interest on borrowings |
|
| — |
|
|
| — |
|
| 73,319 |
|
| 733 |
|
|
| 255,884 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 256,617 |
|
Issuance of warrants to purchase Class B Common Stock from September to December 1993 in conjunction with the issuance of convertible debt |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| 72,893 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| 72,893 |
|
Amortization of deferred compensation |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 243,205 |
|
|
| — |
|
| 243,205 |
|
Accrued dividends on preferred stock |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| (38,467 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| (38,467 | ) |
Note receivable and accrued interest from stockholder |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (39,783 | ) |
| (39,783 | ) |
Net loss |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (3,959,334 | ) |
|
| — |
|
|
| — |
|
| (3,959,334 | ) |
Balance at December 31, 1993 |
|
| — |
|
|
| — |
|
| 9,056,375 |
|
| 90,564 |
|
|
| 10,352,283 |
|
|
| (11,638,487 | ) |
|
| — |
|
|
| (192,757 | ) |
| (1,388,397 | ) |
See accompanying notes to consolidated financial statements.
F-6
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
|
| Class A |
| Class B |
| Capital in |
| Deficit |
| Deferred |
| Note |
|
|
| ||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| compensation |
| stockholder |
| Total |
| ||||||||||
Balance at December 31, 1993 |
| — |
|
| — |
|
| 9,056,375 |
|
| 90,564 |
|
| 10,352,283 |
|
| (11,638,487 | ) |
|
| — |
|
|
| (192,757 | ) |
| (1,388,397 | ) |
Shares issued at $3.50 per share in January and February 1994 |
| — |
|
| — |
|
| 95,715 |
|
| 957 |
|
| 334,046 |
|
| — |
|
|
| — |
|
|
| — |
|
| 335,003 |
|
Shares issued at $3.50 per share in February 1994 as additional interest on borrowings |
| — |
|
| — |
|
| 5,700 |
|
| 57 |
|
| 19,893 |
|
| — |
|
|
| — |
|
|
| — |
|
| 19,950 |
|
Issuance of warrants to purchase Class B Common Stock in January and February 1994 in conjunction with the issuance of convertible debt |
| — |
|
| — |
|
| — |
|
| — |
|
| 115,234 |
|
| — |
|
|
| — |
|
|
| — |
|
| 115,234 |
|
Accrued dividends on preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
| (39,484 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (39,484 | ) |
Accrual of interest on note receivable from stockholder |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (17,315 | ) |
| (17,315 | ) |
Sale of warrants to underwriter in September 1994 |
| — |
|
| — |
|
| — |
|
| — |
|
| 4 |
|
| — |
|
|
| — |
|
|
| — |
|
| 4 |
|
Conversion of notes payable |
| — |
|
| — |
|
| 599,507 |
|
| 5,995 |
|
| 2,079,131 |
|
| — |
|
|
| — |
|
|
| — |
|
| 2,085,126 |
|
Shares issued at $5.00 per share in initial public offering in September 1994, net of expenses of $2,929,835 |
| 3,728,200 |
|
| 37,282 |
|
| — |
|
| — |
|
| 15,673,883 |
|
| — |
|
|
| — |
|
|
| — |
|
| 15,711,165 |
|
Net loss |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| (4,271,501 | ) |
|
| — |
|
|
| — |
|
| (4,271,501 | ) |
Balance at December 31, 1994 |
| 3,728,200 |
|
| 37,282 |
|
| 9,757,297 |
|
| 97,573 |
|
| 28,534,990 |
|
| (15,909,988 | ) |
|
| — |
|
|
| (210,072 | ) |
| 12,549,785 |
|
Shares issued at prices ranging from $1.00 per share to $3.13 per share as compensation for services rendered | �� | 31,559 |
|
| 315 |
|
| — |
|
| — |
|
| 57,184 |
|
| — |
|
|
| — |
|
|
| — |
|
| 57,499 |
|
Exercise of options to purchase Class B Common Stock |
| — |
|
| — |
|
| 681,700 |
|
| 6,817 |
|
| 429,413 |
|
| — |
|
|
| — |
|
|
| — |
|
| 436,230 |
|
Accrued dividends on preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
| (40,600 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (40,600 | ) |
Accrual of interest on note receivable from stockholder |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (17,318 | ) |
| (17,318 | ) |
Exchange of Class B Common Stock for Class A Common Stock |
| 2,855,859 |
|
| 28,559 |
|
| (2,855,859 | ) |
| (28,559 | ) |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
|
Net loss |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| (6,832,866 | ) |
|
| — |
|
|
| — |
|
| (6,832,866 | ) |
Balance at December 31, 1995 |
| 6,615,618 |
|
| 66,156 |
|
| 7,583,138 |
|
| 75,831 |
|
| 28,980,987 |
|
| (22,742,854 | ) |
|
| — |
|
|
| (227,390 | ) |
| 6,152,730 |
|
Exercise of options to purchase Class A Common Stock |
| 214,091 |
|
| 2,141 |
|
| — |
|
| — |
|
| 420,366 |
|
| — |
|
|
| — |
|
|
| — |
|
| 422,507 |
|
Shares issued at prices ranging from $2.06 per share to $3.44 per share as compensation for services rendered |
| 42,077 |
|
| 421 |
|
| — |
|
| — |
|
| 123,029 |
|
| — |
|
|
| — |
|
|
| — |
|
| 123,450 |
|
Issuance of unregistered Class B Common Stock to acquire Wave Interactive Network valued at approximately $.98 per share |
| — |
|
| — |
|
| 375,000 |
|
| 3,750 |
|
| 364,688 |
|
| — |
|
|
| — |
|
|
| — |
|
| 368,438 |
|
Issuance of warrants to purchase unregistered shares of Class A Common Stock in conjunction with the issuance of convertible debt and preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
| 283,455 |
|
| — |
|
|
| — |
|
|
| — |
|
| 283,455 |
|
Conversion of Class B Preferred Stock |
| 2,960,303 |
|
| 29,603 |
|
| — |
|
| — |
|
| 3,078,921 |
|
| — |
|
|
| — |
|
|
| — |
|
| 3,108,524 |
|
Accrual of interest on note receivable |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| (17,315 | ) |
| (17,315 | ) |
Accrued dividends on preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
| (199,014 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (199,014 | ) |
Exchange of Class B Common Stock for Class A Common Stock |
| 1,749,997 |
|
| 17,500 |
|
| (1,749,997 | ) |
| (17,500 | ) |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
|
N*ABLE APIC in connection with the issuance of Class A Common Stock due to merger |
| 873,317 |
|
| 8,733 |
|
| — |
|
| — |
|
| 1,296,241 |
|
| — |
|
|
| — |
|
|
| — |
|
| 1,304,974 |
|
Net loss |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
|
| (10,126,546 | ) |
|
| — |
|
|
| — |
|
| (10,126,546 | ) |
Balance at December 31, 1996 |
| 12,455,403 |
|
| 124,554 |
|
| 6,208,141 |
|
| 62,081 |
|
| 34,348,673 |
|
| (32,869,400 | ) |
|
| — |
|
|
| (244,705 | ) |
| 1,421,203 |
|
See accompanying notes to consolidated financial statements.
F-7
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
|
|
|
|
|
|
|
|
|
|
|
| Deficit |
|
|
|
|
|
|
| |||||||||||
|
|
|
|
|
|
|
|
|
|
|
| Accumulated |
| Series G |
| Note |
|
|
| |||||||||||
|
| Class A |
| Class B |
| Capital |
| during the |
| Convertible |
| receivable |
|
|
| |||||||||||||||
|
| Common stock |
| Common stock |
| in excess of |
| development |
| Preferred |
| from |
|
|
| |||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| Stock |
| stockholder |
| Total |
| |||||||||||
Balance at December 31, 1996 |
| 12,455,403 |
| 124,554 |
| 6,208,141 |
| 62,081 |
| 34,348,673 |
|
| (32,869,400 | ) |
|
| — |
|
| (244,705 | ) | 1,421,203 |
| |||||||
Exercise of options to purchase Class A and B Common Stock |
| 70,326 |
| 703 |
| 10,330 |
| 104 |
| 139,081 |
|
| — |
|
|
| — |
|
| — |
| 139,888 |
| |||||||
Shares issued at prices ranging from $1.00 per share to $3.00 per share as compensation for services rendered |
| 126,885 |
| 1,269 |
| — |
| — |
| 304,227 |
|
| — |
|
|
| — |
|
| — |
| 305,496 |
| |||||||
Conversion of preferred stock into Common Stock |
| 7,998,860 |
| 79,989 |
| — |
| — |
| 6,703,028 |
|
| — |
|
|
| — |
|
| — |
| 6,783,017 |
| |||||||
Issuance of Class A Common Stock and warrants to purchase Class A Common Stock to Aladdin |
| 500,000 |
| 5,000 |
| — |
| — |
| 3,834,000 |
|
| — |
|
|
| — |
|
| — |
| 3,839,000 |
| |||||||
Issuance of Class A Common Stock and warrants to purchase Class A Common Stock |
| 799,964 |
| 8,000 |
| — |
| — |
| 792,000 |
|
| — |
|
|
| — |
|
| — |
| 800,000 |
| |||||||
Reduction in note receivable |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| 50,000 |
| 50,000 |
| |||||||
Accrual of interest on note receivable |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| (17,319 | ) | (17,319 | ) | |||||||
Issuance of warrants to purchase Class A Common Stock in conjunction with the issuance of preferred stock |
| — |
| — |
| — |
| — |
| 386,462 |
|
| — |
|
|
| — |
|
| — |
| 386,462 |
| |||||||
Accrued dividend on preferred stock including accretion of assured incremental yield |
| — |
| — |
| — |
| — |
| (1,372,984 | ) |
| — |
|
|
| — |
|
| — |
| (1,372,984 | ) | |||||||
Assured incremental yield on issuance of Series F convertible preferred stock and debt |
| — |
| — |
| — |
| — |
| 682,000 |
|
| — |
|
|
| — |
|
| — |
| 682,000 |
| |||||||
N*ABLE APIC in connection with the issuance of Class A Common Stock due to merger |
| 1,404,723 |
| 14,047 |
| — |
| — |
| 10,133,497 |
|
| — |
|
|
| — |
|
| — |
| 10,147,544 |
| |||||||
Net loss |
| — |
| — |
| — |
| — |
| — |
|
| (18,012,635 | ) |
|
| — |
|
| — |
| (18,012,635 | ) | |||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 1,796,518 |
| 17,965 |
| (1,796,518 | ) | (17,965 | ) | — |
|
| — |
|
|
| — |
|
| — |
| — |
| |||||||
Balance at December 31, 1997 |
| 25,152,679 |
| $ | 251,527 |
| 4,421,953 |
| $ | 44,220 |
| $ | 55,949,984 |
|
| $ | (50,882,035 | ) |
|
| $ | — |
|
| $ | (212,024 | ) | $ | 5,151,672 |
|
Exercise of options to purchase Class A Common Stock |
| 77,558 |
| 775 |
| — |
| — |
| 151,180 |
|
| — |
|
|
| — |
|
| — |
| 151,955 |
| |||||||
Options issued to employees below fair market-value |
| — |
| — |
| — |
| — |
| 234,723 |
|
| — |
|
|
| — |
|
| — |
| 234,723 |
| |||||||
Exercise of warrants to purchase Class A Common Stock |
| 1,652,770 |
| 16,528 |
| — |
| — |
| 3,945,740 |
|
| — |
|
|
| — |
|
| — |
| 3,962,268 |
| |||||||
Warrants to purchase Class A Common Stock to be issued as part of technology licensing agreement and issued to consultants for services |
| — |
| — |
| — |
| — |
| 1,546,824 |
|
| — |
|
|
| — |
|
| — |
| 1,546,824 |
| |||||||
Shares issued at prices ranging from $1.00 per share to $5.00 per share as compensation for services rendered |
| 121,400 |
| 1,214 |
| — |
| — |
| 647,274 |
|
| — |
|
|
| — |
|
| — |
| 648,488 |
| |||||||
Reduction in note receivable |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| 75,000 |
| 75,000 |
| |||||||
Issuance of Series G Convertible Preferred stock and Common Stock warrants, net of issuance costs of $222,500 |
| — |
| — |
| — |
| — |
| 218,250 |
|
| — |
|
|
| 1,809,250 |
|
| — |
| 2,027,500 |
| |||||||
Assured incremental yield on issuance of Series G convertible preferred stock and debt |
| — |
| — |
| — |
| — |
| 750,000 |
|
| — |
|
|
| — |
|
| — |
| 750,000 |
| |||||||
Accrual of interest on note receivable |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| (12,318 | ) | (12,318 | ) | |||||||
Accrued dividend on preferred stock including accretion of assured incremental yield |
| — |
| — |
| — |
| — |
| (858,863 | ) |
| — |
|
|
| 837,263 |
|
| — |
| (21,600 | ) | |||||||
Conversion of Series G Preferred Stock |
| 2,394,494 |
| 23,945 |
| — |
| — |
| 2,274,756 |
|
| — |
|
|
| (2,298,701 | ) |
| — |
| — |
| |||||||
N*ABLE’s APIC in connection with the issuance of Class A Common Stock due to the merger |
| 2,781 |
| 28 |
| — |
| — |
| 59,182 |
|
| — |
|
|
| — |
|
| — |
| 59,210 |
| |||||||
Net loss |
| — |
| — |
| — |
| — |
| — |
|
| (16,586,027 | ) |
|
| — |
|
| — |
| (16,586,027 | ) | |||||||
Adjustment for net loss of N*ABLE for the six months ended June 30, 1998 |
| — |
| — |
| — |
| — |
| — |
|
| 2,253,461 |
|
|
| — |
|
| — |
| 2,253,461 |
| |||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 1,281,288 |
| 12,813 |
| (1,281,288 | ) | (12,813 | ) | — |
|
| — |
|
|
| — |
|
| — |
| — |
| |||||||
Balance at December 31, 1998 |
| 30,682,970 |
| $ | 306,830 |
| 3,140,665 |
| $ | 31,407 |
| $ | 64,919,050 |
|
| $ | (65,214,601 | ) |
|
| $ | 347,812 |
|
| $ | (149,342 | ) | $ | 241,156 |
|
See accompanying notes to consolidated financial statements.
