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Table Of Contents

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

FORM 10-K

Commission File Number 0-24752

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

413-243-1600
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:

Class A Common Stock, $.01 par value
(Title of Class)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

        The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates as of March 1, 2004 was $101,386,411 (For purposes of this calculation, the market value of a share of Class B Common Stock was assumed to be the same as a share of Class A Common Stock, into which it is convertible.)

        As of March 1, 2004 there were 67,133,415 shares of the registrant's Class A Common Stock and 205,725 shares of the registrant's Class B Common Stock outstanding.

EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE U.S. SECURITIES LITIGATION REFORM ACT OF 1995. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES THAT MAY CAUSE WAVE'S ACTUAL RESULTS OR OUTCOMES TO BE MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, WAVE OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND WAVE'S CONTROL. IMPORTANT FACTORS THAT WAVE BELIEVES MIGHT CAUSE SUCH DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN WAVE'S OTHER FILINGS WITH THE COMMISSION DURING THE PAST 12 MONTHS. IN ASSESSING FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY ALL RISK FACTORS AND CAUTIONARY STATEMENTS CONTAINED IN THIS FORM 10-K AND IN THOSE OTHER FILINGS WITH THE COMMISSION.

Table Of Contents

PART I

Item 1. Business

        Wave Systems Corp., 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 ("TCG"). 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 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. Wave's operations to date have consisted primarily of product development; performance under contract to develop products and preliminary marketing. TCG based systems will require an evolving "eco-system" of new development tools, applications, services and infrastructures. In 2003, Wave began the market introduction of its first commercial products designed to support the emerging products that include TPM's in this marketplace. In addition, Wave is developing additional products supporting these TCG products, some of which are in the final stages of testing for market introduction in 2004.

        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. More recently, Wave has developed a set of applications known as the EMBASSY Trust Suite to work with various other chip manufacturers' TCG compliant 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 National Semiconductor, Atmel, and Infineon, and have been certified for usage on TPM platforms shipped by Intel, IBM, and HP.

        Wave has not realized any significant revenues since we began our operations in 1988. While Wave was successful in signing distribution contracts with both Intel and National Semiconductor in 2003, we do not expect to begin to realize material revenues until the latter part of 2004. Revenues have been nominal in relation to our expenditures due to the highly complex nature of the technology that we are developing and the early stage nature of the market for products that utilize this technology. As a result, we have experienced a slow pattern of corporate development. As of December 31, 2003, we had working capital of approximately $12.4 million. Considering our current cash balance and Wave's projected operating cash requirements, we anticipate that we will need a minimum of $3,000,000 million of additional cash to satisfy our current forecasted cash flow requirements for the year ending December 31, 2004. 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 2004 to fund its cash flow requirements. Given the uncertainty with respect to Wave's revenue forecast for 2004, it is likely that Wave will be required to raise additional capital through either equity or debt

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financing in order to adequately fund its capital requirements for the year ending December 31, 2004. Furthermore, in the event that we are successful in executing our business plan for 2004, 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 2004. Due to our current cash position, our capital needs over the next year and beyond, the fact that we have not at this time secured additional financing and uncertainty as to whether we will achieve our sales forecast of our products and services, substantial doubt exists with respect to our ability to continue as a going concern.

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 V1.1. TCG formally superceded 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 V1.1 standard for trusted computing. In addition, PC platforms which included TPMs were announced and/or available from IBM, Intel and HP.

        The offering of these products 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 enable the work it has done in developing the EMBASSY Trust System towards becoming a leading developer of software, applications and services to this market. Wave formed business relationships with some of these companies as a developer of products that will be essential to the deployment and usage of these new products, thereby creating a new revenue opportunity for Wave. Wave is providing solutions in the market which work with all available TCG compliant products today.

Products and Services

The EMBASSY Trust Suite

        The current version of the EMBASSY Trust Suite is a set of applications, tools and services that are designed to bring functionality and user value to the TPM enabled products. The EMBASSY Trust Suite includes Document Manager Vault, Private Information Manager (PIM) and SmartSignature. Document Manager Vault provides document encryption, decryption and client side storage of documents. The vault, which integrates with Microsoft Office, secures documents against unauthorized users and hackers. PIM uses the TPM to securely store user information such as user names, passwords, credit card numbers and other personal information. It retrieves login information to efficiently fill in web forms and web login information. Data stored using the PIM utilizes the security of the TPM to protect against unauthorized access. SmartSignature is a digital signing application that utilizes the signing keys generated by the TPM. Wave has released two separate versions of the EMBASSY Trust Suite: Business Edition and Professional Edition. Wave has also produced a Beta version of the Suite which includes a client version of Key Transfer Manager ("KTM") (see below), which is scheduled to be released in the first half of 2004. 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 $1,500,000 for 2004.

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EMBASSY Trust Server Applications

        The EMBASSY Trust Server applications include Key Transfer Manager and Attestation Credential Manager (ACM)—essential enablers for managing and determining authenticity of Trusted Platforms. The ACM works with any application to ensure that it is interacting with a Trusted Platform. This is a critical function for attestation and management of TPM equipped devices. The KTM is a server application capable of securely backing up, storing and/or migrating TCG-specific keys from one TPM enabled system to another according to various security policies defined on the server, in a centralized fashion. KTM is being designed to allow an IT manager to provide capabilities to individual TPM users such as recovery services in the event of system malfunctions or new product availability. Both products are planned to be released for availability sometime in 2004. Current planned development costs for this product group are expected to be approximately $4,000,000 for 2004.

Digital Signature and Electronic Document Management

        On October 4, 2001 Wave acquired digital signature and electronic document management technology, SmartSignature and SmartSAFE from SignOnLine, Inc. ("SignOnLine"), a California-based company. This group or products now makes up our eSign Transaction Management Suite, also known as eTMS, which now consists of four core products: SmartIdentity, SmartSignature, SmartSAFE and SmartConnect. SmartSignature Version 3.0 is a digital signature application that connects signers and institutions—banks, insurance companies, enterprises etc.—through a legally binding digital signature. Wave's SmartSignature is currently enabled for the support of TPMs for added security associated with user identity and signing credentials. SmartSAFE Version 3.0 is a web-based document management application where signed documents are archived and tracked. SmartSAFE provides an easy to use environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents. SmartSAFE also supports archival and management of unsigned documents in virtually any format. These products allow a document to be executed, verified, accepted and filed in minutes at a lower cost compared to traditional documentation methods. SmartSignature Version 3.0 and SmartSAFE Version 3.0 have been completed and Wave 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. No further development activities are planned for this product group other than routine updates. Future development will be based on specific customer opportunities. Wave will continue to allocate resources towards marketing and sales to promote these products.

The EMBASSY Trust System

        The EMBASSY Trust System is Wave's proprietary co-processor cryptographic subsystem and supporting infrastructure; a separate chip with its own processor designed to provide security functions such as hidden processing of software applications, protected storage of cryptographic keys and encrypted data, that works with client and server software applications that provide and/or manage various security functions. Products that make up the EMBASSY Trust System include hardware and software. The hardware products that make up this product group are the EMBASSY 2100 security chip (referred to above) and secure user input devices such as EMBASSY Smart Card Readers and EMBASSY Smart Card Reader Keyboards that use EMBASSY 2100 chips. These devices are being marketed to government, military and financial services markets. The software products included in this product group are the Trust Assurance Network, which is the back office security infrastructure of the EMBASSY Trust System; Assistant, a client interface that allows the user to securely enter and store, their personal and financial data, personal identification numbers, passwords, digital certificates and other information that requires security, the Cyber-Comm applet; a secure French banking application that runs on an EMBASSY chip and FINREAD; a JAVA interface for online transactions. No further

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development activities are planned for this product group. The primary assets of this product group have served as the basis for the development of the TCG compliant products in the EMBASSY Trust Suite and EMBASSY Trust Server applications.

Broadband Media Distribution

        Wave offers its data broadband content distribution products through Wavexpress, Inc. ("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 and 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. Suitable media for delivery include an extensive range of file types, including video, movies and games. Wavexpress delivers files presented and assembled as rich media channels. These products are designed to provide a rich consumer experience, allow content partners to participate in the market for broadband distribution and allow enterprise customers to deliver rich content to selected users within the enterprise network. Wave believes the benefits of these products to content owners, network operators and enterprises include incremental revenue streams from content subscriptions and sales, increased consumer acquisition and retention when used as a marketing tool and cost savings over traditional distribution methods. The product has been deployed, and revenue generating enterprise and content customers have been signed.

        Planned future development expenditures are expected to approximate $2,000,000 for the year ending December 31, 2004. As of December 31, 2003, Wave owned 69% of Wavexpress and Sarnoff owned 26%.

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

        Wave, as well as Wavexpress, is a development stage company and has realized minimal operating revenues since our inception. For the years ended December 31, 2003, 2002, and 2001 Wave incurred losses to common shareholders of approximately $25,292,000, $43,467,000, and $48,701,000, respectively. At December 31, 2003 we had an accumulated deficit of approximately $252,686,000. There can be no assurance that we will ever be successful in achieving commercial acceptance of our products and services.

Markets and Business Strategy

        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

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effect creating 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, applications, 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 this 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, as 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 products and services the preferred applications and infrastructure for Trusted Platforms. Key components in achieving this goal include:

Capitalizing on Information Security Industry Trends

        For 2003 and 2004 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 supports cross platform interoperability, ease of use, and a robust set of development tools for TCG products. 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), Intel's LaGrande secure computing program, and AMD's Secure Execution Mode (SEM). Similar programs are under consideration in 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:

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Requirements to authenticate the identity of both platforms and users for access to protected resources and information



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User managed security features



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Major privacy concerns



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Rapid development of new e-commerce business and distribution models



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



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Convergence of consumer electronics and PC's



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Legal status of digital identities and digital signatures, including development of next generation web services which require digital signature solutions.



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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

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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 in consumer markets, and to build upon our alliances with such industry leaders as Intel, HP, IBM and others in the PC industry. In addition, we are engaged in strategic activities with semi-conductor manufacturers National Semiconductor, Atmel and Infineon Technologies to support and/or deploy EMBASSY applications with their TCG compliant TPMs. TCG has expanded its scope to include trusted peripherals, cell phones, PDAs, and consumer elctronics devices. Wave believes its trusted computing offerings can provide significant value in these new markets and platforms, and thus, Wave is working to establish relationships with key partners in each of 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 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:

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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 toolkits which provide this interoperability across platforms. Wave will continue to expand the functions available to ISVs within these enabling toolkits to make it easier to bring new applications to Trusted Platforms.



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Client applications: Wave's EMBASSY Trust Suite provides important applications for the end user which run on their PCs such as Document Manager, Private Information 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.



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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 offerings include the Key Transfer Manager-Enterprise Server, and Attestation Credential Manager. The server family of products will be expanded and enhanced with future versions.

        These development efforts will likely be significant, and Wave intends to expend a substantial portion of its research and development resources towards these enhancements as well as significant marketing and corporate development funds to introduce the products and build market demand. As a result, although Wave reduced its research and development expenditures in 2003, the continued research and development efforts will require substantial capital resources, which will likely necessitate the need for further funding so that Wave may ultimately be able to capitalize on the emerging market opportunities for its products and services. Wave announced major products, primarily for TPM applications in 2003, and is developing significant new client and server based products which we plan

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to announce early in 2004. It is expected that continued product enhancements, new releases and new product development activities will continue through 2004.

Marketing, Sales and Customers

        Because Wave's technology involves a new approach to conducting business and exchanging information using computer systems, as it will require that traditional software-based security be enhanced and/or replaced with next generation hardware-based security, 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 solution is accepted in this emerging market. The current primary focus is on closing business with chip OEMs, PC 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 including: 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 four key markets where we believe our products provide unique benefits:

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PCs—TCG's standards based specifications for trusted hardware is leading the industry towards increased deployment of TPM hardware by a growing number of PC OEMs. The current focus for both TCG and Wave is for enterprise PC platforms, but will be extending into consumer PCs over time. Wave anticipates providing enabling tools to ISV's in order to take advantage of the new trusted computing features of these platforms.



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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.



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Broadband Media—through our Wavexpress joint venture, we have developed a broadband architecture for persistent protection of content from the content owner to the hard disk at home.



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

        Wave's sales for the year ended December 31, 2003 consisted of development contracts for NRE projects, licensing of its products and other services. Of the total revenue realized for the year ended December 31, 2003, 43% was derived from Wavexpress' broadband media distribution segment and the remaining 57% was derived from activities related to Wave's computer security products and services. None of the customers from which Wave derived revenue in 2003 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 customers, the loss of, or lack of substantial future revenues from, any one of which may have a material adverse effect on our business plan going forward. Theses include National Semiconductor, Intel, IBM, Hewlett Packard and others.

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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 that could be leveraged, thereby gaining market share or product acceptance to our detriment. In addition, the rate of market acceptance of trusted computing solutions is still in the formative, 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., Ultimaco, Safenet, and major systems integrators such as IBM, HP and EDS. The competitive factors defining these evolving markets include product performance, compatibility, standards compliance, quality and reliability, ease of use, client services and support, distribution and price. Wave believes its products meet the requirements to be successful viable products in these markets. Wave's features that should allow its products to compete favorably include product differentiation of a cross platform, interoperable solutions, easy use of features, and leading edge trusted client/server infrastructure solutions. In addition, Wave continues to have leading solutions with its digital signature products especially combined with trusted computing platforms and features.