F-8
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
|
| Class A |
| Class B |
| Capital |
| Deficit |
| Series G |
| Accumulated |
| Note |
|
|
| ||||||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| Stock |
| Income |
| stockholder |
| Total |
| ||||||||||||||
Balance at December 31, 1998 |
| 30,682,970 |
| $ | 306,830 |
| 3,140,665 |
| $ | 31,407 |
| $ | 64,919,050 |
| $ | (65,214,601 | ) |
| $ | 347,812 |
|
|
| — |
|
|
| $ | (149,342 | ) |
| $ | 241,156 |
| |
Net loss |
| — |
| — |
| — |
| — |
| — |
| (28,052,572 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (28,052,572 | ) | ||||||||
Unrealized gain on Marketable Securities |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| 2,860,500 |
|
|
| — |
|
| 2,860,500 |
| ||||||||
Comprehensive loss |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| (25,192,072 | ) | ||||||||
Exercise of options to purchase Class A Common Stock |
| 964,000 |
| 9,640 |
| — |
| — |
| 1,622,431 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 1,632,071 |
| ||||||||
Warrants exercised to purchase Class A Common Stock |
| 3,370,238 |
| 33,702 |
| — |
| — |
| 6,708,057 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 6,741,759 |
| ||||||||
Shares Issued at $11.00 per share, net of issuance costs |
| 2,090,405 |
| 20,904 |
| — |
| — |
| 21,481,665 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 21,502,569 |
| ||||||||
Conversion of Bridge to Loan to purchase Class A Common Stock |
| 787,349 |
| 7,874 |
| — |
| — |
| 2,567,380 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 2,575,254 |
| ||||||||
Warrants to Purchase Class A Common Stock For services rendered |
| — |
| — |
| — |
| — |
| 1,075,240 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 1,075,240 |
| ||||||||
Shares issued as compensation for services rendered |
| 83,461 |
| 834 |
| — |
| — |
| 1,149,486 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 1,150,320 |
| ||||||||
Accrual of interest on note receivable |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
|
| (4,818 | ) |
| (4,818 | ) | ||||||||
Conversion of Series G Preferred Stock |
| 377,102 |
| 3,771 |
| — |
| — |
| 344,041 |
| — |
|
| (347,812 | ) |
|
| — |
|
|
| — |
|
| — |
| ||||||||
Accrued dividend on preferred stock |
| — |
| — |
| — |
| — |
| (13,239 | ) | — |
|
| — |
|
|
| — |
|
|
| — |
|
| (13,239 | ) | ||||||||
Exchange of Class B Common Stock for Class A stock |
| 1,090,158 |
| 10,902 |
| (1,090,158 | ) | (10,902 | ) | — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| ||||||||
Balance at December 31, 1999 |
| 39,445,683 |
| $ | 394,457 |
| 2,050,507 |
| $ | 20,505 |
| $ | 99,854,111 |
| $ | (93,267,173 | ) |
| $ | 0 |
|
|
| $ | 2,860,500 |
|
|
| $ | (154,160 | ) |
| $ | 9,708,240 |
|
Net loss |
| — |
| — |
| — |
| — |
| — |
| (47,655,893 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (47,655,893 | ) | ||||||||
Unrealized gain (loss) on marketable securities |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| (937,196 | ) |
|
| — |
|
| (937,196 | ) | ||||||||
Comprehensive loss |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| (48,593,089 | ) | ||||||||
Shares issued at $34.00 per share, net of issuance costs |
| 3,600,800 |
| 36,008 |
| — |
| — |
| 114,941,407 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 114,977,415 |
| ||||||||
Shares issued in exchange for substantially all of the assets of Indigo Networks, LLC at $19.30 per share |
| 374,889 |
| 3749 |
| — |
| — |
| 7,231,609 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 7,235,358 |
| ||||||||
Shares issued as compensation for services at $13.75 per share |
| 7,879 |
| 79 |
| — |
| — |
| 108,254 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 108,333 |
| ||||||||
Exercise of warrants to purchase Class A Common Stock |
| 319,692 |
| 3,197 |
| — |
| — |
| 1,331,048 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 1,334,245 |
| ||||||||
Exercise of Options to purchase Class A Common Stock |
| 2,030,958 |
| 20,309 |
| — |
| — |
| 4,950,872 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 4,971,181 |
| ||||||||
Compensation on Employee Options issued |
| — |
| — |
| — |
| — |
| 318,609 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 318,609 |
| ||||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 1,271,296 |
| 12,713 |
| (1,271,296 | ) | (12,713 | ) | — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| ||||||||
Repayment of note receivable from stockholder |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
|
| 154,160 |
|
| 154,160 |
| ||||||||
Balance at December 31, 2000 |
| 47,051,197 |
| $ | 470,512 |
| 779,211 |
| $ | 7,792 |
| $ | 228,735,910 |
| $ | (140,923,066 | ) |
| $ | 0 |
|
|
| $ | 1,923,304 |
|
|
| $ | 0 |
|
| $ | 90,214,452 |
|
Net loss |
| — |
| — |
| — |
| — |
| — |
| (48,701,057 | ) |
| — |
|
|
| — |
|
|
| — |
|
| (48,701,057 |
| ||||||||
Investment Loss on Marketable Securities |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| (3,328,296 | ) |
|
| — |
|
| (3,328,296 |
| ||||||||
Comprehensive loss |
| — |
| — |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| (52,029,353 |
| ||||||||
Shares issued in exchange for 3,600,000 shares of BIZ Interactive Zone, Inc. at $7.16 per share |
| 2,000,000 |
| 20,000 |
| — |
| — |
| 14,292,800 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 14,312,800 |
| ||||||||
Exercise of Options |
| 523,181 |
| 5,232 |
| — |
| — |
| 749,721 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 754,953 |
| ||||||||
Compensation on Employee Options Issued |
| — |
| — |
| — |
| — |
| 552,554 |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| 552,554 |
| ||||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 422,128 |
| 4,221 |
| (422,128 | ) | (4,221 | ) | — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| ||||||||
Balance at December 31, 2001 |
| 49,996,506 |
| $499,965 |
| 357,083 |
| $3,571 |
| $244,330,985 |
| $(189,624,123 | ) |
| $0 |
|
|
| $(1,404,992 | ) |
|
| $0 |
|
| $53,805,406 |
| ||||||||
See accompanying notes to consolidated financial statements.
F-9
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
| Class A |
| Class B |
| Capital |
| Deficit |
| Accumulated |
|
|
| |||||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| par value |
| stage |
| Income |
| Total |
| ||||||||||||
Balance at December 31, 2001 |
| 49,996,506 |
| $ | 499,965 |
| 357,083 |
|
| $ | 3,571 |
|
| $ | 244,330,985 |
| $ | (189,624,123 | ) |
| $ | (1,404,992 | ) |
| $ | 53,805,406 |
| ||
Net loss |
| — |
| — |
| — |
|
| — |
|
| — |
| (43,467,405 | ) |
| — |
|
| (43,467,405 | ) | ||||||||
Investment Loss on Marketable Securities |
| — |
| — |
| — |
|
| — |
|
| — |
| — |
|
| 1,404,992 |
|
| 1,404,992 |
| ||||||||
Comprehensive loss |
| — |
| — |
| — |
|
| — |
|
| — |
| — |
|
| — |
|
| (42,062,413 | ) | ||||||||
Issuance of Class A Common Stock to acquire 60% of the remaining assets of GlobalWave, Ltd |
| 1,700,000 |
| 17,000 |
| — |
|
| — |
|
| 2,227,000 |
| — |
|
| — |
|
| 2,244,000 |
| ||||||||
Exercise of Options |
| 42,554 |
| 426 |
| — |
|
| — |
|
| 43,673 |
| — |
|
| — |
|
| 44,099 |
| ||||||||
Issuance of warrants to purchase Class A Common Stock |
| — |
| — |
| — |
|
| — |
|
| 143,500 |
| — |
|
| — |
|
| 143,500 |
| ||||||||
Compensation on Expense Employee Options Issued |
| — |
| — |
| — |
|
| — |
|
| 367,247 |
| — |
|
| — |
|
| 367,247 |
| ||||||||
Exchange of Class B Common Stock for Class A CommonStock |
| 32,858 |
| 329 |
| (32,858 | ) |
| (329 | ) |
| — |
| — |
|
| — |
|
| — |
| ||||||||
Balance at December 31, 2002 |
| 51,771,918 |
| $ | 517,720 |
| 324,225 |
|
| $ | 3,242 |
|
| $ | 247,112,405 |
| $ | (233,091,528 | ) |
| $ | 0 |
|
| $ | 14,541,839 |
| ||
Net loss |
| — |
| — |
| — |
|
| — |
|
| — |
| (19,594,798 | ) |
| — |
|
| (19,594,798 | ) | ||||||||
Investment Loss on Marketable Securities |
| — |
| — |
| — |
|
| — |
|
| — |
| — |
|
| 3,640,469 |
|
| 3,640,469 |
| ||||||||
Comprehensive loss |
| — |
| — |
| — |
|
| — |
|
| — |
| — |
|
| — |
|
| (15,954,329 | ) | ||||||||
Issuance of Class A Common Stock at $1.90 per share in a private placement, net of issuance costs of $515,820 |
| 3,725,263 |
| 37,253 |
| — |
|
| — |
|
| 6,524,927 |
| — |
|
| — |
|
| 6,562,180 |
| ||||||||
Issuance of Class A Common Stock upon Exercise of Series H Warrants, net of issuance costs of $180,635 |
| 2,632,311 |
| 26,323 |
| — |
|
| — |
|
| 2,463,844 |
| — |
|
| — |
|
| 2,490,167 |
| ||||||||
Issuance of Class A Common Stock upon exercise of warrants granted to placement agents in connection with the issuance of Series H Convertible Preferred Stock. |
| 322,270 |
| 3,223 |
| — |
|
| — |
|
| — |
| — |
|
| — |
|
| 3,223 |
| ||||||||
Conversion of 548.5 shares of Series H Convertible Preferred Stock into Class A Common Stock at a conversion price of $0.76 per share, net of issuance costs of $75,000 |
| 7,217,105 |
| 72,171 |
| — |
|
| — |
|
| 5,412,829 |
| — |
|
| — |
|
| 5,485,000 |
| ||||||||
Issuance of Class A Common Stock upon exercise of employee stock options |
| 1,340,739 |
| 13,406 |
| — |
|
| — |
|
| 2,855,509 |
| — |
|
| — |
|
| 2,868,915 |
| ||||||||
Issuance of Series H Convertible Preferred Stock and Warrants to Purchase Class A Common Stock |
| — |
| — |
| — |
|
| — |
|
| 4,464,571 |
| — |
|
| — |
|
| 4,464,571 |
| ||||||||
Dividends on Series H Convertible Preferred, including non-cash accretion of $5,485,000 |
| — |
| — |
| — |
|
| — |
|
| (5,697,518 | ) | — |
|
| — |
|
| (5,697,518 | ) | ||||||||
Issuance of warrants to purchase Class A Common Stock |
| — |
| — |
| — |
|
| — |
|
| 315,971 |
| — |
|
| — |
|
| 315,971 |
| ||||||||
Fair market value of warrants issued in connection with private placement of Class A Common Stock |
| — |
| — |
| — |
|
| — |
|
| (1,254,948 | ) | — |
|
| — |
|
| (1,254,948 | ) | ||||||||
Issuance of warrants to purchase Class A Common Stock for services |
| — |
| — |
| — |
|
| — |
|
| 43,176 |
| — |
|
| — |
|
| 43,176 |
| ||||||||
Compensation expense on employee stock options issued |
| — |
| — |
| — |
|
| — |
|
| 146,389 |
| — |
|
| — |
|
| 146,389 |
| ||||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 118,500 |
| 1,185 |
| (118,500 | ) |
| (1,185 | ) |
| — |
| — |
|
| — |
|
| — |
| ||||||||
Balance at December 31, 2003 |
| 67,128,106 |
| $ | 671,281 |
| 205,725 |
|
| $ | 2,057 |
|
| $ | 262,387,155 |
| $ | (252,686,326 | ) |
| $ | 3,640,469 |
|
| $ | 14,014,636 |
| ||
F-10
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders’ Equity (Deficiency) And Comprehensive Income (Loss)—(Continued)
|
| Class A |
| Class B |
| Capital in Excess |
| Deficit |
| Accumulated |
|
|
| ||||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| of Par Value |
| Stage |
| Income |
| Total |
| ||||||||||||
Balance at December 31, 2003 |
| 67,128,106 |
| $ | 671,281 |
| 205,725 |
|
| $ | 2,057 |
|
|
| $ | 262,387,155 |
|
| $ | (252,686,326 | ) |
| $ | 3,640,469 |
|
| $ | 14,014,636 |
|
Net loss |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| (14,498,038 | ) |
| — |
|
| (14,498,038 | ) | ||||||
Unrealized Gain on Marketable Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Unrealized holding gains during the period |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| 1,156,321 |
|
| — |
| ||||||
Less: reclassification adjustment for gain included in net income |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| (4,330,248 | ) |
| (3,173,927 | ) | ||||||
Comprehensive loss |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
| (17,671,965 | ) | ||||||
Issuance of Class A Common Stock at $0.85 per share, net of issuance costs of $222,101 |
| 3,529,412 |
| 35,294 |
| — |
|
| — |
|
|
| 2,742,603 |
|
| — |
|
| — |
|
| 2,777,897 |
| ||||||
Issuance of Class A Common Stock at $1.05 per share, net of issuance costs of $284,300 |
| 5,484,790 |
| 54,848 |
| — |
|
| — |
|
|
| 5,419,880 |
|
| — |
|
| — |
|
| 5,474,728 |
| ||||||
Issuance of Class A Common Stock upon exercise of employee stock options |
| 35,309 |
| 353 |
| — |
|
| — |
|
|
| 33,942 |
|
| — |
|
| — |
|
| 34,295 |
| ||||||
Issuance of warrants to purchase Class A Common Stock for services |
| — |
| — |
| — |
|
| — |
|
|
| 80,609 |
|
| — |
|
| — |
|
| 80,609 |
| ||||||
Balance as of December 31, 2004 |
| 76,177,617 |
| $ | 761,776 |
| 205,725 |
|
| $ | 2,057 |
|
|
| $ | 270,664,189 |
|
| $ | (267,184,364 | ) |
| $ | 466,542 |
|
| $ | 4,710,200 |
|
Net loss |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| (17,562,462 | ) |
| — |
|
| (17,562,462 | ) | ||||||
Unrealized loss on marketable securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Unrealized holding losses during the period |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| (385,571 | ) |
|
|
| ||||||
Less: reclassification adjustment for gain included in net income |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| (80,971 | ) |
| (466,542 | ) | ||||||
Comprehensive loss |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
|
| — |
|
| (18,029,004 | ) | ||||||
Issuance of Class A Common Stock at $0.88 per share, less issuance cost of $208,041 |
| 4,659,090 |
| 46,591 |
| — |
|
| — |
|
|
| 3,845,368 |
|
| — |
|
| — |
|
| 3,891,959 |
| ||||||
Issuance of Class A Common Stock at $0.90 per share, less issuance cost of $210,975 |
| 4,000,000 |
| 40,000 |
| — |
|
| — |
|
|
| 3,349,205 |
|
| — |
|
| — |
|
| 3,389,205 |
| ||||||
Issuance of Class A Common Stock at $0.585 per share, less issuance cost of $159,110 |
| 5,982,906 |
| 59,829 |
| — |
|
| — |
|
|
| 3,281,061 |
|
| — |
|
| — |
|
| 3,340,890 |
| ||||||
Warrants Exercised at $1.13 per share, less issuance cost of $90,400 |
| 2,000,000 |
| 20,000 |
| — |
|
| — |
|
|
| 2,149,600 |
|
| — |
|
| — |
|
| 2,169,600 |
| ||||||
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.7565 per share |
| 253,475 |
| 2,535 |
| — |
|
| — |
|
|
| 189,219 |
|
| — |
|
| — |
|
| 191,754 |
| ||||||
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.68 per share |
| 238,666 |
| 2,387 |
| — |
|
| — |
|
|
| 159,906 |
|
| — |
|
| — |
|
| 162,293 |
| ||||||
Compensation cost for stock options granted to consultant |
| — |
| — |
| — |
|
| — |
|
|
| 7,294 |
|
| — |
|
| — |
|
| 7,294 |
| ||||||
Exchange of Class B Common Stock for Class A Common Stock |
| 30,000 |
| 300 |
| (30,000 | ) |
| (300 | ) |
|
| — |
|
| — |
|
| — |
|
| — |
| ||||||
Balance as of December 31, 2005 |
| 93,341,754 |
| $ | 933,418 |
| 175,725 |
|
| $ | 1,757 |
|
|
| $ | 283,645,842 |
|
| $ | (284,746,826 | ) |
| $ | — |
|
| $ | (165,809 | ) |
See accompanying notes to consolidated financial statements.