        One of the market challenges facing Wave is the establishment of a newly defined market category for trusted computing software and services that includes a more complex business model for adoption. While Wave has developed a very complex cryptographic system that required significant skills and resources, the market for security solutions that are as complex as those developed by Wave 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 are often relying on Federal Express and UPS to deliver physical media, which Wavexpress technology replaces. In the network operator arena, Wavexpress competes against Video-on-demand companies such as SkyStream Networks. Several companies compete for the digital delivery of content over broadband, including CDNs (content delivery networks) such as Akamai and startup caching companies such as Maven Networks.

International Market

        Most of our software products and many components of the EMBASSY Trust System are controlled under various United States export control laws and regulations and may require export licenses for certain exports of the products and components outside of the United States and Canada. We have received export licenses from the U.S. Department of Commerce's Bureau of Export Administration (the "BXA") for the sale and export of our EMBASSY chip and related products and technology to any end-user in any country throughout the world with the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria, subject to certain restrictions and in some cases, certain reporting requirements. 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

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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 six (6) patents pending before the United States Patent Office. In addition, we have filed foreign patent applications for seven patents. Our patents are material to protecting some of our technology.

        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.

Research and Development

        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, 2003, 2002, and 2001 we spent approximately $7.4 million, $12.0 million, and $17.7 million, respectively, on research and development activities. Planned development expenditures for the year ended December 31, 2004 are expected to be approximately $7.5 million.

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Employees

        As of December 31, 2003, we employed eighty-three (83) full-time employees, forty-two (42) of whom were involved in sales, marketing and administration and forty-one (41) of whom were involved in research and development (including twenty-one (21) employed by Wavexpress, nine (9) of whom were in sales, marketing and administration and twelve (12) of whom were involved in research and development.) As of December 31, 2003 we retained the services of six (6) full-time consultants, three (3) of whom were retained by Wavexpress. We believe our employee relations are satisfactory.

Item 2. Properties

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

Item 3. Legal Proceedings

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. The Commission has not concluded that there has been any wrongdoing and Wave is cooperating fully with the Commission on this matter. Wave cannot predict the potential effect on Wave as a result of this investigation at this time.

Purported Class Actions

        Several (9 known) similar purported class action complaints have been filed between January 23, 2004 and February 23, 2004 most in the United States District Court for the District of Massachusetts, seven (7) of which name Wave, its Chief Executive Officer and its Chief Financial Officer and two (2) of which also name Wave's Chairman, as defendants. The purported class action complaints have 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 complaints claim that Wave and the named individuals violated the federal securities laws by publicly disseminating materially false and misleading statements regarding Wave, relating to Intel and IBM agreements, resulting in the artificial inflation of Wave's Class A Common Stock price during the purported class periods. The complaints do not specify the amount of alleged damages plaintiffs seek to recover.

        Wave intends to defend the actions vigorously. At this time, Wave is unable to predict the outcome of these actions.

Derivative Actions

        Wave has learned of three (3) other complaints filed in the United States District Court for the District of Massachusetts. Wave believes that the complaints name all of its directors as defendants and allege claims for breach of fiduciary duties and other claims. The allegations are very similar to the allegations made in the purported securities class actions because the allegations concern the very same

11

alleged statements alleged in the purported class actions. Wave is also named as a nominal defendant, although the actions are derivative in nature and purportedly asserted on behalf of Wave. Wave is in the process of evaluating these claims.

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

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

        On November 21, 2003, Wave held a special meeting of shareholders (the "Special Meeting"). At the Special Meeting, the shareholders voted on the following matters:

1.

To consider and act upon a proposal to ratify the appointment of KPMG LLP as the Company's independent auditors for the year ending December 31, 2004. The proposal was adopted with the following results: 56,337,541 votes for, 334,336 votes against and 232,803 abstentions.

2.

To ratify the action of the Board of Directors in amending the 1994 Employee Stock Option Plan to increase the number of shares of Class A Common Stock authorized for issuance thereunder from 13,000,000 to 15,500,000. The proposal was adopted with the following results: 8,744,408 votes for, 2,385,919 votes against and 240,715 abstentions.

3.

To ratify the action of the Board of Directors in amending the 1994 Employee Stock Option Plan to extend the termination date thereof from January 1, 2004 to January 1, 2009. The proposal was adopted with the following results: 8,956,274 votes for, 2,143,224 votes against and 273,436 abstentions.

[The remainder of this page is intentionally left blank.]

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PART II

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.

        As of February 15, 2004, there were approximately 39,000 holders of our Class A Common Stock. As of such date, there were 16 holders of our Class B Common Stock.

        On March 1, 2004, the last sale price reported on the Nasdaq National Market for the Class A Common Stock was $1.52.

        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

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

        In connection with a software development agreement that Wave entered into with Archon Technologies, Inc. ("Archon"), Wave issued to Archon a warrant to purchase 50,000 shares of Class A Common Stock at $3.48 per share, pursuant to an individual compensation plan with Archon (the

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"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.

        A director of Wavexpress, Inc. ("Wavexpress"), a joint venture between Wave and Sarnoff Corporation, was granted a warrant to purchase 10,000 shares of Class A Common Stock at $10.00 per share, pursuant to an individual compensation plan with the director, upon acceptance of an offer to serve on Wavexpress' board. This warrant is currently exercisable and expires on August 24, 2004. No additional warrants are required to be granted pursuant to this individual compensation plan.

        As a result of the successful placement of 350 shares of Series B preferred stock, 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 are currently exercisable and expire on March 1, 2006.

        In connection with a consulting agreement that Wave entered into with the William Morris Agency, Inc. ("William Morris"), Wave issued William Morris a warrant to purchase 10,000 shares of Class A Common Stock at $14.73 per share, pursuant to an individual compensation plan with William Morris (the "William Morris Plan"). No additional warrants are required to be granted pursuant to the William Morris Plan. This warrant is currently exercisable and expires on March 31, 2004.

        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. 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.

Recent Sales of Unregistered Securities

        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 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 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. Proceeds from this issuance of common stock have been and will be used to fund Wave's ongoing operations, specifically its sales and marketing efforts, as well as its engineering, development and customer support teams and its general corporate overhead.

        In completing the sale of the unregistered Class A Common Stock referred to above, we relied upon Section 4(2) of the Securities Act of 1933 for exemption from registration of these securities. The common stock issued in the private placement was not registered under the Securities Act of 1933, as amended, at the time of issuance, and could not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. 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.

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Item 6.    Selected Financial Data

Statement of Operations Data

See Notes to Financial Statements

15

Balance Sheet Data

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

Overview

        During the year ended December 31, 2003 Wave's management made a significant shift in its business focus, devoting less attention and resources to its proprietary EMBASSY Trust System, to developing and marketing TCG-compliant software products known as its EMBASSY Trust Suite and EMBASSY Trust Server Applications in connection with TCG-compliant 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 in organizing its business to capitalize on the opportunities presented by this emergence, and overcoming the specific challenges in achieving this goal.

        The market trends and opportunities that management focused the company's activities on during the year ended December 31, 2003 included the following:

•

The market for information security services is growing rapidly—according to industry analyst, IDC, the U.S. market for information security services is expected to grow from approximately $4 billion in 2001 to $10.7 billion in 2006 representing a compound annual growth rate of 21.7%. The global market for information security is expected to reach $23 billion by 2006.¹

¹

IDC, The Shifting Landscape: U.S. Information Security Services, Jan. 2003, document #28640.

•

The persistence of security threats indicates that hardware is needed to provide more robust security than traditional software solutions.

•

Emergence of TPM-enabled PC's 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 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.

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•

Need to educate the marketplace of the advantages of utilizing hardware 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 2003).

        As more PC and chip OEM's 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 two separate OEM partners. Although no significant revenue has been recognized on these contracts through December 31, 2003, the forecasts that we've received from these customers provide an expectation that revenues of some significance may be realized later in calendar 2004 and 2005. In addition, we have sought to develop our products such that they operate on all of the major chip 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 TCG hardware enabled security. 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 to successfully implement a Trusted Platform solution. Wave's objective is to have these tools and applications ready to satisfy this need in 2004.

        With respect to sales and marketing, management is focused on broadening our distribution strategies to include resellers and systems integrators and expanding our presence selling directly to OEMs. We have re-organized and shifted the focus of our sales force during the latter part of the year in order to achieve these objectives.

        Management is also focused on opportunities for its eTM 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 experienced significant interest in these products and we continue to pursue this opportunity.

        With respect to Wavexpress' secure broadband media distribution products and services, the first revenue producing contracts were entered into during the year ended December 31, 2003 and Wave began realizing revenue starting in the third quarter of 2003 as a result of its first contract. Wavexpress continues to focus on sales and marketing activities and has signed additional contracts late in 2003 and during the first quarter of 2004, which will generate revenue during 2004. It is expected that these contracts that have been signed will generate revenue that is in-line with the revenue that Wavexpess has generated in the last two fiscal quarters. Management plans to devote increasing development resources towards building its feature set, to meet market demand.

        Finally, 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 and financial service sectors.

Operating Expense Trends

        In addition to the trend of decreasing research and development expenses discussed in Item I—Business; selling, general and administrative expenses ("S,G&A") have likewise been trending downward over the three years ended December 31, 2003. For the years ended December 31 2003,

17

2002 and 2001 we have incurred approximately $12.7 million, $19.2 million, and $24.2 million in S,G&A expenses, respectively. The activities supported by these expenditures include business development, sales, marketing (including product development and product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions. The downward trend in S,G&A expenses and expenses in general, is indicative of Wave's strict cost cutting measures which began during the second half of 2001 and have continued well into 2003. 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 to focus strictly on the government security sector and to a lesser degree, the financial services market. While Wave adjusted its emphasis to focus on the emerging TCG services market segment towards 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 an introductory 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 re-building our sales force, expanding our distribution channels and implementing a global sales and marketing strategy.

        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 will be an increase in sales and marketing expenditures, compared with the latter two fiscal quarters of 2003 with research and development remaining at approximately the same level as 2003, the overall forecast is for 2004 expenditures to be slightly less than 2003. (See Liquidity and capital resources.)

        While management has committed to pursuing the business opportunities and objectives described above, it recognizes significant risks that are involved with pursuing its strategy. Hardware-based computer security is but one approach to information security, and one that has significant hurdles to overcome. There remains a high level of uncertainty as to whether hardware based computer security will become a major category within the information security market, how large this category will be in terms of sales value, and the length of time that it may take for these products to become a widely utilized information security solution.

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

Critical Accounting Policies

        Wave's discussion and analysis of its financial condition and results of operations are based on the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, accounts receivable reserves, marketable securities, valuation of long-lived and intangible assets, accounting for joint ventures and software development. Management bases its estimates on

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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. "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, 2003, all of Wave's marketable equity securities are classified as available-for-sale.

        Inventories—Inventories, which are stated at the lower of cost or net realizable value, consist of inventory held for resale to customers. Cost is determined on the first-in, first-out basis and includes freight and other incidental costs incurred. Judgment is involved in evaluating backlog and in assessing the recoverability of inventory held at the balance sheet date. Wave provides inventory allowances based on the determination of excess and obsolete inventories as determined through the evaluation of future sales and changes in technology. During the quarter ended September 30, 2003, Wave recorded a write down of approximately $1,114,000, representing the value of its EMBASSY 2100 chips that were 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. While Wave continues to actively pursue business opportunities for EMBASSY 2100 chips, the sales cycle for these chips if any, is further into the future, raising greater uncertainty about the recoverability of the value of this inventory. Accordingly, we have written down the value of this inventory and recorded the charge as a separate item in its Statement of Operations rather than as an element of cost of goods sold since there have been no substantial sales of these products.

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        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.

        Wave adopted SFAS No. 144 during the first quarter of fiscal year 2002 without a material impact on its financial position or results of operations.

        Revenue Recognition—Wave's business model targets revenues from various sources including: licensing of EMBASSY Trust Suite, Wavexpress' broadband media distribution and eTMS software products, sales of hardware and development contracts. To date, our sales arrangements have not included multiple-elements, nor have our arrangements required significant modification or customization of the software, except for our contract with SSP Solutions for which we used the percentage of completion method of accounting that is described below.

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

        PRODUCTS—SOFTWARE AND HARDWARE

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

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

        SERVICES

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

        In October 2000, we entered into a $10 million comprehensive development agreement with SSP Solutions to integrate Wave's EMBASSY Trusted Client technology into the SSP Secure Service Provider™ Suite to be deployed in 5 million digital set top boxes and integrated gateway products such as cable and DSL modems. In May 2001 the agreement was amended whereby under the amended terms of the agreement, the parties agreed to a $5 million development services contract whereby Wave agreed to port its EMBASSY platform to run in a Linux environment. In addition, SSP agreed to place with Wave an open $5,000,000 purchase order for EMBASSY products. Payment terms of the agreement provided that SSP Solutions make payments of $277,778 per month for eighteen months. In addition, the parties agreed that in the event that SSP Solutions failed to pay any monthly installment, within 30 days of receiving written notice by Wave that it was in default, the unpaid portion of the installment would automatically convert into a stock acquisition right allowing Wave to acquire a number of shares in SSP Solutions to be determined by dividing the unpaid amount by the fair market value of SSP Solutions common stock. As the contract was for a discrete project to integrate our technology with the SSP platform, revenue under the development services agreement was recognized on a percentage of completion basis in accordance with SOP 97-2 as it relates to contract accounting

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under SOP 81-1. Percentage complete was determined based upon the actual costs incurred compared to the total estimated costs to complete, subject to cash received and milestones accomplished. Milestones included specific software development objectives required to have been completed and accepted by SSP Solutions. As of December 31, 2002 Wave had received $555,556 in cash and had not exercised any stock appreciation rights. We have recognized approximately $198,000 and $358,000 in revenue under the development agreement for the years ended December 31, 2002 and 2001, respectively. On September 30, 2002 Wave and SSP executed the Termination Agreement and Mutual Release in connection with the development agreement referred to above whereby Wave was issued an additional 1,600,000 shares of SSP Class A Common Stock and a non-negotiable, non-interest bearing, subordinated convertible promissory note due December 31, 2005 in the principal amount of $270,000 (the "Note"). (For further discussion of the termination of the development contract, see Other Income and Expenses below.)