F-11
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows
Years ended December 31, 2005, 2004, 2003, and the Period
From February 12, 1988 (Date of Inception) through December 31, 2005
|
|
|
|
|
|
|
| Period from |
| ||||||
|
|
|
|
|
|
|
| February 12, 1988 |
| ||||||
|
|
|
|
|
|
|
| (date of inception) |
| ||||||
|
|
|
|
|
|
|
| through |
| ||||||
|
|
|
|
|
|
|
| December 31, |
| ||||||
|
| 2005 |
| 2004 |
| 2003 |
| 2005 |
| ||||||
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net loss |
| $ | (17,562,462 | ) | $ | (14,498,038 | ) | $ | (19,594,798 | ) |
| $ | (284,746,826 | ) |
|
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
|
|
| ||||
Write-off of goodwill |
| — |
| — |
| — |
|
| 3,054,456 |
|
| ||||
Goodwill amortization |
| — |
| — |
| — |
|
| 2,294,176 |
|
| ||||
Depreciation and amortization |
| 841,729 |
| 854,629 |
| 1,241,035 |
|
| 12,569,524 |
|
| ||||
Reserve for note from affiliate |
| — |
| — |
| — |
|
| 1,672,934 |
|
| ||||
Recovery of officer note receivable |
| — |
| — |
| (999,518 | ) |
| — |
|
| ||||
Accretion of assured incremental yield on convertible debt |
| — |
| — |
| — |
|
| 119,000 |
|
| ||||
Common stock issued in connection with license agreement |
| — |
| — |
| — |
|
| 1,124,960 |
|
| ||||
Realized gain on marketable securities |
| (80,971 | ) | (4,330,248 | ) | (234,759 | ) |
| (5,188,435 | ) |
| ||||
Net losses realized on GlobalWave investment |
| — |
| — |
| — |
|
| 5,738,650 |
|
| ||||
Common stock issued for services rendered and additional interest on borrowings |
| — |
| — |
| — |
|
| 3,600,199 |
|
| ||||
Warrants issued as compensation for services |
| — |
| 80,609 |
| 43,176 |
|
| 3,018,880 |
|
| ||||
Issuance of warrants to Aladdin |
| — |
| — |
| — |
|
| 2,939,000 |
|
| ||||
Accrued interest on note payable |
| — |
| — |
| — |
|
| 121,219 |
|
| ||||
In-process research and development |
| — |
| — |
| — |
|
| 2,176,000 |
|
| ||||
Write-off of impaired assets |
| — |
| 301,366 |
| — |
|
| 3,634,314 |
|
| ||||
Loss on other than temporary decline in marketable equity Securities |
| — |
| — |
| — |
|
| 13,249,781 |
|
| ||||
Gain on termination of development contract with SSP |
| — |
| — |
| — |
|
| (1,818,000 | ) |
| ||||
Gain on decrease in value of warrant liability |
| (490,334 | ) | (498,723 | ) | (263,097 | ) |
| (1,252,154 | ) |
| ||||
Preferred stock issued for services rendered |
| — |
| — |
| — |
|
| 265,600 |
|
| ||||
Compensation associated with issuance of stock options |
| 7,294 |
| — |
| 146,389 |
|
| 2,026,557 |
|
| ||||
Amortization of deferred compensation |
| — |
| — |
| — |
|
| 398,660 |
|
| ||||
Amortization of discount on notes payable |
| — |
| — |
| — |
|
| 166,253 |
|
| ||||
Common stock issued by principal stockholder for services |
| — |
| — |
| — |
|
| 565,250 |
|
| ||||
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
|
|
| ||||
Increase in deferred revenue |
| 152,440 |
| 276,968 |
| 74,222 |
|
| 503,630 |
|
| ||||
Decrease in accrued interest on note receivable |
| — |
| — |
| 142,540 |
|
| — |
|
| ||||
Decrease in inventories |
| — |
| — |
| 1,112,818 |
|
| — |
|
| ||||
(Increase) decrease in accounts receivable and prepaid expenses |
| (201,788 | ) | (67,085 | ) | 368,844 |
|
| (444,027 | ) |
| ||||
(Increase) decrease in other assets |
| 23,935 |
| 93,570 |
| 50,688 |
|
| (210,160 | ) |
| ||||
Increase (decrease) in accounts payable and accrued expenses |
| 189,086 |
| 63,540 |
| (567,853 | ) |
| 3,478,252 |
|
| ||||
Decrease in amounts due to charities |
| — |
| (243,197 | ) | (19,959 | ) |
| — |
|
| ||||
Decrease in cash collected on behalf of charities |
| — |
| 211,717 |
| 23,836 |
|
| — |
|
| ||||
Net cash used in operating activities |
| (17,121,071 | ) | (17,754,892 | ) | (18,476,436 | ) |
| (230,942,307 | ) |
| ||||
|
|
|
|
|
| (Continued) |
| ||||||||
See accompanying notes to consolidated financial statements.
F-12
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows (Continued)
Years ended December 31, 2005 2004 2003 and the Period
From February 12, 1988 (Date of Inception) through December 31, 2005
|
| 2005 |
| 2004 |
| 2003 |
| Period from |
| ||||||
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
| ||||
Acquisition of property and equipment |
| (160,829 | ) | (304,172 | ) | (985,146 | ) |
| (12,893,623 | ) |
| ||||
Investment in GlobalWave joint venture |
| — |
| — |
| — |
|
| (5,701,250 | ) |
| ||||
Cash received in GlobalWave acquisition |
| — |
| — |
| — |
|
| 1,380,464 |
|
| ||||
Purchase of intangible assets |
| — |
| — |
| — |
|
| (2,500,000 | ) |
| ||||
Short-term loans to affiliate |
| — |
| — |
| — |
|
| (1,672,934 | ) |
| ||||
Organizational costs |
| — |
| — |
| — |
|
| (14,966 | ) |
| ||||
Proceeds provided by sale of marketable equity securities |
| 336,309 |
| 6,759,751 |
| 430,934 |
|
| 9,689,447 |
|
| ||||
Exercise of warrant to acquire marketable equity securities |
| — |
| — |
| — |
|
| (1,620,000 | ) |
| ||||
Net cash provided by (used in) investing activities |
| 175,480 |
| 6,455,579 |
| (554,212 | ) |
| (13,332,862 | ) |
| ||||
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net proceeds from issuance of common stock |
| 13,145,701 |
| 8,286,920 |
| 11,924,486 |
|
| 225,968,325 |
|
| ||||
Net proceeds from issuance of preferred stock and warrants |
| — |
| — |
| 4,780,540 |
|
| 16,988,573 |
|
| ||||
Payment on (issuance of) note receivable from stockholder |
| — |
| — |
| 1,135,320 |
|
| — |
|
| ||||
Payment of dividends on preferred stock |
| — |
| — |
| (212,517 | ) |
| (212,517 | ) |
| ||||
Proceeds from notes payable and warrants to stockholders |
| — |
| — |
| — |
|
| 4,083,972 |
|
| ||||
Repayments of notes payable to stockholders |
| — |
| — |
| — |
|
| (1,069,972 | ) |
| ||||
Proceeds from notes payable and warrants |
| — |
| — |
| — |
|
| 1,284,250 |
|
| ||||
Repayments of note payable |
| — |
| — |
| — |
|
| (255,000 | ) |
| ||||
Redemption of Preferred Stock |
| — |
| — |
| — |
|
| (506,440 | ) |
| ||||
Net cash provided by financing activities |
| 13,145,701 |
| 8,286,920 |
| 17,627,829 |
|
| 246,281,191 |
|
| ||||
Net increase (decrease) in cash and cash equivalents |
| (3,799,890 | ) | (3,012,393 | ) | (1,402,819 | ) |
| 2,006,022 |
|
| ||||
Cash and cash equivalents at beginning of year |
| 5,805,912 |
| 8,818,305 |
| 10,221,124 |
|
| — |
|
| ||||
Cash and cash equivalents at end of year |
| $ | 2,006,022 |
| $ | 5,805,912 |
| $ | 8,818,305 |
|
| $ | 2,006,022 |
|
|
Supplemental information about noncash investing and financing activities:
On March 27, 2003 Wave granted a bonus to an officer that was used to repay a note receivable in the amount of $281,399, consisting of $250,000 in principal and $31,899 in accrued interest (see note 5).
Wave recorded accretion of discount of $5,485,000 for the year ended December 31, 2003 in connection with the issuance of 548.5 shares of its Series H Convertible Preferred Stock (see note 8).
During 2003 Wave issued 7,217,105 shares of Class A Common Stock in connection with the conversion of 548.5 shares of Series H Convertible Preferred Stock, with an aggregate face value of $5,485,000 at a conversion price of $0.76 per share of Class A Common Stock.
See accompanying notes to consolidated financial statements.
F-13
Wave Systems Corp., a development stage company, develops, produces and markets products for hardware-based digital security including security applications and services that are complementary to and compliant with the specifications of the Trusted Computing Group, www.trustedcomputinggroup.org (“TCG”). Specifications developed by the TCG are designed to address a broad range of current and evolving digital security issues facing the industry. These issues include the following: identity protection, data security, digital signatures, electronic transaction integrity, platform trustworthiness, network security, and regulatory compliance. Wave’s products are designed to solve many of these digital security issues.
The financial statements of Wave have been presented in the development stage format as prescribed by Statement of Financial Accounting Standards No. 7. Management has determined that Wave meets the criteria of a development stage enterprise as prescribed in Statement of Financial Accounting Standard No. 7 because it has devoted substantially all of its efforts since inception toward research and development activities and establishing a new business; and although planned principal operations have commenced, there has been no significant revenue from those operations.
The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has incurred substantial operating losses since its inception, and as of December 31, 2005, has an accumulated deficit of $284,746,826. We also expect Wave will incur an operating loss for the calendar year of 2006. As of December 31, 2005, we had negative working capital of $1,112,413.
Wave has begun market introduction of its security and broadband media distribution software products and has signed initial distribution contracts for these applications. However, due to the early stage nature of this market, it is unlikely that Wave will generate sufficient revenue to cover all of its cash flow needs to fund its operating requirements for the year ending December 31, 2006.
Because Wave does not have sufficient cash to fund operations for the year ending December 31, 2006; and given the uncertainties described above with respect to Wave’s revenue outlook for 2006, Wave has been and will continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending December 31, 2006. These activities include the filing of a second $25,000,000 S-3 shelf registration with the SEC on December 16, 2005 which was declared effective on January 31, 2006; and the sale of 8,348,598 shares of common stock at $0.535 per share for gross proceeds of $4,466,500 in an initial round of financing under this shelf registration on February 15, 2006, upon which we received approximately $4,247,000 in net proceeds. We also granted warrants as part of the February 15 financing that will allow the purchasers to acquire an additional 1,550,868 shares of Wave common stock for $0.72 per share. If exercised, the warrants will generate additional gross proceeds of $1,116,625. These warrants expire on August 15, 2006.
It is likely that we will be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, utilizing this shelf registration, to raise additional capital to continue to fund our operations for the year ending December 31, 2006. The remaining availability under this shelf registration statement for future financings, after subtracting the proceeds from the February 15, 2006 financing referred to above is $20,533,500, including $1,116,625 reserved for the warrants.
Also, previously, on April 15, 2004 Wave filed a $25,000,000 registration statement with the SEC, under which Wave has drawn down a total of $22,219,030 in gross proceeds, through various sales of common stock and issuances of Warrants (See footnote 8). Accordingly, there remains approximately $2,781,000 in gross proceeds available under the April 15, 2004 shelf of which $875,000 is reserved for warrants to purchase 1,093,750 shares with an exercise price of $0.80, that expire May 5, 2006.
F-14
(2) Liquidity (Continued)
The combined availability under the two registration statements for future financings totals $23,314,500, of which $1,991,625 is reserved for outstanding warrants. The availability and amount of any such financings are unknown at this time. In addition, presently the outstanding warrants are “out-of-the-money” and will expire unexercised if the market price of Wave’s common stock does not exceed the exercise prices of the warrants before their expiration date.
Considering our current cash balance, including the additional capital raised on February 15, 2006 that is referred to above, we project that we have enough liquid assets to continue operating into May 2006. We estimate we will need a minimum of approximately $12,000,000 of additional cash from a combination of revenue growth and additional financings, to fund operating expenses and capital expenditures for the year ending December 31, 2006.
If Wave is not successful in raising the needed capital referred to above, or is not successful in executing its business plan, we could be forced to reduce expenses which may significantly impede our ability to meet our sales, marketing and development objectives, cease operations or merge with another company. No assurance can be provided that any of these initiatives will be successful. 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 enough financing to fund our operations through December 31, 2006 and beyond, and the uncertainty as to whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.
(3) Significant Accounting Policies
(a) Basis of Consolidation
The consolidated financial statements include the financial statements of Wave, Wave Systems Holdings, Inc., a wholly owned subsidiary and Wavexpress, Inc. a majority-owned joint venture. All significant intercompany accounts and transactions have been eliminated in consolidation.
(b) Use of Estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, depreciation and amortization, charges for other than temporary declines in value of marketable equity securities and other special charges, inventory allowances and contingencies. Actual results could differ from those estimates.
(c) 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 (see note 12).
(d) Cash and Cash Equivalents
Wave considers all highly liquid instruments with an original or remaining maturity of three months or less to be cash equivalents. Substantially all cash and cash equivalents are custodial with two major financial institutions.
(e) 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
F-15
(3) Significant Accounting Policies (Continued)
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 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, 2004, all of Wave’s marketable equity securities were classified as available-for-sale. Wave held no marketable securities as of December 31, 2005.
(f) Property and Equipment
Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets which range from between three to five years. Amortization of leasehold improvements is computed using the remaining lease terms.
(g) Income Taxes
Wave accounts for income taxes under the asset and liability method. As such, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(h) Stock Option Plan
Statement of Financial Accounting Standards No. 123, “Accounting for Stock-based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation Transition and Disclosure—an amendment to FASB Statement No. 123,” (“SFAS No. 123”) allows companies to recognize expense for the fair value of stock-based awards or to continue to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees,” and disclose the effects of SFAS No. 123 as if the fair-value-based method defined in SFAS No. 123 had been applied. Under APB Opinion No. 25, compensation expense is recognized only if on the measurement date the fair value of the underlying stock exceeds the exercise price. Wave has elected to apply the intrinsic value method pursuant to APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123 and SFAS No. 148.
F-16
(3) Significant Accounting Policies (Continued)
The following table presents Wave’s pro forma net loss and loss per share as if the company had accounted for stock options under SFAS No. 123 for the years ended December 31:
|
| 2005 |
| 2004 |
| 2003 |
| |||
Net loss—as reported |
| $ | (17,562,462 | ) | $ | (14,498,038 | ) | $ | (19,594,798 | ) |
Pro-forma compensation cost using the fair-value method |
| (2,103,508 | ) | (2,840,103 | ) | (3,023,011 | ) | |||
Net loss—pro forma |
| (19,665,970 | ) | (17,338,141 | ) | (22,617,809 | ) | |||
Net loss to Common stockholders—as reported |
| (17,562,462 | ) | (14,498,038 | ) | (25,292,316 | ) | |||
Net loss to Common shareholders—pro forma |
| (19,665,970 | ) | (17,338,141 | ) | (28,315,327 | ) | |||
Loss per Common share—as reported |
| (0.21 | ) | (0.21 | ) | (0.45 | ) | |||
Loss per Common share—pro forma |
| $ | (0.24 | ) | $ | (0.25 | ) | $ | (0.51 | ) |
The per share weighted-average fair value of stock options granted under all plans for the years ended December 2005, 2004 and 2003 pursuant to SFAS No. 123 were $0.81, $1.03 and $1.20, respectively. The expense that would have been recognized pursuant to SFAS No. 123 and the weighted average fair values per share referred to herein were arrived at using the Black Scholes option-pricing model with the following weighted-average assumptions:
|
| 2005 |
| 2004 |
| 2003 |
|
Expected Life (Years) |
| 5 |
| 5 |
| 5 |
|
Interest Rate |
| 4.23 | % | 3.675 | % | 3.25 | % |
Volatility |
| 104 | % | 120 | % | 125 | % |
Dividend Yield |
| 0 | % | 0 | % | 0 | % |
Wave applies APB Opinion No. 25 in accounting for its Plans. Compensation expense has been recognized in the financial statements for Stock options granted to employees at exercise prices below fair market value of approximately $7,294 in 2005, $0 in 2004 and $146,000 in 2003.
(i) Research and Development and Software Development Costs
Research and development costs are expensed as incurred. Software development costs are accounted for pursuant to Statement of Financial Accounting Standards No. 86 “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” which requires software development costs for products that have achieved commercial marketability to be capitalized subsequent to the establishment of a product’s technological feasibility and prior to general release of the product. Wave did not capitalize any software development costs for 2005. Wave capitalized software development costs of approximately $73,000 and $712,000 during the years ended December 31, 2004 and 2003, respectively. Amortization of capitalized software costs for the years ended December 31, 2005, 2004 and 2003 was $621,419, $538,781 and $232,373, respectively
(j) Loss Per Share
Basic net loss per common share has been calculated based upon the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is also computed using the weighted average number of common shares and excludes dilutive potential common shares outstanding, as their effect is anti-dilutive. Dilutive potential common shares consist primarily of employee stock options, stock warrants and convertible preferred stock. Diluted net loss per share is equal to basic net loss per share and is therefore not presented separately in the financial statements. The weighted average number of potential common shares that would have been included in diluted loss per share had their effect not been anti-dilutive for the each of the years ended December 31, 2005, 2004 and 2003 were approximately 200,000 shares, 261,000 shares and 4,200,000 shares, respectively. Employee stock options and other stock warrants to purchase a weighted average of approximately 16,544,000, 14,260,000 and
F-17
(3) Significant Accounting Policies (Continued)
8,784,000 shares were outstanding for the years ended December 31, 2005, 2004 and 2003 respectively, but would not have been included in the computation of diluted loss per share because their exercise price was greater than the average share price of Wave’s common shares and, therefore, their effect would have been anti-dilutive.
(k) 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” (“SFAS No. 144”) and SFAS No.86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” (“SFAS No. 86”), respectively. Wave is required to assess the recoverability of long-lived assets and capitalized software development costs basis 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 capitalized software development costs 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.