Comparison of the years ended December 31, 2003 and 2002

Results of Operations

        For the twelve months ended December 31, 2003 and December 31, 2002, revenues were $189,363 and $446,588, respectively. The decrease in revenue is attributable to decreases in Product and Services and off set by an increase in Licensing and Other revenues, as set forth in the following table:

        The decrease in product revenue was the result of less demand and thus fewer shipments of hardware products in 2003 versus 2002. This trend is also indicative of management's shift in focus, as discussed in the Overview section above, away from its proprietary EMBASSY Trust System hardware to becoming a provider of security software applications that are compatible with various chip OEMs' security hardware, or TPMs. The service contract revenue for the year ended December 31, 2002 was derived in large part from a development contract with SSP Solutions, a former shareholder of Wave. (Wave also owns 16.5% of SSP Solutions as of December 31, 2003). The service contract revenue derived from this development contract for the year ended December 31, 2002 was $197,965, or 64% of the total service contract revenue for that year. Revenue on the contract was recognized on a percentage of completion basis limited to cash received and milestones accomplished. Work under this contract was suspended during the first quarter of 2002, and the contract was formally terminated pursuant to a settlement reached on September 30, 2002, in which Wave was issued 1,600,000 additional shares of SSP common stock and a convertible note with a face value of $270,000 that was converted into 200,000 additional common shares of SSP (See Item 8, Financial Statements, Note 11). Services revenue recognized in 2003 was for a number of smaller contracts with various customers. The increase in Licensing and Other revenues was due in large part to a licensing contract between Wavexpress and a customer which generated approximately $80,000 in revenue. The remainder of this License revenue was derived from contracts for Wave's eTMS software applications and OEM license contracts for Wave's EMBASSY Trust Suite of products.

        Cost of sales for the year ended December 31, 2003, was $55,179 compared with $202,208 for the same period in 2002. Gross profit was $134,184 representing a gross profit margin of 71% for the year ended December 31, 2003 versus gross profit of $244,380 representing a gross profit margin of 55% for the year ended December 31, 2002. The $110,196 decrease in gross profit was primarily the result of the overall decrease in sales, offset in part with a higher gross profit margin for the year ended

22

December 31, 2003, due to higher margins realized on licensing revenues in 2003 versus hardware and development services in 2002.

        Revenue and gross margins during the year ended December 31, 2003 versus the same period in 2002 is indicative of a downward trend, with neither period showing significant revenues. The amount of revenues in both years has not reached a level that would contribute significantly to Wave's operations and has been sporadic. (For a forward looking discussion on revenues, See Liquidity and capital resources, Revenue outlook.)

        Research and development expenses for the twelve months ended December 31, 2003 were $7,384,708 as compared to $12,009,713 for the comparable period of 2002. This 39% decrease in research and development expenses was primarily attributable to headcount reductions of employees and consultants, which decreased expenses by a total of $3,175,000 including salary and consultant compensation, fringe cost and all other headcount related expense associated with these headcount reductions. Thirty four positions were eliminated in 2003, due to an overall reduction in design and development activities in 2003. In addition, Wave reduced rent and other infrastructure related costs by $740,000 and depreciation expense was reduced by $343,000, due to assets becoming fully depreciated. Wavexpress' research and development expenses were $1,873,463 for the year ended December 31, 2003 versus $2,331,080 for the year ended December 31, 2002, for a reduction of 20%. 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.

        S,G&A expenses for the twelve months ended December 31, 2003 were $12,698,682 as compared to $19,188,046 for the comparable period of 2002. The 34% decrease in selling, general and administrative expenses was attributable to several factors. Wave reduced employee compensation, fringe expenses and other employee related expenses by approximately $2,833,000 by reducing its selling, general and administrative headcount by twenty-two (22) positions in 2003, in addition to the thirty-three (33) position decrease in the prior year. The headcount reductions were primarily in the areas of product marketing, business development and sales. Wave also reduced headcount in administrative and support areas within the company where it was possible to consolidate and restructure certain functions. Much of the cost savings were for reductions made during 2002, the cost reductions for which, carried into 2003 because the expenses were incurred for part of the year in 2002. These positions supported products and/or lines of business that Wave had de-emphasized in the prior year including our internet related businesses: MyPublish.com, a service that allows individual publishers to offer digital content for sale via the MyPublish.com website; CharityWave.com, an online charitable donation service; Wave Direct, a website offering digital content that could be consumed using a Wave hardware device and iShopHere.com, an internet shopping portal. In addition, during 2003, as Wave shifted the focus of its business more towards developing Trusted Platform software applications and less towards business development for its proprietary EMBASSY Trust System, management eliminated much of the product marketing, business development and sales positions that had previously been devoted toward supporting these products. Later in the year, management began re-building much of its sales organization to focus on the emerging trusted computing software application opportunity. Included in S,G&A expense were bonuses of approximately $986,000 and $831,000 paid to employees for the years ended December 31, 2003 and 2002, respectively. Additional cost reductions for the year ended December 31, 2003 versus 2002 consisted of reductions in legal costs of $605,000 as a result of fewer legal matters during 2003 versus 2002, reductions in trade show expenses of approximately $388,000 and public relations and marketing expenses were reduced by approximately $951,000. In addition, Wave reduced office rent and other infrastructure expense by approximately $376,000 by consolidating some locations and other cost cutting measures. Wave also reduced software license and maintenance agreement costs by $446,000, depreciation expense by $416,000 and franchise tax expenses by $118,000. Also, accrued litigation losses decreased by $488,000 due primarily to a charge for this amount that was recorded in the quarter ended March 31, 2002,

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related to a demand for arbitration brought by a former supplier against Wave. The arbitration arose out of a claim that Wave had breached a contract with the supplier to purchase computer components to be incorporated into an Internet security device produced by Wave. Wavexpress incurred S,G&A expenses of $2,014,828 in 2003, compared to $2,506,768 for 2002, for a decrease of 20%. The reasons set forth above encompass Wavexpress as well as Wave as a whole.

        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.

        Restructuring charges and charges for write-off of intangibles and other impaired assets decreased by $726,280 and $1,571,031 for the year ended December 31, 2003 versus 2002. This was due to a restructuring and cost reduction program during the year ended December 31, 2002 which Wave undertook to prioritize its initiatives, reduce expenses and improve efficiency. This program included a workforce reduction, the relocation of its Wavexpress office and restructuring of certain business functions. As a result of this program, Wave recorded restructuring costs and other charges of $726,280 consisting of $229,000 in severance benefits associated with the workforce reduction, $426,000 for lease termination fees and brokerage fees and $71,000 for moving expenses related to the Wavexpress office relocation. In addition, Wave recorded impairment charges of $905,390 for abandoned leasehold improvements and other tangible fixed assets that were disposed of or removed from operations. In the third quarter of 2002, Wave recorded an additional impairment charge which was associated with a license that was acquired in connection with its purchase of 60% of GlobalWave Group plc of $665,641. As a result of these two impairment events, total asset impairment charges for the twelve months ended December 31, 2002 were $1,571,031. No such charges were taken in the year ended December 31, 2003.

Other Income and Expenses

        Interest and other income for the year ended December 31, 2003 was $127,192 versus $477,902 for the year ended December 31, 2002, for a decrease of 73%. This decrease resulted from a decrease in interest bearing assets during 2003 and lower rates earned on those interest-bearing assets.

        For the year ended December 31, 2002, Wave took a charge for an "other than temporary decline" in the value of its investment in SSP of $11,513,099. This charge was taken because it was determined that an other than temporary decline in SSP's share price had occurred due to concerns about SSP's financial condition and near-term prospects. The amount was calculated as the difference between the previously adjusted cost basis of Wave's 4,883,083 shares of SSP, 3,083,083 of which were acquired in February 2001 and 1,800,000 which were acquired as settlement for termination of a development agreement (discussed below), versus the fair value of the shares based on the closing price of SSP as of December 31, 2002 on the Nasdaq National Exchange, or $0.59 per share. Also, during 2002, Wave was issued 1,800,000 shares of SSP in connection with the termination of a development contract between Wave and SSP. These shares were recorded as a gain on the termination of $1,818,000 of the contract for the year ended December 31, 2002. Wave sold 332,500 of its holdings of 4,883,083 shares of SSP during the year-ended December 31, 2003 for total proceeds of $430,934, recording a realized gain of $234,759. The 4,550,583 remaining shares of SSP are presented on the December 31, 2003 balance sheets at $6,325,310 versus $2,881,016 for the 4,883,083 shares held at December 31, 2002, respectively, which represents the closing value of the shares on the Nasdaq National Exchange on these dates. The increase in the value of the adjusted cost basis of the remaining shares as of December 31, 2003 of $3,640,469 is presented as an unrealized gain on marketable securities as a separate component of stockholders' equity as of December 31, 2003.

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        For the year ended December 31, 2003, Wave recorded income of $263,097 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 $1,254,948 as of the closing date of the private placement. As of December 31, 2003, the fair value of the liability was $991,851. 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 November 18, 2003 to December 31, 2003. Because the price of Wave's Class A Common Stock declined, the fair value of the warrants declined as well resulting in the gain. No such gains were realized for the year ended December 31, 2002.

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

        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 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.

        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. (See Note 8 to the Financial Statements).

Comparison of the years ended December 31, 2002 and 2001

Results of Operations

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

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

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

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

        S,G&A expenses for the twelve months ended December 31, 2002 were $19,188,046 as compared to $24,184,317 for the comparable period of 2001. The 21% decrease in selling, general and administrative expenses was attributable to several factors. Wave reduced employee compensation and fringe expenses by approximately $3,500,000 by reducing its selling, general and administrative headcount by an average of thirty-three (33) positions. Bonuses of approximately $936,000 and $1,570,000 were paid to employees for the years ended December 31, 2002 and 2001, respectively, accounting for $634,000 of the overall reduction in compensation costs. Wave also reduced professional fees expense by approximately $358,000 by eliminating three (3) consultant positions. The headcount reductions of both employees and consultants were made primarily in the areas of product marketing and operations for positions that supported products and/or lines of business that Wave has de-emphasized or abandoned. These included our internet related businesses: MyPublish.com, a service that allows individual publishers to offer digital content for sale via the MyPublish.com website; CharityWave.com, an online charitable donation service; Wave Direct, a website offering digital content that could be consumed using a Wave hardware device and iShopHere.com; an internet shopping portal. These products and services never reached full-scale production because the demand never reached a level that would warrant a full-scale production launch. The consultant positions that were eliminated as a result of the de-emphasis of these products were primarily involved in content preparation for these services (that is, the process of encrypting digital content to be consumed using certain Wave e-commerce technology). Wave also reduced headcount in administrative and support areas within the company where it was possible to consolidate and restructure certain functions. Additionally, during 2002 Wave undertook an aggressive cost cutting program that resulted in reductions in travel and entertainment expenses of $478,000 and reductions to telecommunications

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expenses totaling $163,000. In addition, Wave reduced office rent expense by approximately $296,000 as a result of the termination of its Wavexpress lease, and its move into smaller, less costly office space. Wavexpress incurred S,G&A expenses of $2,506,768 in 2002, compared to $4,800,927 for 2001, for a decrease of 48%. The reasons set forth above encompass Wavexpress as well as Wave as a whole.

        During the year ended December 31, 2002, Wave completed a restructuring and cost reduction program to prioritize its initiatives, reduce expenses and improve efficiency. This program included a workforce reduction, the relocation of its Wavexpress office and restructuring of certain business functions. As a result of this program, Wave recorded restructuring costs and other charges of $726,280 consisting of $229,000 in severance benefits associated with the workforce reduction, $426,000 for lease termination fees and brokerage fees and $71,000 for moving expenses related to the Wavexpress office relocation. All of these costs were incurred or paid by March 31, 2002. In connection with this program, Wave reduced its workforce by a total of thirty-six (36) employees, nineteen (19) of which were in research and development and seventeen that were in selling, general and administrative departments. All employees were notified of the work force reduction during the three months ended March 31, 2002. In addition, Wave recorded an impairment charge of $905,390 for abandoned leasehold improvements and other tangible fixed assets that were disposed of or removed from operations. In the third quarter of 2002, Wave recorded an additional impairment charge which was associated with a license that was acquired in connection with its purchase of 60% of GlobalWave Group plc of $665,641. As a result of these two impairment events, total asset impairment charges for the twelve months ended December 31, 2002 were $1,571,031. For the year ended December 31, 2001, Wave took a charge of $1,562,500 to write-off a technology license that it had purchased in connection with the development of the Wavexpress data broadcast system, and wrote-off $199,417 for hardware, also part of the Wavexpress terrestrial data casting system. These write-offs totaling $1,761,917, were the result of modifications to Wavexpress' business model; consequently, the value of these assets became impaired because they were no longer needed in the business and had no alternative uses.