(l) Revenue Recognition
Wave’s business model targets revenues from various sources including: licensing of EMBASSY Trust Suite, Wavexpress’ broadband media distribution and eTMS software products and development contracts. Many of our sales arrangements include multiple-elements, and/or required significant modification or customization of our software.
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, delivery has occurred, 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.
F-18
(3) Significant Accounting Policies (Continued)
PRODUCTS—SOFTWARE
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, for arrangements that contain multiple elements. Revenue is deferred for undelivered elements for these arrangements. 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 have been met for that element.
Prepaid royalty fees received pursuant to distribution software licenses with OEMs in which Wave earns a royalty, based upon units shipped by the OEM to end customers, are deferred when received, and recognized as revenue as units are shipped by the OEM.
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.
(m) Accounting for Warrants Containing Cash Settlement Provisions
Wave follows the FASB’s Emerging Issues Task Force pronouncement No. 00-19 (“EITF 00-19”) to account for derivative financial instruments indexed to, and settled in our own stock. These would include financial instruments such as options or warrants to purchase Wave stock, but does not include employee stock options. EITF 00-19 requires that freestanding financial instruments of this nature be classified as an asset or liability at fair value, in the event that the contract underlying any such financial instruments includes a net cash settlement provision. In addition, EITF 00-19 requires any such asset or liability to be marked to market at the end of each period, with any resulting difference in fair value to be recorded as income or loss, through the company’s statement of operations, depending upon whether the difference results in a gain or loss.
F-19
(3) Significant Accounting Policies (Continued)
On November 18, 2003, Wave granted warrants to purchase 931,309 shares of Wave common stock at an exercise price of $2.62 per share, in connection with a private placement of common stock with a group of accredited investors. The warrants have a three-year term. The contract underlying the warrants includes a provision that would require Wave to pay liquidated damages in cash to the warrant holders if the warrants are “in the money” and the registration statement underlying such shares ceases to remain continuously effective. Because of this provision, the contract is considered to contain a net cash settlement provision as defined in EITF 00-19. Although the registration statement was declared effective by the Securities Exchange Commission on February 12, 2004, the net cash settlement provision still applies because of the stipulation that it must remain continuously effective and there are circumstances that could potentially cause the registration statement to cease to remain effective. Accordingly, Wave recorded a liability in its balance sheet that was valued at $2,794 as of December 31, 2005, and $493,128 as of December 31, 2004. These values were arrived at utilizing the Black-Scholes option pricing model with the following assumptions:
|
| As of December 30, 2005 |
| As of December 31, 2004 |
| ||||
Expected life remaining (years) |
|
| .90 |
|
|
| 1.92 |
|
|
Interest rate |
|
| 4.36 | % |
|
| 3.0 | % |
|
Volatility |
|
| 62 | % |
|
| 128 | % |
|
Dividend yield |
|
| 0 | % |
|
| 0 | % |
|
The decrease in fair value of the liability associated with the warrants of $490,334 and $498,723 was recorded as an unrealized gain in Wave’s statement of operations in the year ended December 31, 2005 and 2004, in accordance with EITF 00-19.
(4) Related Party Transactions
(a) Notes Receivable from Officers
Prior to the enactment of the Sarbanes-Oxley Act of 2002, Wave had made loans to certain of its officers. Some of the loans were extended beyond their original terms by one year. These loans and the 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 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. All loans to officers have been paid in full, therefore there were no balances owed on the loans as of December 31, 2005 and 2004. Details with respect to the officer loans are as follows:
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 bore interest at a rate per annum equal to 1% over the prime interest rate. Interest on the loan accrued monthly and was payable at maturity. The terms of the loan were substantially equivalent to market terms at that time. The due date of the demand note was subsequently extended until March 26, 2003. As of March 26, 2003 the loan balance, including accrued interest thereon was $281,399. On March 27, 2003, the Compensation Committee approved a bonus in an amount equal to Mr. Feeney’s obligations with respect to such loan and accrued interest. Proceeds of this bonus were used to repay the loan and all interest accrued on such loan. The bonus was granted during the year so that Mr. Feeney could repay his loan, rather than at fiscal year end when bonuses are usually awarded. The factors used in granting this extraordinary bonus were the amount of the loan, the ability to repay the loan and the impact that non-repayment of the loan would have on Mr. Feeney’s abilities to fulfill his duties for Wave. Wave no longer intends to award bonuses to executive officers or directors in
F-20
(4) Related Party Transactions (Continued)
order for them to repay outstanding loans because there are no outstanding loans to any current executive officers or directors and the Sarbanes-Oxley Act of 2002 prohibits any future such loans. The largest aggregate amount outstanding with respect to indebtedness of Mr. Feeney during the year ended December 31, 2003 was $281,399. Wave has taken this 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 evidenced by demand notes for $713,320 dated February 27, 2001, $184,500 dated July 25, 2001 and $164,000 dated September 5, 2001 for a total of $1,062,000. These demand notes carried terms of one year and bore interest at a rate per annum equal to 1% over the prime rate of interest. Interest on the loans accrued monthly and was payable at maturity. The terms of the loans were substantially equivalent to market terms at that time. Two of the loans in the amount of $713,320 and $184,500 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. The remaining loan that had an original face value of $164,319, the balance of which was $174,391 including accrued interest, came due in September 2002. On November 12, 2002, the Compensation Committee approved the payment of a bonus that Mr. Sprague used to repay the $164,319 balance of the note plus accrued interest of $10,072. This bonus was granted during the year so that Mr. Sprague could repay his loan, rather than at fiscal year end when bonuses are usually awarded. This bonus was awarded based on the same factors as the bonus awarded to Mr. Feeney.
Wave had recorded a reserve for uncollectibility for 100% of the loans that were outstanding as of December 31, 2002, which totaled $999,518, because the Company had determined that there was substantial doubt as to Mr. Sprague’s ability to repay the loans. Mr. Sprague resigned as Chairman of Wave as of March 31, 2003 and was appointed Chairman and Chief Executive Officer of Wavexpress. On August 14, 2003, Mr. Sprague repaid the entire balance outstanding as of that date of $1,028,087, consisting of $897,820 in original principal and $130,267 in interest from origination through the date of repayment. Accordingly, Wave reversed the reserve previously established in the amount of $999,518 and recorded interest income of $28,569 in its Statement of Operations for the year ended December 31, 2003.
Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a written policy prohibiting future loans to officers and directors.
(b) Payments to Related Party
In March 2003, Mr. Peter Sprague, who is the former Chairman of Wave, was appointed Chairman and Chief Executive Officer of Wavexpress. Mr. Sprague was paid $129,000, $175,667 and $185,000 for the years ended December 31, 2005, 2004 and 2003, respectively in salary in this capacity (for the year ended December 31, 2003, $138,750 was paid by Wavexpress for Mr. Sprague’s duties as an officer of Wavexpress and $46,250 was paid by Wave for Mr. Sprague’s duties as an officer of Wave.) Mr. Peter Sprague is the father of Wave’s President and Chief Executive Officer, Steven Sprague.
On August 1, 1997, Michael Sprague became an employee of Wave, at an annual salary of $110,000. On November 1, 1999 he became an employee of Wavexpress at an annual salary of $120,000 and was paid $150,000, $150,000 and $143,750 for the years ended December 31, 2005, 2004 and 2003, respectively. Michael Sprague is the brother of Steven Sprague and the son of Wave’s former Chairman, Peter Sprague.
F-21
(5) Property and Equipment
Property and equipment as of December 31 consisted of the following:
|
| 2005 |
| 2004 |
| ||
Computer Equipment |
| $ | 6,003,899 |
| $ | 5,848,420 |
|
Furniture, fixtures and improvements |
| 887,843 |
| 882,492 |
| ||
Computer software |
| 4,821,247 |
| 4,821,248 |
| ||
|
| 11,712,989 |
| 11,552,160 |
| ||
Less: Accumulated depreciation and amortization |
| 10,958,836 |
| 10,117,107 |
| ||
Total |
| $ | 754,153 |
| $ | 1,435,053 |
|
Computer software includes $1,864,256 of capitalized software development costs pursuant to SFAS 86 as of December 31, 2005 and 2004. Capitalized software pursuant to SFAS 86 is amortized over a three-year life using the straight-line method, once the product is ready to bring to market.
Depreciation and amortization expense on property and equipment amounted to approximately $842,000, $855,000 and $1,241,000 for the years ended December 31, 2005, 2004, 2003, respectively.
(6) Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses as of December 31 consisted of the following:
|
| 2005 |
| 2004 |
| ||
Accounts payable |
| $ | 993,926 |
| $ | 819,278 |
|
Accrued consulting and professional fees |
| 472,290 |
| 531,165 |
| ||
Accrued payroll and related costs |
| 1,139,814 |
| 1,012,897 |
| ||
Accrued rent |
| 53,905 |
| 77,670 |
| ||
Annual report and shareholders meeting |
| 77,073 |
| 80,404 |
| ||
State & local taxes payable |
| 92,397 |
| 72,472 |
| ||
Accrued software licenses |
| 162,500 |
| 162,500 |
| ||
Accrued expenses in connection with sales of Wave common stock |
| 54,219 |
| 43,544 |
| ||
Other accrued expenses |
| 43,026 |
| 100,134 |
| ||
Total accounts payable and accrued expenses |
| $ | 3,089,150 |
| $ | 2,900,064 |
|
(7) Preferred Stock
(a) Series H Preferred Stock
Wave has authorized 2,000,000 shares of preferred stock having a par value of $.01 per share.
On April 30, 2003, Wave completed a private placement of 548.5 shares of its Series H Convertible Preferred Stock (the “Series H Stock”) and warrants to purchase Wave’s Class A Common Stock for an aggregate purchase price of $5,485,000, with a group of institutional and accredited investors. Wave realized aggregate proceeds of $4,780,540 net of commissions and other cash fees of $704,460, in connection with the transaction. In addition, Wave incurred commissions of $315,971 for the fair market value of warrants granted to placement agents to purchase approximately 325,000 shares of Wave’s Class A Common Stock at $0.01. As of December 31, 2003 all 548.5 shares of Series H Stock were converted at a conversion price of $0.76 into 7,217,105 shares of Class A Common Stock. In addition, 2,632,311 shares of Class A Common Stock were issued in connection with the exercise of Series H Warrants for net proceeds of $2,490,167. Series H Warrants to acquire 65,789 shares of Class A Common Stock remain outstanding as of March 1, 2005, at an exercise price of $1.13 per share.
F-22
(7) Preferred Stock (Continued)
Dividends on the Series H Stock accrued on the initial liquidation preference amount of each share ($10,000) at an annual rate of 10%, and would have increased to 12% on April 30, 2004. Dividends were payable out of any assets legally available to pay dividends when and if declared by the board of Directors of the Company, or upon liquidation or conversion of the Series H Stock. Dividend expense in connection with converted Series H Stock (not including accretion of discount on the Series H Stock) for the year ended December 31, 2003 totaled $212,510.
Pursuant to the Series H Convertible Preferred Stock Purchase Agreement (the “Series H Purchase Agreement”), the Series H Stock was convertible, at the option of the holder, on the trading day following the date of Wave’s 2003 annual meeting of stockholders in which stockholders would vote on the proposal to approve the issuance of shares of Class A Common Stock in excess of 19.99% of the number of shares of Class A Common Stock outstanding prior to April 30, 2003, upon the conversion and exercise of shares of Series H Convertible Preferred Stock and the related Warrants. The Series H Stock was initially convertible into 7,217,105 shares of Wave’s Class A Common Stock at an initial conversion price of $0.76 per share. The excess of the estimated aggregate fair value of the Series H Stock upon conversion over the proceeds of the Series H Stock has been calculated as follows:
Class A Common Shares if converted |
| 7,217,105 |
| |
Closing price on April 30, 2003 |
| $ | 0.98 |
|
Aggregate fair value upon conversion |
| $ | 7,072,763 |
|
Gross Proceeds of Series H Stock |
| 5,485,000 |
| |
Excess fair value upon conversion |
| $ | 1,587,763 |
|
As part of the transaction, Wave issued to the investors warrants to purchase shares of Class A Common Stock, with an initial exercise price of $1.13 per share and a five (5) year life (the “Series H Warrants” and, together with Series H Stock, the “Series H Securities”). Initially, the Series H Warrants were exercisable for a total of 3,608,558 shares of Class A Common Stock on the trading day following the date of Wave’s 2003 annual meeting of stockholders. If exercised in full, the original Series H Warrants would have generated up to an additional $4,077,671, at the initial exercise price.
During September 2003 the terms of the Series H Purchase Agreement and other documents governing the Series H Stock and the Series H Warrants were modified, pursuant to a letter agreement and waiver (collectively the “Waiver”) whereby, each holder that executed the Waiver was required to convert their Series H Stock on the effective date of the Waiver and agreed to allow Wave to reduce their Series H Warrant shares by the holders’ proportion of a 900,000 reduction in the total number of Series H Warrant shares. This allowed the holders of the Series H Securities to convert and exercise their Series H Securities prior to the shareholder vote to approve or disapprove the issuance of shares because it was no longer in excess of 19.99% of the Class A Common Stock outstanding before the issuance of the Series H Securities. In the absence of these Waivers, any such conversion or exercise prior to the shareholder vote would have violated Nasdaq listing requirements. Also, pursuant to the Waiver, the exercise price of the Series H Warrants was reduced from $1.13 to $1.00 for the holders that signed the Waiver.
In connection with the issuance of the Series H Stock and the Series H Warrants, Wave recorded a beneficial conversion feature discount of $2,903,146 in the quarter ended June 30, 2003. In addition, $1,561,424 was allocated to the Series H Warrants as an additional discount to the Series H Stock. The remaining gross proceeds of $1,020,430 were allocated to commissions and fees on the Series H Stock, therefore, no proceeds remained to allocate to the preferred stock. Wave followed the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) 98-5 and EITF 00-27 in determining the beneficial conversion feature, whereby the proceeds were first allocated to the Series H Stock and the
F-23
(7) Preferred Stock (Continued)
warrants on a relative fair value basis. Wave utilized the Black Scholes option pricing model to calculate the fair value of the Series H Warrants with the following assumptions:
Expected Life in years |
| 5 |
|
Interest rate |
| 3.0 | % |
Volatility |
| 112.8 | % |
Dividend yield |
| 0 | % |
The fair value of the Series H Stock was calculated as the number of shares of Class A Common Stock that the Series H Stock is convertible into, multiplied by the closing price of Wave’s Class A Common Stock on Nasdaq on the closing date of this financing. The value of the beneficial conversion feature was calculated by multiplying the number of Class A Common shares that the Series H Stock was convertible into by the intrinsic value per share, which was calculated as the closing price of Wave’s Class A Common Stock on Nasdaq as of April 30, 2003 less the effective conversion price of the Series H Stock. The beneficial conversion feature and warrant discount were accreted as a dividend on a straight line basis, which approximated the effective yield over the period from the date of issuance through the trading day following Wave’s annual meeting of stockholders in which stockholders would vote on the proposal to approve the issuance of shares of Class A Common Stock in excess of 19.99% of the number of shares of Class A Common Stock outstanding prior to April 30, 2003, upon the conversion and exercise of shares of Series H Stock and the related Warrants, which was initially scheduled for August 27, 2003 and then amended on August 11, 2003 to be held by November 17, 2003. As of December 31, 2003, the balance of the Series H Stock, net of all discounts, consisted of the following:
Gross offering proceeds |
| $ | 5,485,000 |
|
Fees and Commissions deducted from proceeds |
| (704,459 | ) | |
Net Cash proceeds |
| 4,780,541 |
| |
Placement agent warrants |
| (315,970 | ) | |
Net Series H Stock after all fees |
| 4,464,571 |
| |
Additional Discounts: |
|
|
| |
Series H Warrants |
| (1,561,425 | ) | |
Beneficial Conversion Feature (BCF) |
| (2,903,146 | ) | |
Total Additional Discounts |
| (4,464,571 | ) | |
Net Series H Stock after allocations |
| -0- |
| |
Accretion of Discounts: |
|
|
| |
Placement agent warrants |
| 315,971 |
| |
Fees paid or deducted from proceeds in cash |
| 704,458 |
| |
Series H Warrants |
| 1,561,425 |
| |
BCF |
| 2,903,146 |
| |
Total Accretion of Discounts |
| 5,485,000 |
| |
Preferred Stock value as of December 31, 2003 |
| 5,485,000 |
| |
Conversion of 548.5 shares of Series H Stock |
| (5,485,000 | ) | |
Balance as of December 31, 2003 |
| $ | -0- |
|
The registration statement that Wave filed with the Securities and Exchange Commission covering the resale of the shares of Wave’s Class A Common Stock issuable upon conversion or exercise of the Series H Stock and the Series H Warrants was declared effective by the Securities and Exchange Commission on August 24, 2003.
F-24
(7) Preferred Stock (Continued)
(b) Series G Preferred Stock
During March of 1998, Wave issued 150,000 shares of newly created Series G Convertible Preferred Stock for an aggregate purchase price of $3,000,000. The Series G Convertible Preferred Stock was senior to Wave’s classes of Common Stock, and was junior to Wave’s Series A Preferred Stock in liquidation rights. The Series G Convertible Preferred Stock accrued dividends at the rate of 6% per annum. The Series G Convertible Preferred Stock was convertible into Wave’s unregistered Class A Common Stock at the lower of $1.12 or 80% of the average of the five lowest closing bids for the 25 calendar days prior to conversion. In addition, Wave issued warrants to the purchaser and placement agent for 225,000 shares of Wave’s Class A Common Stock at an exercise price of $1.38. The Series G Convertible Preferred Stock was converted into 2,394,494 and 377,102 shares of Wave’s Class A Common Stock during 1998 and 1999, respectively.
(c) Series F Preferred Stock
In October 1997 Wave raised approximately $1,850,000, net of issuance costs of $397,000 ($224,000 of which related to the value ascribed to warrants issued), through the private placement of 112,500 shares of newly created Series F Convertible Preferred Stock. The Series F Convertible Preferred Stock had a stated value of $20 per share, which accrued dividends payable quarterly in cash at 6%. The Series F Convertible Preferred Stock was convertible into the Class A Common Stock at an effective conversion price of the lower of (a) $1.05 and (b) 80% of the average of the five (5) lowest trading prices of Class A Common Stock. During 1997 all of the Series F Convertible Preferred Stock was converted into 2,961,086 shares of Wave’s Class A Common Stock.
(d) Series D Preferred Stock
In May of 1997 Wave raised approximately $1,316,000, net of issuance costs of $272,000 ($162,000 of which related to the value ascribed to warrants issued), through the placement of 80,000 shares of newly created Series D Convertible Preferred Stock. The Series D Preferred Stock had a stated value of $20 per share, which accrued dividends payable quarterly in cash at 6%.
The Series D Convertible Preferred Stock was convertible into the Class A Common Stock of Wave at an effective conversion price of the lower of (i) $1.35, or (ii) 80% of the average closing bid price on the NASDAQ National Market System of Wave’s Class A Common Stock for the five (5) trading days immediately preceding the date of conversion. During 1997 all of the Series D Convertible Preferred Stock was converted into 2,070,095 shares of Wave’s Class A Common Stock.
(e) Series C Preferred Stock
In December of 1996, Wave raised $2,634,037 net of issuance costs of $365,963 ($101,964 of which related to the value ascribed to warrants issued) through the placement of 150,000 shares of Series C Preferred Stock pursuant to Regulation D of the Act. The Series C Preferred Stock had a stated value of $20 per share, which accrued dividends payable quarterly in cash at 6% per annum.
The Series C Preferred Stock ranked senior to Wave’s Common Stock and junior to the Series A and B Preferred Stock. Series C Preferred Stock was convertible by the holder, in increments, into Wave’s Class A Common Stock based on the market price of Wave’s Class A Common Stock at the time of conversion. The Series C Preferred Stock was convertible at the lesser of $2.31 per share or 80%, as adjusted, of the average of the fair value of the Class A Common Stock for the five days prior to the conversion date. During 1997 all of the Series C Preferred Stock was converted into 2,850,439 shares of Wave’s Class A Common Stock.
F-25
(7) Preferred Stock (Continued)
(f) Series B Preferred Stock
In May of 1996, Wave raised $3,214,026, net of issuance costs of $285,974, through the placement of 350 shares of Series B Preferred Stock (“Series B Preferred Stock”) pursuant to Regulation S of the Securities Act of 1933 (“the Act”). The Series B Preferred Stock had a stated value of $10,000 per share, accrued dividends for liquidation and conversion purposes at 6% per annum and ranked senior to Wave’s Common Sock and Series C Convertible Preferred Stock (“Series C Preferred Stock”) and junior to the Series A Preferred Stock. Series B Preferred Stock was convertible by the holder, in increments, into Wave’s Class A Common Stock. The Series B Preferred Stock was convertible at the lesser of 110% of the average closing bid price for the five days immediately preceding the issue date or 85% of the average closing bid price for the five days immediately preceding the conversion date.
During 1996, 330 shares of Wave’s Series B Preferred Stock were converted into 2,960,303 shares of Wave’s Class A Common Stock and the remaining 20 shares of Series B Preferred Stock were converted in 1997 into 117,240 shares of Wave’s Class A Common Stock.
(g) Series A Preferred Stock
On October 19, 1992, the Board of Directors designated and issued 360 shares of this preferred stock of Wave as “Series A Cumulative Redeemable Preferred Stock” (“Series A Preferred Stock”). The Series A Preferred Stock was issued in settlement of compensation owed to a former officer of Wave for services provided to Wave. The holder of the Series A Preferred Stock was entitled to receive a dividend at the rate of $60 per share per annum, when and as declared by the Board of Directors of Wave. Dividends were cumulative from the date of original issue, and payable upon redemption. On August 11, 1999, Wave redeemed these shares for a total payment of $506,440, including accrued and unpaid dividends.
(8) Common Stock
On December 5, 2005, Wave entered into a Securities Purchase Agreement, pursuant to which Wave sold and issued 5,982,906 shares of Class A Common Stock, par value $.01 per share, to certain purchasers who are parties to the Purchase Agreement for an aggregate purchase price of $3,500,000. The Common Shares were priced at $0.585 per share. JPC Capital Partners, Inc. (formerly Corpfin Inc.) (the “Placement Agent”), had entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave paid the Placement Agent a fee equal to 4.0% of the gross proceeds of this offering. Wave realized net proceeds of $3,340,890 after deducting placement agent and other fees associated with the issuance of these securities.
On August 5, 2005, Wave entered into a securities purchase agreement, pursuant to which Wave agreed to sell and issue 4,000,000 shares of Class A Common Stock, par value $.01 per share, for $0.90 per share, to certain purchasers who are parties to the Purchase Agreement for an aggregate purchase price of $3,600,000. The Placement Agent had entered into a placement agency agreement with Wave in which they agreed to act as a placement agent in connection with the offering. Wave has agreed to pay the Placement Agent a fee equal to 4.0% of the gross proceeds of this offering. Wave realized net proceeds of $3,389,205 after deducting the placement agent fees of $144,000 and additional legal and other fees associated with the issuance of these securities of $66,795.
On August 1, 2005, Wave received gross proceeds of $2,260,000 less placement agent fees of $90,400 for net proceeds of $2,169,600, for the issuance of 2,000,000 shares of Class A Common Stock upon partial exercise of a warrant that was granted to an accredited investor as part of a securities purchase agreement with the accredited investor, dated July 30, 2004. The warrants were exercised at a price of $1.13 per share.
On March 15, 2005, Wave entered into a securities purchase agreement, pursuant to which Wave sold and issued 4,659,090 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase
F-26
(8) Common Stock (Continued)
price of $4,100,000. The shares of Class A Common Stock were priced at $0.88. The Placement Agent, had entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave paid the placement agent a fee equal to 4% of the gross proceeds of this offering. Wave realized net proceeds of $3,891,959 after deducting placement agent and other fees associated with the issuance of these securities, which totaled $208,041.
On December 16, 2004, Wave entered into a Securities Purchase Agreement, pursuant to which Wave sold and issued 5,484,790 shares of Class A Common Stock, par value $.01 per share, to certain purchasers who are parties to this purchase agreement for an aggregate purchase price of $5,759,030. The Common Shares were priced at $1.05. The Placement Agent had entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave paid the Placement Agent a fee equal to 4.0% of the gross proceeds of this offering. Wave realized net proceeds of $5,474,728 after deducting placement agent and other fees associated with the issuance of these securities.
On July 30, 2004, Wave entered into a securities purchase agreement, pursuant to which Wave sold and issued 3,529,412 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,000,000. The shares of Class A Common Stock were priced at $0.85. Wave realized net proceeds of $2,777,897 after deducting placement agent and other fees associated with the issuance of these securities. Wave also granted warrants to purchase up to 4,411,765 shares of Class A Common Stock, in connection with this securities purchase agreement.
The warrants granted in this transaction were made up of two different series, Series A and Series B. The Series A warrants were exercisable for up to 3,529,412 shares of Class A Common Stock at an exercise price of $1.15 per share. The Series A warrants were exercisable from January 30, 2005, until August 1, 2005. The Series B warrants are exercisable for up to 882,353 shares of Class A Common Stock at an exercise price of $1.30 per share. The Series B warrants are exercisable from July 30, 2005, until January 30, 2006. The Series A and Series B warrants issued in this transaction carries a subsequent equity clause that requires Wave to adjust the initial exercise price, pro-rata, for any subsequent equity sales that are made at a price that is lower than the initial exercise price. As a result several sales of common stock subsequent to the July 30, 2004 securities purchase agreement, the exercise prices of the Series A and Series B warrants were adjusted to $1.13 and $1.20, respectively, in accordance with the formula pursuant to the warrant agreements. On August 1, 2005 a Series A Warrant holder exercised a portion of the Series A Warrant for a total of 2,000,000 shares at an exercise price of $1.13 per share, for aggregate gross proceeds of $2,260,000, less placement agent fees of $90,400, for net proceeds of $2,169,600. The remaining Series A warrants for 1,529,412 shares expired on August 1, 2005. All of the Series B Warrants granted in connection with the July 30, 2004 securities purchase agreement remain outstanding as of December 31, 2005.
Wave also granted the purchaser a 90-day additional investment right and two series of warrants. The additional investment right granted in this transaction allowed the purchaser to purchase up to 3,529,412 additional shares of Class A Common Stock at a price of $1.00 per share, and expired on November 2, 2004 unexercised. These shares would have been drawn-down off of the shelf registration statement, had the investment right been exercised.
The Placement Agent entered into a placement agency agreement with Wave in which they have agreed to act as placement agent in connection with the offering. Wave has agreed to pay the Placement Agent a fee equal to 4.0% of the actual gross proceeds from the sale of the shares and exercise of the investment rights and warrants referred to above.
F-27
(8) Common Stock (Continued)
All of the above shares were drawn-down off of a shelf registration statement which was filed by Wave on April 15, 2004 and declared effective by the Securities and Exchange Commission (the “SEC”) on May 10, 2004.
On December 1, 2005 Wave sold 238,666 shares of Class A Common Stock to Wave and Wavexpress employees for $0.68 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $162,293, from the sale of these shares.
On June 1, 2005 Wave sold 253,475 shares of Class A Common Stock to Wave and Wavexpress employees for $0.7565 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $191,754, from the sale of these shares.
On November 18, 2003, Wave issued 3,725,263 shares of its Class A Common Stock at a price of $1.90 per share and granted warrants to purchase 931,309 shares of Class A Common Stock at a an exercise price of $2.62 per share in a private placement to a group of accredited investors for proceeds of approximately $6,562,000, net of issuance costs of approximately $516,000. The warrants have a three (3) year term. In addition, in connection with the transaction, Wave incurred commissions of $218,000 for the fair market value of warrants granted to placement agents to purchase approximately 161,595 shares of Wave’s Class A Common Stock. The warrants granted to the placement agents are also exercisable at a price of $2.62 per share and have a 3 year life as well. If exercised in full, the warrants granted in connection with this financing will generate up to an additional $2,863,000, at the exercise price. Pursuant to a registration rights agreement entered into with the accredited investors for the sales of these shares, Wave agreed to file a registration statement with the Securities and Exchange Commission covering the resale of the Class A Common Shares sold and those underlying the warrants. Wave filed a registration statement on Form S-3 covering the resale of the shares on January 20, 2004. On February 12, 2004 the registration statement was declared effective by the Commission.
On July 24, 2002 Wave issued 1,700,000 shares of its Class A Common Stock to Redwave plc in exchange for 60% of the remaining assets of GlobalWave Limited for a total purchase price of approximately $2,244,000. Prior to this transaction, Wave owned 40% of GlobalWave Limited (See Note 13 Joint Ventures).
On February 2, 2001 Wave issued 2,000,000 shares of its Class A Common Stock, at a price of $7.16 per share, for an aggregate purchase price of $14,312,800 to acquire 3,600,000 shares of the Series B Preferred Stock of BIZ, then a privately held company, in a private placement exempt from registration under code section 4(2) of the Securities Act of 1933, as amended. Wave’s investment in BIZ represented approximately 17.8% of the outstanding capital stock of BIZ. On August 24, 2001 Litronic, Inc. (“Litronic”), a provider of authentication and encryption security technology, completed a merger with BIZ to form SSP Solutions. SSP Solutions trades on the NASDAQ National Stock Market as SSPX. As a result of the merger, Wave’s 3,600,000 shares of BIZ were converted into 3,083,083 shares of common stock of SSP.
On August 31, 2000 the Company sold 374,889 shares of its Class A Common Stock, at a price of $19.30 per share in exchange for substantially all of the assets of Indigo Networks, LLC and its e-commerce shopping network, iShopHere.com. Additional costs to complete the transaction were $210,000. These Securities were registered on September 21, 2000.
On March 7, 2000 Wave sold 3,600,800 shares of its Class A Common Stock at a price of $34.00 per share, for an aggregate purchase price of $122,427,200. The shares were sold to a group of accredited investors pursuant to Regulation D promulgated under the Securities Act of 1933, as amended. Pacific Growth Equities, Inc. acted as sole placement agent for the private placement, receiving a commission of 6% or approximately $7.3 million for their services.
F-28
(8) Common Stock (Continued)
In January 2000, the Company issued 275,000 shares of its class A Common Stock to one (1) accredited investor, for an aggregate purchase price of $1,100,000. These shares were issued upon the exercise of a warrant granted on January 26, 1999. The warrant to purchase 275,000 shares of the Company’s Class A Common Stock at an exercise price of $4.00 per share, was exercisable until January 26, 2004. The Warrants were issued as consideration for a $2,000,000 promissory note, bearing no interest, due January 26, 2002.
On March 23, 1999, Wave sold 2,090,954 shares of its Class A Common Stock at a price of $11.00 per share, for an aggregate purchase price of $23,000,494. These shares were sold to a group of accredited investors pursuant to Regulation D promulgated under the securities act of 1933, as amended. Pacific Growth Equities, Inc. acted as sole placement agent for the private placement, receiving a commission of 6% or approximately $1.2 million for their services.
During 1997 Wave issued 126,885 shares of Wave’s Class A Common Stock to vendors or for the settlement of liabilities. Expenses of $305,496 have been recorded representing the stocks’ fair value at the date of issuance.
During 1997 Wave sold approximately 800,000 shares of Wave’s Class A Common Stock and warrants to purchase 160,000 shares of Wave’s Class A Common Stock, exercisable at an exercise price of $1.00, for an aggregate purchase price of $800,000. The warrants were exercised or expired during 1999.
During 1997 Wave issued 500,000 shares of Wave’s Class A Common Stock in connection with a license agreement with Aladdin Knowledge Systems, Ltd. for its proprietary persistent encryption technology. The shares were issued at their fair value on the date of issuance.
In July and August 1996, Wave issued 15,000 and 3,077 shares of Class A Common Stock to two consultants as compensation for services rendered. Expenses of $40,938 have been recorded representing the stock’s fair value of $2.06 and $3.44 per share, respectively, at their dates of issuance.
In July 1995, Wave issued 19,559 shares to two vendors in payment for services rendered. Costs of $20,000 were recorded representing the stock’s fair value of approximately $1.00 per share at the time the services were rendered.
In February 1995, Wave agreed to grant 36,000 shares of Class A Common Stock, 12,000 of which were issued in 1995 with the remainder issued in 1996, to two consultants and six non-employee directors as compensation for services rendered. Expenses of $112,500 were recorded in 1995 representing the stock’s fair value of $3.13 per share at the time of the agreement to grant.
In May and November, 1992, Wave issued 770,000 shares of Class B restricted Common Stock to certain employees, officers and stockholders of Wave for a purchase price of $.003 per share, payable in the form of services to Wave. As these shares were issued for services rendered, compensation expense of $1,927,500 was recorded representing the estimated fair value of $2.50 per share at the date of issuance, the price at which Common Stock was sold to third parties near the time of issuance.