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

Other Income and Expenses

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

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

        For the year ended December 31, 2002, Wave took a charge for an "other than temporary decline" in the value of its investment in SSP of $11,513,099. This charge was taken because it was determined that an other than temporary decline in SSP's share price had occurred due to concerns about SSP's financial condition and near-term prospects. The amount was calculated as the difference between the previously adjusted cost basis of Wave's 4,883,083 shares of SSP, 3,083,083 of which were acquired in February 2001, and 1,800,000 which were acquired as settlement for termination of a development agreement (discussed below), versus the fair value of the shares based on the closing price of SSP as of

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December 31, 2002 on the Nasdaq National Exchange, or $0.59 per share. As a result of this charge and a similar charge that was taken in the fourth quarter of 2001 for $1,736,682, the cost basis of the investment as of December 31, 2002 was adjusted to $2,881,019 from its original cost basis of $16,130,800. The investment is presented on the December 31, 2001 balance sheet at $11,160,758, which represents the closing value of the shares on the Nasdaq National Exchange on that date. The difference between the value and the adjusted cost basis is presented as an unrealized loss in stockholders' equity.

        On September 30, 2002 Wave and SSP executed the Termination Agreement and Mutual Release in connection with a development agreement previously entered into between the parties whereby Wave was issued an additional 1,600,000 shares of SSP Common Stock and the Note. The Note was convertible into SSP Common Stock at the conversion rate of $1.35, subject to adjustments for anti-dilution stock splits, stock dividends, reclassifications, reorganizations and the like. In exchange, Wave was released from its obligation to provide any further services under the development contract as amended. The shares that Wave received were recorded on its balance sheet at estimated fair value based on the average closing price of the shares on the Nasdaq National Exchange for the period from the two trading days before to the two trading days after the date of issuance of the shares, or $1.05 per share, for an aggregate value of $1,680,000. On December 31, 2002, SSP exercised its right to convert the Note and issue to Wave 200,000 shares of SSP common stock at the conversion rate of $1.35. The shares that Wave received from the Note conversion were recorded at a value per share of $0.69, for an aggregate value of $138,000. The SSP common stock that Wave received in connection with the Termination Agreement and Mutual Release and the Note conversion were recorded as a gain of $1,818,000 in Wave's statement of earnings for the year ended December 31, 2002.

        In the quarter ended December 31, 2002, Wave recorded a reserve for uncollectibility of $999,518 in respect of certain notes receivable from Peter J. Sprague, Wave's former Chairman. The Company had determined that Mr. Sprague was unable to repay the loan promptly. Mr. Sprague resigned as Chairman of Wave as of March 31, 2003. Wave engaged Mr. Sprague as Chairman and Chief Executive Officer of Wavexpress. Consistent with the provisions of the Sarbanes-Oxley Act of 2002, Wave has adopted a written policy prohibiting future loans to officers and directors.

Liquidity and capital resources

        We have experienced net losses and negative cash flow from operations since our inception, and, as of December 31, 2003, had a deficit accumulated during the development stage of $252,686,326. Total stockholders' equity as of December 31, 2003 was $14,014,636. 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 $224,848,569.

Sources and Uses of Cash

        At December 31, 2003, we had $8,818,305 in unrestricted cash and cash equivalents versus $10,221,124 as of December 31, 2002, resulting in a net decrease in cash of $1,402,819 for the year ended December 31, 2003. 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, 2003.

        As shown below, the total net decrease in cash for each of the last three years has decreased significantly from a net cash decrease for the year ended December 31, 2001 of $40,266,771, to a net cash decrease for the year ended December 31, 2002 of $30,215,995 to a net cash decrease for the year ended December 31, 2003 of $1,402,819.

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Statement of Cash Flow Data

Cash used in operations

        The amount of cash used in operations decreased significantly in each of the three years presented from $38,214,486 used for the year ended December 31, 2001, to $29,096,904 used for the year ended

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December 31, 2002 to $18,476,436 used for the year ended December 31, 2003. The decease in cash used in operations was, in large part, the result of the reduction in the Net Losses reported by Wave over the three year period as shown above, and as discussed in the previous Results of Operations section. In addition, the table above shows the significant items that were added back or subtracted from the Net Loss, as reported, that are either non-cash elements of the Net Losses or operating-related cash receipts and disbursements that are not reported in the Statement of Operations, to arrive at the amount of cash used by operating activities.

Adjustments to reconcile Net Loss to cash used in operating activities

        These amounts represent items reported in Wave's 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, and their fluctuations from year to year, are described in the Results of Operations section above. These items in the aggregate make up a significant portion of the differences between the reductions in Wave's reported Net Losses year over year, versus the differences in the reductions in cash used in operations over each of the periods. These items resulted in add-backs of $1,282,427, $14,777,100 and $12,919,838 for the years ended December 31, 2003, 2002 and 2001, respectively, to the reported Net Losses, due to large loss items included in the reported Net Loss that did not involve the outlay of cash in the periods. In addition, there were changes in asset and liability accounts and other adjustments, primarily for the pay down of accounts payable and accrued expenses and purchases of inventory as detailed above which represent additional uses of cash in each of the three years, and the receipt of $1,026,365 for the liquidation of other assets (this was for the return of security deposits in connection with expired leases) in 2002. Accordingly, while the overall Net Loss decreased by $23,872,607 (from $43,467,405 to $19,594,798) for the year ended December 31, 2003 versus the year ended December 31, 2002, cash used in operating activities decreased by the lesser amount of $10,620,468 (from $29,096,904 to $18,476,436.) Conversely, while the overall Net Loss decreased by $5,233,652 (from $48,701,057 to $43,467,405) for the year ended December 31, 2002 versus the year ended December 31, 2001, cash used in operating activities decreased by the greater amount of $9,117,582 (from $38,214,486 to $29,096,904), mainly due to more cash having been used to pay down trade payables and accrued expenses in 2001, and cash received in 2002 for the reimbursement of security deposits on leases.

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 $985,146, $1,148,723 and $1,507,598 for the years ended December 31, 2003, 2002 and 2001, respectively. Such amounts included the cost of internally developed capitalized software in the amount of $580,543, $770,468 and $610,413 for each of the three years ended December 31, 2003, 2002 and 2001, respectively. Wave expects to continue to acquire fixed assets primarily to replace computer equipment to be used internally and to develop capitalized software products to be licensed to customers. These expenditures are expected to continue at approximately the same level as the 2003 expenditures.