In January 1994, the Board of Directors authorized Wave to amend and restate Wave’s Certificate of Incorporation to reflect the authorization of 25,000,000 shares of a newly created Class A Common Stock, which stock has voting rights of one vote per share, and the reclassification of the then current outstanding shares of Common Stock into Class B Common Stock. In June 1994, the Board of Directors authorized that the Class B Common stock will have one vote per share, except that Class B Common Stock will have five votes per share in cases where one or more directors are nominated for election by persons other than 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, the Class B Common Stock will have five votes per share on all matters submitted to a vote of the stockholders in the event that
F-29
(8) Common Stock (Continued)
any person or group of persons acquires beneficial ownership of 20% or more of the outstanding voting securities of Wave. The Class B Common Stock is convertible into shares of Class A Common Stock at any time. The classes of Common Stock are alike in all other respects.
In December 1989, March through October 1990, and November 1991, substantially all stockholders as of December 29, 1989 were offered the right to acquire a number of shares equivalent to their pre-offering holdings at a price of $.003 per share. Substantially all stockholders that received the offer accepted this offer. This was accounted for essentially as a stock split effected in the form of a rights offering, and all shares issued in conjunction with this offering were reflected in the accompanying consolidated financial statements retroactively.
Two principal stockholders did not acquire the full amount of shares to which they were entitled. Most of the additional proportionate shares that these stockholders would have been credited with were offered instead to certain officers, employees and stockholders for $.003 per share. To the extent that these rights were offered to the individuals as compensation for services rendered to Wave, compensation expense equal to the difference between the estimated fair value as of the date of issuance and the purchase price of the stock was recorded. The estimated fair value of the Common Stock was determined based on sales to third parties near the date of issuance. Compensation expense associated with the issuance of these shares of $430,250 is included in the accompanying consolidated statement of operations for the period from inception to December 31, 2005.
1994 Plans
In January 1994, the Board of Directors authorized the establishment of the 1994 Employee Stock Option Plan (the “1994 Plan”). The initial term of the plan was ten years and the initial number of shares of Class A Common Stock subject to the 1994 Plan was 1,000,000. Options are granted with exercise prices that approximate fair market value at the date of grant. In May 1996, July 1997, November 1998, June 2000, November 2003 and June 2004, Wave’s shareholders approved amendments to Wave’s 1994 Plan to increase the number of shares of Class A Common Stock reserved for issuance there under by 1,000,000, 1,000,000, 5,000,000, 5,000,000, 2,500,000, and 5,000,0000, respectively. Therefore, the total number of shares of Class A Common Stock reserved for issuance under the 1994 Plan, as amended is 20,500,000 shares. In addition, in November 1993, Wave’s shareholders approved an amendment to the 1994 Plan to extend its termination date until January 1, 2009.
In January 1994, the Board of Directors authorized the establishment of the Non-Employee Directors Stock Option Plan (the “Directors’ Plan”). The total number of shares of Class A Common Stock subject to the Directors’ Plan was initially 200,000. Pursuant to the Directors’ Plan, each director who was not an employee of Wave received an initial grant of options to purchase 12,000 shares of Class A Common Stock. Options are granted with exercise prices that approximate fair market value at the date of grant.
Any person subsequently elected as a director who was not an employee of Wave received an initial grant of options to purchase 12,000 shares of Class A Common Stock on the day he or she was elected a director. In addition, on the day immediately following each of the dates on which an incumbent director was reelected, he or she received an additional grant of options to purchase 2,000 shares of Class A Common Stock.
The Stockholders of Wave have since, authorized certain changes to the Directors’ Plan. In February 1995, the annual option grant for directors was increased from a total of 2,000 shares of Class A Common Stock to 10,000 shares of Class A Common Stock. In July 1995, the Board authorized an increase to the total number of shares subject to the Directors’ Plan from 200,000 shares to 500,000 shares. In
F-30
(9) Options and Warrants (Continued)
November 1998, the stockholders of Wave authorized an increase to the total number of shares subject to the Directors’ Plan from 500,000 shares to 1,000,000 shares. The stockholders also amended the Directors’ Plan to provide that options issued to non-employee directors under such plan vest on the day following the grant. (Initial option grants under the Directors’ Plan vested one-third upon grant, and one-third on each of the first and second anniversaries. Annual option grants vested 25% after each three-month period following grant.) In June 2004, Wave’s Stockholders approved an additional amendment to the Directors Plan to extend the termination date of the Directors’ Plan from January 18, 2004 to January 18, 2009.
Options under the Directors’ Plan are exercisable for a period of ten years from the date of grant. Options may not be exercised after the option holder ceases to be a director of Wave, except that in the event of death or disability of the option holder, the option may be exercised for a period of one year after the date of death or disability, and, in the event of retirement of the option holder, the option may be exercised for a period of three months after the date of retirement.
The 1996 Plan
In September 1996, the Board of Directors authorized and the shareholders approved the establishment of the 1996 Performance Stock Option Plan (the “1996 Plan”). The initial number of shares of Class A Common Stock subject to the 1996 Plan was 800,000. The terms of the 1996 Plan are similar to those of the Plan. Options are granted with exercise prices that approximate fair market value at the date of grant.
F-31
(9) Options and Warrants (Continued)
Summary of Option Activity
A summary of option activity for all Wave option plans through December 31, 2005 follows:
|
| Class A and B shares |
| Weighted average |
| |||||
|
| subject to option |
| exercise price |
| |||||
Balance at January 1, 1991 |
|
| — |
|
|
| $ | — |
|
|
Options granted |
|
| 30,000 |
|
|
| 1.67 |
|
| |
Balance at December 31, 1991 |
|
| 30,000 |
|
|
| 1.67 |
|
| |
Options granted |
|
| 816,750 |
|
|
| 1.18 |
|
| |
Balance at December 31, 1992 |
|
| 846,750 |
|
|
| 1.20 |
|
| |
Options granted |
|
| 949,186 |
|
|
| 3.10 |
|
| |
Balance at December 31, 1993 |
|
| 1,795,936 |
|
|
| 2.20 |
|
| |
Options granted |
|
| 310,200 |
|
|
| 3.05 |
|
| |
Options canceled |
|
| (108,500 | ) |
|
| 3.38 |
|
| |
Balance at December 31, 1994 |
|
| 1,997,636 |
|
|
| 2.27 |
|
| |
Options granted |
|
| 777,850 |
|
|
| 2.22 |
|
| |
Options canceled |
|
| (349,205 | ) |
|
| 2.11 |
|
| |
Options exercised |
|
| (681,700 | ) |
|
| 0.64 |
|
| |
Balance at December 31, 1995 |
|
| 1,744,581 |
|
|
| 2.92 |
|
| |
Options granted |
|
| 1,342,075 |
|
|
| 2.65 |
|
| |
Options canceled |
|
| (503,879 | ) |
|
| 3.20 |
|
| |
Options exercised |
|
| (214,091 | ) |
|
| 1.97 |
|
| |
Balance at December 31, 1996 |
|
| 2,368,686 |
|
|
| 2.79 |
|
| |
Options granted |
|
| 707,914 |
|
|
| 1.02 |
|
| |
Options canceled |
|
| (676,741 | ) |
|
| 1.57 |
|
| |
Options exercised |
|
| (70,326 | ) |
|
| 1.90 |
|
| |
Balance at December 31, 1997 |
|
| 2,329,533 |
|
|
| 2.38 |
|
| |
Options granted |
|
| 5,756,893 |
|
|
| 2.47 |
|
| |
Options canceled |
|
| (707,384 | ) |
|
| 2.48 |
|
| |
Options exercised |
|
| (78,653 | ) |
|
| 1.94 |
|
| |
Balance at December 31, 1998 |
|
| 7,300,389 |
|
|
| 2.40 |
|
| |
Options granted |
|
| 1,925,447 |
|
|
| 10.15 |
|
| |
Options canceled |
|
| (450,378 | ) |
|
| 3.51 |
|
| |
Options exercised |
|
| (964,000 | ) |
|
| 1.69 |
|
| |
Balance at December 31, 1999 |
|
| 7,811,458 |
|
|
| 4.33 |
|
| |
Options granted |
|
| 3,444,037 |
|
|
| 13.58 |
|
| |
Options canceled |
|
| (905,145 | ) |
|
| 12.33 |
|
| |
Options exercised |
|
| (2,030,958 | ) |
|
| 2.51 |
|
| |
Balance at December 31, 2000 |
|
| 8,319,392 |
|
|
| 7.90 |
|
| |
Options granted |
|
| 2,934,272 |
|
|
| 3.46 |
|
| |
Options canceled |
|
| (1,128,327 | ) |
|
| 8.16 |
|
| |
Options exercised |
|
| (473,511 | ) |
|
| 1.42 |
|
| |
Balance at December 31, 2001 |
|
| 9,651,826 |
|
|
| 6.85 |
|
| |
F-32
(9) Options and Warrants (Continued)
|
| Class A and B shares |
| Weighted average |
| |||||
|
| subject to option |
| exercise price |
| |||||
Balance at December 31, 2001 |
|
| 9,651,826 |
|
|
| 6.85 |
|
| |
Options granted |
|
| 1,607,959 |
|
|
| 1.94 |
|
| |
Options canceled |
|
| (1,033,989 | ) |
|
| 8.44 |
|
| |
Options exercised |
|
| (42,553 | ) |
|
| 1.04 |
|
| |
Balance at December 31, 2002 |
|
| 10,183,243 |
|
|
| 5.94 |
|
| |
Options granted |
|
| 2,287,670 |
|
|
| 1.41 |
|
| |
Options canceled |
|
| (1,589,495 | ) |
|
| 8.08 |
|
| |
Options exercised |
|
| (1,340,739 | ) |
|
| 2.14 |
|
| |
Balance at December 31, 2003 |
|
| 9,540,679 |
|
|
| 5.03 |
|
| |
Options granted |
|
| 2,344,538 |
|
|
| 1.22 |
|
| |
Options canceled |
|
| (515,355 | ) |
|
| 6.19 |
|
| |
Options exercised |
|
| (32,809 | ) |
|
| 1.04 |
|
| |
Balance at December 31, 2004 |
|
| 11,337,053 |
|
|
| $ | 4.20 |
|
|
Options granted |
|
| 1,509,625 |
|
|
| 1.00 |
|
| |
Options canceled |
|
| (478,068 | ) |
|
| 3.77 |
|
| |
Options exercised |
|
| -0- |
|
|
| 0.00 |
|
| |
Balance at December 31, 2005 |
|
| 12,368,610 |
|
|
| $ | 3.82 |
|
|
At December 31, 2005, there were 8,902,971 options exercisable at prices ranging from $0.69 to $37.50 and there were an additional 8,324,915 shares available for grant.
The following table summarizes information about stock options outstanding at December 31, 2005:
|
| Options Outstanding |
| Options Exercisable |
| ||||||||||||||||
Exercise Price Range |
|
|
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| ||||||||
$0.69 - $1.04 |
| 3,457,994 |
|
| 8.5 years |
|
|
| $ | 0.94 |
|
| 1,052,336 |
|
| $ | 0.93 |
|
| ||
$1.05 - $1.58 |
| 992,979 |
|
| 4.8 years |
|
|
| 1.27 |
|
| 866,081 |
|
| 1.28 |
|
| ||||
$1.59 - $2.39 |
| 2,899,986 |
|
| 7.1 years |
|
|
| 1.79 |
|
| 1,976,903 |
|
| 1.84 |
|
| ||||
$2.40 - $3.60 |
| 323,667 |
|
| 3.6 years |
|
|
| 3.35 |
|
| 313,667 |
|
| 3.37 |
|
| ||||
$3.61 - $5.42 |
| 2,840,881 |
|
| 3.6 years |
|
|
| 3.87 |
|
| 2,840,881 |
|
| 3.87 |
|
| ||||
$5.43 - $8.15 |
| 106,540 |
|
| 4.0 years |
|
|
| 6.76 |
|
| 106,540 |
|
| 6.76 |
|
| ||||
$8.16 - $12.24 |
| 870,863 |
|
| 4.0 years |
|
|
| 11.77 |
|
| 870,863 |
|
| 11.77 |
|
| ||||
$12.25 - $18.38 |
| 624,450 |
|
| 4.3 years |
|
|
| 14.80 |
|
| 624,450 |
|
| 14.80 |
|
| ||||
$18.39 - $27.59 |
| 219,250 |
|
| 4.6 years |
|
|
| 19.61 |
|
| 219,250 |
|
| 19.61 |
|
| ||||
$27.60 - $37.50 |
| 32,000 |
|
| 4.1 years |
|
|
| 31.64 |
|
| 32,000 |
|
| 31.64 |
|
| ||||
Total |
| 12,368,610 |
|
| 6.0 years |
|
|
| $ | 3.82 |
|
| 8,902,971 |
|
| $ | 4.86 |
|
| ||
F-33
(9) Options and Warrants (Continued)
1999 Wavexpress Stock Incentive Plan
In April 2000, the board of directors of Wavexpress authorized the establishment of a stock option plan. The total number of shares of Wavexpress’ Class A Common Stock subject to the Plan is 2,500,000. Options terminate upon the earlier of the date of expiration of the option or upon termination of the employment relationship between Wavexpress and the optionee for any reason other than death, disability or retirement.
Employees are entitled to exercise their options on dates determined by Wavexpress’ Compensation Committee of the Board of Directors. Vesting provisions for options granted generally range from immediate vesting to pro rata vesting over a three-year period.
Stock option activity during 2005, 2004 and 2003 is as follows:
|
| 2005 |
| 2004 |
| 2003 |
| |||||||||||||||
|
| Number of |
| Weighted |
| Number of |
| Weighted |
| Number of |
| Weighted |
| |||||||||
Balance at Beginning of year |
| 1,302,829 |
|
| $ | 1.21 |
|
| 1,315,062 |
|
| $ | 1.21 |
|
| 1,402,841 |
|
| $ | 1.21 |
|
|
Granted |
| — |
|
|
|
|
| 24,500 |
|
| 1.20 |
|
| — |
|
| — |
|
| |||
Canceled |
| (610,933 | ) |
| 1.20 |
|
| (36,733 | ) |
| 1.20 |
|
| (87,779 | ) |
| 1.20 |
|
| |||
Balance at end of year |
| 691,896 |
|
| 1.23 |
|
| 1,302,829 |
|
| 1.21 |
|
| 1,315,062 |
|
| 1.21 |
|
| |||
Exercisable at end of year |
| 682,229 |
|
| 1.23 |
|
| 1,210,029 |
|
| 1.21 |
|
| 927,105 |
|
| 1.22 |
|
| |||
Additional shares available for grant at end of year |
| 1,780,327 |
|
|
|
|
| 1,169,394 |
|
|
|
|
| 1,157,161 |
|
|
|
|
| |||
The per share weighted-average fair value of stock options granted during 2004 was $0.72, on the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:
|
| 2004 |
|
Expected dividend yield |
| 0 | % |
Risk-free interest rate |
| 3 | % |
Expected Volatility |
| 114 | % |
Expected life |
| 3 years |
|
No options were granted under the Wavexpress stock option plan during the years ended December 31, 2005 or December 31, 2003.
The following table summarizes information about Wavexpress’ stock options outstanding at December 31, 2004:
|
| Options Outstanding |
| Options Exercisable |
| ||||||||||||||||||||
|
|
|
| Weighted |
|
|
|
|
|
|
| ||||||||||||||
|
|
|
| Average |
|
|
|
|
|
|
| ||||||||||||||
|
| Number |
| Remaining |
| Weighted |
| Number |
| Weighted |
| ||||||||||||||
Exercise Price |
|
|
| Outstanding |
| (in years) |
| Exercise Price |
| Exercisable |
| Exercise Price |
| ||||||||||||
$1.20 |
|
| 683,699 |
|
|
| 6.0 |
|
|
| $ | 1.20 |
|
|
| 674,032 |
|
|
| $ | 1.20 |
|
| ||
$3.00 - $4.50 |
|
| 8,197 |
|
|
| 4.6 |
|
|
| $ | 3.37 |
|
|
| 8,197 |
|
|
| $ | 3.37 |
|
| ||
$1.20 - $4.50 |
|
| 691,896 |
|
|
| 6.0 |
|
|
| $ | 1.23 |
|
|
| 682,229 |
|
|
| $ | 1.23 |
|
| ||
F-34
(9) Options and Warrants (Continued)
Warrants
On December 5, 2005, Wave granted warrants to purchase up to 1,093,750 shares of Class A Common Stock, in connection with a securities purchase agreement, pursuant to which Wave sold and issued 5,982,906 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,500,000. The warrants are exercisable at an exercise price of $0.80 per share and expire on June 5, 2006. If exercised in full, the warrants granted in connection with this financing will generate up to an additional $875,000, at the exercise price. The shares of Class A Common Stock issuable upon exercise of theses warrants are to be drawn-down off of the shelf registration statement, if the warrants are exercised. All of the warrants granted in connection with the December 5, 2005 securities purchase agreement remain outstanding as of December 31, 2005.
On July 30, 2004, Wave granted warrants to purchase up to 4,411,765 shares of Class A Common Stock, in connection with a securities purchase agreement, pursuant to which Wave sold and issued 3,529,412 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,000,000. The warrants granted in this transaction were made up of two different series, Series A and Series B. The Series A warrants were exercisable for up to 3,529,412 shares of Class A Common Stock at an exercise price of $1.15 per share. The Series A warrants were exercisable from January 30, 2005, until August 1, 2005. The Series B warrants are exercisable for up to 882,353 shares of Class A Common Stock at an exercise price of $1.30 per share. The Series B warrants are exercisable from July 30, 2005, until January 30, 2006. The shares of Class A Common Stock issuable upon exercise of the Series A warrants and Series B warrants are also to be drawn-down off of the shelf registration statement, if the warrants are exercised. The Series A and Series B warrants issued in this transaction carries a subsequent equity clause that requires Wave to adjust the initial exercise price, pro-rata, for any subsequent equity sales that are made at a price that is lower than the initial exercise price. As a result several sales of common stock subsequent to the July 30, 2004 securities purchase agreement, the exercise prices of the Series A and Series B warrants were adjusted to $1.13 and $1.20, respectively, in accordance with the formula pursuant to the warrant agreements. On August 1, 2005 a Series A Warrant holder exercised a portion of the Series A Warrant for a total of 2,000,000 shares at an exercise price of $1.13 per share, for aggregate gross proceeds of $2,260,000, less placement agent fees of $90,400, for net proceeds of $2,169,600. The remaining warrants for 1,529,412 expired on August 1, 2005. All of the Series B Warrants granted in connection with the July 30, 2004 securities purchase agreement remain outstanding as of December 31, 2005 and expired unexercised on January 30, 2006.
In connection with an agreement that Wave entered into with an outside software development consultant, Wave issued warrants to purchase 65,000 shares of Class A Common Stock at a price of $1.00 per share, pursuant to an individual compensation plan with the consultant. The fair market value of these warrants was approximately $81,000 and was recorded as consultant expense in 2004. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. These warrants are currently exercisable and expire January 2, 2009 through April 30, 2009.
On November 18, 2003, Wave granted warrants to purchase 931,309 shares of Class A Common Stock at an exercise price of $2.62 per share in connection with a private placement to a group of accredited investors. The warrants have a three year term. In addition, in connection with the transaction, Wave granted additional warrants to purchase 161,595 shares of Class A Common Stock as commissions to placement agents in connection with the private placement. The warrants granted to the placement agents are also exercisable at a price of $2.62 per share and have a 3 year life as well. If exercised in full, the warrants granted in connection with this financing will generate up to an additional $2,863,000, at the exercise price. All of the warrants granted in connection with the November 18, 2003 private placement remain outstanding as of December 31, 2005.
F-35
(9) Options and Warrants (Continued)
On April 30,2003, Wave granted the Series H Warrants to purchase shares of Class A Common Stock, with an initial exercise price of $1.13 per share and a five (5) year life. Initially, the Series H Warrants were exercisable for a total of 3,608,556 shares of Class A Common Stock on the trading day following the date of Wave’s 2003 annual meeting of stockholders. During September 2003 the terms of the Series H Purchase Agreement and other documents governing the Series H Stock and the Series H Warrants were modified, as discussed in note 8(a), above. As of December 31, 2003, 2,632,315 shares of Class A Common Stock were issued in connection with the exercise of Series H Warrants for net proceeds of $2,565,167. Series H Warrants to acquire 65,789 shares of Class A Common Stock remain outstanding as of December 31, 2005.
In connection with an agreement that Wave entered into with an outside sales representative, Wave issued warrants to purchase 44,365 shares of Class A Common Stock at prices ranging from $0.95 to $1.45 per share, pursuant to an individual compensation plan with the sales representative. The fair market value of these warrants was approximately $146,000 and was recorded as consultant expense in 2003. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. These warrants are currently exercisable and expire January 1, 2013 through April 30, 2013.
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 exercisable on November 9, 2002, and expires on November 9, 2007.
In 1993 and 1994, Wave issued warrants to acquire a total of 151,600 shares of Class B Common Stock at $3.50 per share in conjunction with sales of Class B Common Stock to individuals and institutions. All warrants were exercisable for a period of five years from the date of issuance and were subsequently canceled or exercised in 1998 and 1999.
In 1993 and 1994, Wave issued warrants to acquire a total of 376,253 shares of Class B Common Stock at $3.50 per share in conjunction with the issuance of its 10% Convertible Notes which have since been repaid and in 1994, Wave issued warrants to acquire a total of 46,799 shares of Class B Common Stock at $6.00 per share in conjunction with the issuance of its 15% Notes, also which have since been repaid. All warrants were exercisable for a period of five years from their dates of issuance. These warrants were exercised or canceled in 1998 and 1999.
Under the terms of Wave’s initial public offering, the underwriter acquired warrants to purchase 360,000 Class A Common Stock at a price of $6.50 per share for nominal consideration. These warrants were exercisable for four years commencing in September 1995. These warrants were exercised during 1999.
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 exercisable for ten years commencing in March 1996, and are still outstanding.
Due to the successful placement of 150,000 shares of Wave’s Series C Convertible Stock, Wharton Capital Partners Ltd. and The Shemano Group, Inc., two financial consulting firms, were issued warrants by Wave to purchase 37,500 Class A Common Stock each at a price of $2.54 per share. These warrants were exercised in 1999.
In connection with the acquisition of WIN, Wave issued a warrant that allowed the holder the ability to purchase unregistered shares of Wave’s Class A Common Stock at a price of $1.25 per share at the earlier of the conversion of a note or April 18, 1998 for a period of five years. The number of shares able to
F-36
(9) Options and Warrants (Continued)
be purchased under this warrant is based on a formula of $170,000 divided by 80% of the fair market value of the Class A Common Stock at the time of conversion. This warrant was subsequently extended one year by issuing 100,000 additional warrants to be exercised at prices ranging from $1.49 to $3.43. These warrants were exercised during July 1999.
As a result of the successful placement of 80,000 shares of Wave’s Series D Preferred Stock, JNC Opportunity Fund, the acquirer of the placement, received 80,000 warrants to purchase Wave’s unregistered Class A Common Stock, and financial consultants, primarily Wharton Capital Partners, received a total of 40,000 warrants. The warrants were exercised in 1999 at an exercise price of $1.62.
As a result of the successful placement of 112,500 shares of Wave’s Series F Preferred Stock, Combination Inc., the acquirer of the placement, received 112,500 warrants to Wave’s unregistered Class A Common Stock, and Wharton Capital Partners received 56,250 warrants. The warrants had an exercise price of $1.26, and expired on October 9, 2002. The warrants were exercised in 1998.
In connection with the private placement of approximately 800,000 shares of Wave’s Class A Common Stock, Wave issued 160,000 warrants to purchase shares of Wave’s unregistered Class A Common Stock at an exercise price of $1.00. The warrants were exercised or expired during 1999.
In connection with a technology license agreement with Aladdin, Wave issued two warrants on July 18, 1997 to purchase Wave’s Class A Common Stock. The first warrant was exercisable in 100,000 share lots, and provided the holder with the right to acquire 1,216,136 shares of Wave’s unregistered Class A Common Stock at an exercise price of $1.70 per share. The first warrant had a life of two years. The second warrant provided the holder with the right to acquire 7% of Wave’s Class A Common Stock on a fully diluted basis for the average closing price for the 15 trading days prior to exercise and had a three year life. During June of 1998, Aladdin exercised a portion of the second warrant to purchase 1,000,000 shares of Common Stock. On March 31, 1999 Aladdin exercised their entire first warrant for 1,216,136 Class A Common Stock. Associated with the second warrant, Aladdin had the right to acquire shares approximating 3.45% of Wave’s Class A Common Stock. The remaining shares under the second warrant were not exercised, and expired July 17, 2001.
In connection with a $2,000,000 convertible promissory note, warrants to acquire 275,000 shares of Class A Common Stock were issued. Wave incurred a non-cash charge to interest expense for approximately $666,000. These warrants were subsequently exercised in January 2000.
A summary of warrants outstanding at December 31, 2005, follows:
|
| Warrants Outstanding |
| Warrants Exercisable |
| ||||||||||||||||
|
|
|
| Weighted |
|
|
|
|
|
|
| ||||||||||
Exercise Price |
|
|
| Number of |
| Average |
| Weighted |
| Number of |
| Weighted |
| ||||||||
$0.80 - $1.20 |
| 1,254,367 |
|
| 1.1 |
|
|
| $ | 0.83 |
|
| 1,254,367 |
|
| $ | 0.83 |
|
| ||
$1.21 - $1.80 |
| 896,891 |
|
| 0.2 |
|
|
| $ | 1.24 |
|
| 896,891 |
|
| $ | 1.24 |
|
| ||
$1.81 - $2.70 |
| 1,092,904 |
|
| 0.9 |
|
|
| $ | 2.62 |
|
| 1,092,904 |
|
| $ | 2.62 |
|
| ||
$2.71 - $3.48 |
| 65,000 |
|
| 1.5 |
|
|
| $ | 3.39 |
|
| 65,000 |
|
| $ | 3.39 |
|
| ||
|
| 3,309,162 |
|
| 0.8 |
|
|
| $ | 1.58 |
|
| 3,309,162 |
|
| $ | 1.58 |
|
| ||
Employee Stock Purchase Plan
In November 2004, the Board of Directors adopted the Wave Systems Corp. 2004 Employee Stock Purchase Plan (the “Purchase Plan”) pursuant to which a total of 3,000,000 shares of Wave’s Common
F-37
(9) Options and Warrants (Continued)
Stock may be sold to eligible employees at a 15% discount from the market value of the shares. Under the terms of the Purchase Plan, employees may elect to have withheld, up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave Common Stock. Offering periods commence on May 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the beginning or the ending of the offering period. Approximately 49% of eligible employees participated in the Purchase Plan during 2005. The Purchase Plan was ratified by a shareholder vote at Wave’s 2005 annual shareholder meeting on May 23, 2005. For the year ended December 31, 2005 employees purchased 492,141 shares of Wave Class A Common Stock at an average share price of $0.72 per share, for an aggregate of $354,047 in proceeds to Wave.
(10) Investments
On February 2, 2001, Wave issued 2,000,000 shares of its Class A Common Stock, at a price of $7.16 per share, for an aggregate purchase price of $14,312,800 to acquire 3,600,000 shares of the Series B Preferred Stock of BIZ Interactive Zone, Inc., then a privately held company, in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. Wave’s investment in BIZ represented approximately 17.8% of the outstanding capital stock of BIZ. Accordingly, the investment had been accounted for under the cost method of accounting, because the investment was less than 20% of the outstanding capital stock of BIZ and because Wave could not exercise significant influence over BIZ. On August 24, 2001, SSP Solutions, Inc. was formed through a merger with Litronic, Inc., a publicly traded company that provided authentication and encryption security technology. As a result of the merger, Wave was issued 3,083,083 shares (14.95%) of the common stock of SSP in exchange for the BIZ shares it held.
During 2002, SSP issued Wave an additional 1,800,000 shares of common stock in connection with the cancellation of a development agreement that was entered into in October 2000. The basis of the shares acquired in 2002 of $1,818,000 was recorded as a gain from termination of the development contract.
In August 2004, SSP merged with Saflink Corporation. Pursuant to the merger agreement between SSP and Saflink, holders of SSP common stock were issued 0.6 shares of Saflink common stock for every share of SSP common stock held. At the time of the merger, Wave held 2,043,283 shares of SSP, which were surrendered in exchange for 1,225,970 shares of Saflink, in accordance with the 0.6 ratio.
As detailed in the table below, Wave’s investments in marketable securities, which were classified as available-for-sale securities, consisted of 259,670 shares of Saflink common stock valued at $721,880, as of December 31, 2004. All marketable securities were sold as of December 31, 2005.
|
| Shares |
| Adjusted cost |
| Unrealized |
| Carrying value |
| Value per |
| ||||||||
Balance of investment in SSP Common Stock as of December 31, 2003 |
| 4,550,583 |
| $ | 2,684,841 |
| $ | 3,640,469 |
|
| $ | 6,325,310 |
|
|
| $ | 1.39 |
|
|
Sales of SSP Common Stock |
| (2,507,300 | ) | (1,479,308 | ) | — |
|
| (1,479,308 | ) |
|
| (0.59 | ) |
| ||||
Conversion of shares to Saflink Corp. |
| (817,313 | ) | — |
| — |
|
| — |
|
|
| — |
|
| ||||
Sales of Saflink Corp. common stock |
| (966,300 | ) | (950,195 | ) | — |
|
| (950,195 | ) |
|
| (0.98 | ) |
| ||||
Other comprehensive income—change in accumulated unrealized gain |
| — |
| — |
| (3,173,927 | ) |
| (3,173,927 | ) |
|
| — |
|
| ||||
Balance as of December 31, 2004 |
| 259,670 |
| $ | 255,338 |
| $ | 466,542 |
|
| $ | 721,880 |
|
|
| $ | 2.78 |
|
|
Sales of Saflink Corp. common stock |
| (259,670 | ) | (255,338 | ) | (466,542 | ) |
| (721,880 | ) |
|
| (1.30 | ) |
| ||||
Balance as of December 31, 2005 |
| — |
| $ | — |
| $ | — |
|
| $ | — |
|
|
| $ | — |
|
|
F-38
(10) Investments (Continued)
During the year ended December 31, 2005, Wave sold 259,670 shares of Saflink, in a series of separate sales, at an average selling price of $1.32 per share, realizing an aggregate gain from the sales of $80,971. For the year ended December 31, 2004, Wave sold 2,507,300 shares of SSP in a series of separate sales, at an average selling price of $1.73 per share, and 966,300 shares of Saflink at an average price of $2.50 per share realizing an aggregate gain from the sales of $4,330,248.
Wave recorded unrealized holding gains on marketable equity securities included in other comprehensive income, as follows, for the years ended December 31:
|
| 2005 |
| 2004 |
| 2003 |
| |||
Unrealized holding gains |
| $ | (385,571 | ) | $ | 1,156,321 |
| $ | 3,875,228 |
|
Reclassification adjustment for realized gains on securities sold, included in net income |
| (80,971 | ) | (4,330,248 | ) | (234,759 | ) | |||
Net change in accumulated unrealized gain |
| $ | (466,542 | ) | $ | 3,173,927 |
| $3,640,469 |
| |
(11) Joint Ventures
(a) Wavexpress
In April 1999, Wave joined with Sarnoff Corporation to form a new joint venture, Wavexpress. Wavexpress develops secure broadband media distribution software products, infrastructure and content services. This technology and these services allow content providers and other enterprises to send digital content to properly equipped PCs. Consumers or enterprise end-users may receive this content directly through a secure network connection, thus enabling a new revenue stream for broadcasters or cable television operators or a new content distribution method for enterprises. On October 15, 1999, Wave and Sarnoff signed a joint venture agreement that formally established Wavexpress. Under this agreement, Sarnoff and its affiliates received a 40% equity stake in Wavexpress. Wave received a 53% equity interest; and its affiliates, who purchased founders stock in April 1999 for a nominal amount, owned the remaining 7% of the outstanding capital stock. The affiliates of Wave include Peter Sprague, former Chairman of Wave; Steven Sprague, Chief Executive Officer of Wave; certain members of the Board of Directors of Wave; and certain Wave employees.
Wave has funded Wavexpress through a series of convertible notes, some with attached warrants. The notes bear interest at rates of 2% to 3% above the prime rate of Chase Manhattan Bank. Generally, the notes are convertible into shares of Common Stock of Wavexpress at varying prices per share. In addition, some of the notes carry attached warrants that allow Wave to purchase additional shares of Wavexpress, generally at the conversion price of the notes. As of December 31, 2005, Wave owned 69% of Wavexpress while Sarnoff owned 26%. Through December 31, 2005, Wave has funded Wavexpress with approximately $38 million in cash, plus approximately $11.1 million in accrued interest. During 2001, some of the notes, totaling approximately $9.5 million matured and were converted into 1,826,570 shares of Wavexpress common stock. These amounts are eliminated in consolidation.
Neither Sarnoff nor any of the other minority shareholders have provided or are obligated to provide funding to Wavexpress. Accordingly, the financial statements of Wavexpress have been included in the consolidated financial statements of Wave for all periods presented. In addition, Wave has not recorded a minority interest in Wavexpress in the consolidated financial statements and therefore has reflected 100% of Wavexpress’ balance sheet and operating results in its consolidated financial statements. Wavexpress has incurred net operating losses of $2.2 million, $3.4 million and $3.9 million, for the years ended December 31, 2005, 2004 and 2003, respectively.
F-39
(12) Commitments and Contingencies
Leases
Summarized below is a listing of properties leased by Wave pursuant to non-cancelable operating leases. Our principal research and development activities are conducted at the Princeton and Cupertino facilities.
Location |
|
|
| Annual |
| Lease Expiration |
| |||
Lee, MA |
| $ | 126,877 |
|
| Jul. 2007 |
|
| ||
Princeton, NJ |
| 157,367 |
|
| Dec. 2009 |
|
| |||
Cupertino, CA |
| 275,916 |
|
| Feb. 2008 |
|
| |||
Orvault, France |
| 67,260 |
|
| Sep. 2007 |
|
| |||
New York, NY(1) |
| 377,172 |
|
| Apr. 2006 |
|
| |||
Total |
| $ | 1,004,597 |
|
|
|
|
| ||
(1) Wavexpress facility
Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2005 are as follows:
2006 |
| $ | 766,430 |
|
2007 |
| 533,643 |
| |
2008 |
| 218,212 |
| |
2009 |
| 171,623 |
| |
Thereafter |
| — |
| |
Total minimum lease payments |
| $ | 1,689,908 |
|
Rent expense for the years ended December 31, 2005, 2004, 2003 amounted to approximately $957,000, $940,000 and $978,000, respectively.
There were no capital lease obligations as of December 31, 2005.
Securities and Exchange Commission Investigation
On December 17, 2003, Wave received an Order by the Securities and Exchange Commission (the “Commission”) regarding a formal investigation. The focus of this investigation is on certain public statements made by Wave during and around August 2003, as well as certain trading in Wave’s securities during such time. Wave is cooperating fully with the Commission in this investigation. Wave is unable to predict the outcome of this investigation at this time.
Purported Class Actions
A consolidated amended class action complaint is pending in the United States District Court for the District of Massachusetts, naming Wave, its Chief Executive Officer and its Chief Financial Officer as defendants. Brumbaugh et al. v. Wave Systems Corp. et al., Civ. No. 04-30022 (D. Mass.) (MAP).
The purported class action has been filed by alleged purchasers of Wave’s Class A Common Stock during the purported class period July 31, 2003 through February 2, 2004. The complaint claims that Wave and the named individuals violated Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), Rule 10(b)-5 promulgated thereunder and Section 20(a) of the 1934 Act by publicly disseminating materially false and misleading statements, relating to Wave’s agreements with Intel and IBM. The complaint does not specify the amount of alleged damages plaintiffs seek to recover.
F-40
(12) Commitments and Contingencies (Continued)
Wave intends to defend the action vigorously. Recently, the Court granted in part and denied in part defendants’ motion to dismiss. The Court dismissed two but let stand seven alleged misrepresentations or omissions. This is not a finding of fault or liability, it is a decision not entirely to dismiss plaintiffs’ pleading. Wave is unable to predict the outcome of this action.
Derivative Actions
A consolidated, purported derivative action was pending in the United States District Court for the District of Massachusetts, Sachs v. Sprague et al. Civ. No. 04-30032 (D. Mass.) (MAP) The complaint names all of Wave’s directors during the period July 2003 through February 2004 as defendants and alleges claims for breach of fiduciary duties and other claims based on allegations similar to the purported securities class action. Wave is also named as a nominal defendant, although the actions are derivative in nature and purportedly asserted on behalf of Wave.
On December 22, 2004, Wave moved to dismiss the complaint. The Court held oral arguments on March 25, 2005. On September 26, 2005, the Court entered an Order stating that the defendants’ motion to dismiss has been allowed. On November 22, 2005 the Court issued a memorandum of decision and entered judgment. The case is terminated in the District Court. However, Plaintiffs have filed a Notice of Appeal. The appeal is proceeding.
At this time, Wave is unable to predict the outcome of this action.
(13) Income Taxes
The Company did not provide for any income tax expense or (benefit) for the years ending December 31, 2005, 2004 and 2003.
The following table summarizes the significant differences between the United States federal statutory tax rate and the Company’s effective tax rate for financial statement reporting purposes:
|
| 2005 |
| 2004 |
| 2003 |
| ||||||
Statutory tax rate |
|
| 34 | % |
|
| 34 | % |
|
| 34 | % |
|
Gain on warrant liability |
|
| (1 | ) |
|
| (1 | ) |
|
| — |
|
|
Change in valuation allowance |
|
| (33 | ) |
|
| (33 | ) |
|
| (34 | ) |
|
Total |
|
| — | % |
|
| — | % |
|
| — | % |
|
The tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2005 and 2004 are as follows:
|
| 2005 |
| 2004 |
| ||
Deferred tax assets: |
|
|
|
|
| ||
Net operating and capital loss carryforwards |
| $ | 91,503,000 |
| $ | 83,980,000 |
|
Accrued expenses |
| 480,000 |
| 403,000 |
| ||
Intangibles |
| 534,000 |
| 666,000 |
| ||
Reserves |
| 903,000 |
| 1,010,000 |
| ||
Depreciation |
| 532,000 |
| 681,000 |
| ||
Unrealized losses |
| — |
| 55,000 |
| ||
Total gross deferred tax assets |
| 93,952,000 |
| 86,795,000 |
| ||
Less valuation allowance |
| (93,952,000 | ) | (86,795,000 | ) | ||
Net deferred tax asset |
| $ | — |
| $ | — |
|
F-41
(13) Income Taxes (Continued)
The valuation allowance increased by approximately $7.2 million and $7.5 million, during the years ended December 31, 2005 and 2004, respectively.
Management has concluded that it is more likely than not that Wave will not have sufficient taxable income of an appropriate character within the carryback and carryforward periods permitted by current law to allow for the utilization of the deferred tax assets and, therefore, a valuation allowance has been established against the deferred tax assets of $93,952,000 as of December 31, 2005. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2005 will be allocated as follows: $93,137,000 to continuing operations and $815,000 to additional paid-in capital for amounts attributable to exercise of employee stock options.
Wave has net operating loss carryforwards for tax return purposes of approximately $242.7 million, which expire beginning in 2010 through 2025. Wave also has capital loss carryforwards for tax return purposes of approximately $8.6 million, which expire beginning in 2008 through 2010. Pursuant to Section 382 of the Internal Revenue Code, the annual utilization of Wave’s net operating and capital loss carryforwards may be substantially limited if a cumulative change in ownership of more than 50% occurs within any three-year period. Wave has not determined whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred. However, in considering Section 382 of the Internal Revenue Code, Wave believes that it is likely that such a change in ownership has occurred thus raising the likelihood that such net operating and capital loss carryforwards are subject to annual limitations.
(14) Defined Contribution Plan
Wave adopted the Wave Systems Corp. 401(k) Savings and Investment Plan, a defined contribution plan, to which substantially all employees can contribute, on January 1, 1995. Employees of Wave become eligible immediately on employment. Wave has the option to make discretionary matching contributions; no contributions were made in 2005, 2004 or 2003.
(15) Disclosures about the Fair Value of Financial Instruments
Cash and Cash Equivalents, Marketable Securities, Prepaid Expenses and Other Receivables, Accounts Payable and Accrued Expenses
The carrying amounts of these instruments approximate fair value because of their short maturities. Marketable securities are valued based on the value of the securities as traded on the Nasdaq Stock Exchange.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
(16) Impairment of Developed Software
In the quarter ended June 30, 2004, Wave took a charge of $301,366 to write off developed software that had been capitalized. The software that was written off was developed for a distribution agreement that was entered into with National Semiconductor Corp. (“NSC”) whereby NSC was to distribute it with their trusted platform module chip. The write-off was the result of the termination of the agreement, and because the version of the software that was written off has been discontinued and superseded by a new version. Consequently, the value of the software became impaired because it had no alternative uses. Wave continues to maintain a license agreement with NSC, whereby Wave is paid royalties based on Wave Intellectual Property (“IP”) that is included in NSC’s chip design.
F-42
(17) Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued its final standard on accounting for share-based payments, Statement of Financial Accounting Standard No. 123(R)—Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires companies to expense the fair value of employee stock options and similar equity compensation, also known as share-based payment (“SBP”) awards. The statement applies to all outstanding and unvested SBP awards as of a company’s adoption date. The Securities and Exchange Commission delayed implementation of SFAS 123(R) to fiscal years beginning after June 15, 2005. Therefore, we implemented SFAS 123(R) effective January 1, 2006 using the modified prospective method, which requires the recognition of expense for SBP awards over their remaining vesting period. The portion of these SBPs’ fair value attributable to awards that vested prior to the adoption of SFAS 123(R) is never recognized under this method. We estimate that the impact of the adoption of SFAS 123(R), to Wave for the year ending December 31, 2006, will be an expense of approximately $1.4 million, or $0.01 to $0.02 per share. However, our assessment of the estimated compensation charges is dependent upon assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the volatility of our stock price, interest rates, the level and type of SBPs that Wave awards and employee stock option exercise behaviors. As such, our actual share-based compensation expense may differ from this estimated amount.
(18) Segment Reporting
Wave’s products include the Wave EMBASSY® digital security products and services and Wavexpress broadband media distribution products and services. These products and services constitute Wave’s reportable segments under Statement of Financial Accounting Statement No. 131—Disclosures about Segments of an Enterprise and Related Information. Net losses for reportable segments exclude interest income, unrealized gains on decrease in value of warrant liability, liquidated damages in connection with a private placement of equity securities, recovery of a note receivable with a former officer, gain on sales of marketable securities and other income. These items are not reported by segment since they are excluded from the measurement of segment performance reviewed by Wave’s management.
F-43
(18) Segment Reporting (Continued)
The following sets forth reportable segment data:
|
| For the years ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
Operating Revenues: |
|
|
|
|
|
|
| |||
EMBASSY® digital security products and services |
| $ | 976,807 |
| $ | 164,350 |
| $ | 107,635 |
|
Wavexpress broadband media distribution products and services |
| 41,657 |
| 44,961 |
| 81,728 |
| |||
Total Operating Revenues |
| 1,018,464 |
| 209,311 |
| 189,363 |
| |||
Net Loss: |
|
|
|
|
|
|
| |||
EMBASSY® digital security products and services |
| (15,986,692 | ) | (15,915,487 | ) | (17,224,356 | ) | |||
Wavexpress broadband media distribution products and services |
| (2,219,354 | ) | (3,436,453 | ) | (3,839,292 | ) | |||
Total Segments Net Loss |
| (18,206,046 | ) | (19,351,940 | ) | (21,063,648 | ) | |||
Interest Income |
| 70,779 |
| 24,931 |
| 74,822 |
| |||
Unrealized gain on decrease in value of warrant liability |
| 490,334 |
| 498,723 |
| 263,097 |
| |||
Liquidated damages in connection with private placement |
| — |
| — |
| (155,716 | ) | |||
Recovery of officer note receivable |
|
|
|
|
| 999,518 |
| |||
Gain on sale of marketable securities |
| 80,971 |
| 4,330,248 |
| 234,759 |
| |||
Other Income |
| 1,500 |
| — |
| 52,370 |
| |||
Net Loss |
| $ | (17,562,462 | ) | $ | (14,498,038 | ) | $ | (19,594,798 | ) |
Depreciation and Amortization Expense: |
|
|
|
|
|
|
| |||
EMBASSY® digital security products and services (1) |
| 746,536 |
| 703,137 |
| 932,869 |
| |||
Wavexpress broadband media distribution products and services |
| 95,193 |
| 151,492 |
| 308,166 |
| |||
Total Depreciation Expense |
| $ | 841,729 |
| $ | 854,629 |
| $ | 1,241,035 |
|
Capital Expenditures: |
|
|
|
|
|
|
| |||
EMBASSY® digital security products and services |
| 152,474 |
| 186,756 |
| 831,147 |
| |||
Wavexpress broadband media distribution products and services |
| 8,355 |
| 117,416 |
| 153,999 |
| |||
Total Capital Expenditures |
| $ | 160,829 |
| $ | 304,172 |
| $ | 985,146 |
|
Assets: |
|
|
|
|
|
|
| |||
EMBASSY® digital security products and services |
| 3,235,946 |
| 8,167,614 |
| 17,726,026 |
| |||
Wavexpress broadband media distribution products and services |
| 193,819 |
| 286,968 |
| 434,404 |
| |||
Total Assets |
| $ | 3,429,765 |
| $ | 8,454,582 |
| $ | 18,160,430 |
|
(19) Selected Quarterly Financial Data (unaudited)
|
| Quarter-ended |
| ||||||||||||
|
| December 31, |
| September 30, |
| June 30, |
| March 31, |
| ||||||
|
| 2005 |
| 2005 |
| 2005 |
| 2005 |
| ||||||
Revenues |
| $ | 347,598 |
|
| $ | 335,335 |
|
| $ | 257,655 |
| $ | 77,876 |
|
Gross Profit |
| 151,663 |
|
| 150,419 |
|
| 80,771 |
| (91,242 | ) | ||||
Loss from Operations |
| (4,533,151 | ) |
| (4,464,460 | ) |
| (4,526,144 | ) | (4,682,289 | ) | ||||
Net loss to common shareholders |
| (4,495,149 | ) |
| (4,361,808 | ) |
| (4,159,925 | ) | (4,545,578 | ) | ||||
Net loss to common shareholders per Common Share |
| $ | (0.05 | ) |
| $ | (0.05 | ) |
| $ | (0.05 | ) | $ | (0.06 | ) |
F-44
(19) Selected Quarterly Financial Data (unaudited) (Continued)
|
| Quarter-ended |
| ||||||||||||
|
| December 31, |
| September 30, |
| June 30, |
| March 31, |
| ||||||
|
| 2004 |
| 2004 |
| 2004 |
| 2004 |
| ||||||
Revenues |
| $ | 108,193 |
|
| $ | 44,375 |
|
| $ | 6,300 |
| $ | 50,443 |
|
Gross Profit |
| 21,756 |
|
| 9,334 |
|
| 3,208 |
| 23,309 |
| ||||
Loss from Operations |
| (4,262,591 | ) |
| (4,602,961 | ) |
| (5,448,637 | ) | (5,037,751 | ) | ||||
Net loss to common shareholders |
| (2,967,830 | ) |
| (3,800,517 | ) |
| (4,320,927 | ) | (3,408,764 | ) | ||||
Net loss to common shareholders per Common Share |
| $ | (0.04 | ) |
| $ | (0.05 | ) |
| $ | (0.06 | ) | $ | (0.05 | ) |
(20) Subsequent Event
On February 15, 2006, Wave entered into a securities purchase agreement, pursuant to which Wave agreed to sell and issue 8,348,598 shares of Class A Common Stock, par value $.01 per share, to certain purchasers who are parties to the Purchase Agreement (the “Purchasers”) for an aggregate purchase price of $4,466,500. The Common Shares were priced at $0.535 per share. The Purchasers were also granted warrants (the “Warrants”) to purchase up to 1,550,868 shares of Class A common stock at an exercise price of $0.72. The Warrants are exercisable for a period of six months following the date of issuance. Each Warrant is subject to cancellation if the closing bid price of Wave’s common stock exceeds $0.86 for 10 out of 20 consecutive trading days and the Warrant has not been exercised by the close of business on the trading day after the 10th trading day on which the closing bid price exceeds $0.86. The Placement Agent had entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave has agreed to pay the Placement Agent a fee equal to 4.0% of the gross proceeds of this offering. Wave realized net proceeds of approximately $4,247,840 after deducting the placement agent fees of $218,660 and additional legal and other fees associated with the issuance of these securities, which Wave estimates will be approximately $40,000. This securities purchase agreement specifies that the shares shall be issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and declared effective by the Securities and Exchange Commission (the “SEC”) on January 13, 2006.
F-45