        During 2003, Wave sold 332,500 shares of the common stock of SSP for total proceeds of $430,934 in open market transactions, at an average selling price of $1.30 per share net of broker commissions. Wave owned approximately 16.8% of the outstanding common stock of SSP prior to the sales. As of December 31, 2003, Wave owned approximately 16.5% of the outstanding common stock of SSP.

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 year ended December 31, 2003, we needed to finance much of our operations through the sale of newly

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issued common stock as described below. In addition, Wave received funds from the repayment of notes receivable with an officer and a former officer of Wave, 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

Private Placement of Common Stock

        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 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 $2,864,000, 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, 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. 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, 2004.

        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.

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Exercise of Employee Stock Options

        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. As of March 1, 2004, "in the money" employee stock options to purchase approximately 1,634,000 shares of Class A Common Stock were outstanding.

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. Loans receivable from officers were $1,277,860 with a reserve of $999,518 for a net balance of $278,342 as of December 31, 2002. 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 bonus were the amount of the loan, the ability of Mr. Feeney to repay the loan and the impact that non-repayment of the loan would have had on Mr. Feeney's abilities to fulfill his duties for Wave. Wave no longer intends to award bonuses to executive officers or directors in 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 intends to take 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

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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. As of 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.

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 decreased 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, 2004 will be approximately $18,000,000, including research and development (including capitalized product development), acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

        Expected sources of capital include the following:

•

cash on hand of $8,818,000 as of December 31, 2003



•

sales of marketable securities valued at approximately $6,325,000 as of December 31, 2003



•

gross margin contribution from sales and licensing of products



•

additional financings

        Given Wave's capital requirements for the year ending December 31, 2004 as indicated above, the cash on hand of $8,818,000 as of December 31, 2003, by itself will not be sufficient to fund its operations for the full year ending December 31, 2004. An additional source of cash to fund operations for 2004 will likely come from the sales of its marketable securities valued as of December 31, 2003 at approximately $6,325,000, which consist of 4,550,583 shares of SSP's common stock. Wave may sell some or all of its holdings in SSP, as needed to fund its operations during 2004. As of March 1, 2004, Wave has sold 1,020,300 shares of SSP common stock for total proceeds of approximately $1,765,000.

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 2003 totaled approximately $227,000. Wave has received forecasts from its partner OEMs with which it currently has bundling contracts that will generate license royalty revenues. Although these forecasts indicate an upward trend in revenue for 2004, 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. Wave continues to work with its current 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 hardware-based secure computing and thereby increase its market

33

share and revenues. However, because TCG hardware security 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. Wave will also continue to pursue hardware sales and licensing of its proprietary EMBASSY Trust System, primarily in government-related security markets and financial markets, although currently has only a de minimus backlog of orders at this time for such sales. In addition, the company is exploring and pursuing contracts that will pay Wave for non-recurring engineering development services, although no such firm orders currently exist.

        Wavexpress has likewise begun to enter into contracts with customers for its broadband media distribution services. The types of contracts that Wavexpress has entered into thus far are by and large revenue sharing arrangements, whereby the customer's end-users pay a subscription fee to receive the service, and Wavexpress and the customer have a contractually agreed upon revenue sharing arrangement, in exchange for Wavexpress licensing its applications to the customer. 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 2004; 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

        From the discussion above, Wave's cash and marketable securities on hand will not, on their own, be sufficient to fund operations for the full year-ending December 31, 2004. Furthermore, given the uncertainties described above with respect to Wave's revenue outlook for 2004, there exists a reasonably high likelihood that additional funding will need to be generated, in the event that revenues are not sufficient to cover operating expenses. Also, given the unpredictability of revenues, and the time to complete a debt or equity financing, the company will likely be required to raise additional capital through either a debt or equity financing in order to continue as a going concern in 2004. Alternatively, Wave will be required to reduce expenses which may significantly impede its ability to meet its sales, marketing and development objectives. The amount of any such financing is unknown at this time. However, in the event that revenues do not grow substantially and given the available cash and marketable securities currently on hand, it is likely that Wave will be required to generate at least $3,000,000 in additional funding to continue in business through the end of 2004. It should also be noted that the market price of SSP's common stock is and has historically been volatile, and there is not certainty such market price will not go down thereby reducing the amount of capital available from this investment.

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 several class action securities and derivative shareholder lawsuits that have been served on 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 not known, however it is not unlikely that this negative publicity may be an impediment to Wave realizing its operational objectives until these matters are resolved, if indeed they are resolved in a non-damaging manner.

        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.

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        Furthermore, the achievement of sufficient revenue is dependent upon continued significant expenditures both in terms of the amount which will likely be required for research and development and sales and marketing to increase market awareness, beyond 2004. Therefore, if Wave is not able to begin to generate significant revenues by the end of 2004 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 2004.

Commitments

        Wave has no significant commitments other than with respect to operating leases for its facilities, which are listed below:

Net Operating Loss Carryforwards

        As of December 31, 2003, Wave had available net operating loss carryforwards for Federal income tax purposes of approximately $202 million, which expire beginning in 2004 through 2023. Because of the "change in ownership" provisions of the Tax Reform Act of 1986, our net operating loss carryforwards may be subject to an annual limitation on the utilization of these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50 percent of Wave occurs within any three-year period. We have made no determination concerning whether there 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.

Going Concern Opinion

        Wave's consolidated financial statements as of December 31, 2003 have been prepared under the assumption that we will continue as a going concern. Wave's independent auditors, KPMG LLP, have issued a report dated March 12, 2004, 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

        None that materially impact the Company.

Item 7A.    Quantitative and Qualitative Disclosure about Market Risk

        Wave's investment portfolio consists of a minority equity investment in SSP Solutions, a publicly traded company. As of December 31, 2003, we held 4,550,583 shares of common stock, representing a 16.35% equity interest in SSP. These securities are classified as available-for-sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. This investment is inherently risky because the markets for the technologies or products they have under development are typically in the early stages and may never materialize. For the year ended December 31, 2003, we recorded an unrealized gain on this investment of approximately $3.6 million as a separate component of stockholders' equity. We recorded charges against earnings associated with losses in value on our investment in SSP that were considered to be "other than temporary" of $11.5 million and $1.7 million for the years ended December 31, 2002 and 2001, respectively. Despite the unrealized gain that was recognized for the year ended December 31,

35

2003, our investment in these shares is subject to potentially significant declines in value. The following table presents the hypothetical change in fair values of Wave's investments in marketable equity securities of publicly traded entities using the high and low closing prices of the securities from January 1, 2001 through January 16, 2004:

        Assuming hypothetical future changes in the market prices of these investments based on the historical data presented above, the potential loss in future values resulting from such changes could range from between 64% and 89% of the fair market value of these investments as of December 31, 2003. The amount of such hypothetical future losses in fair market value would be equal to $4,048,000, $4,491,000 and $5,630,000, using hypothetical losses of 64%, 71% and 89%, respectively. It should be noted however that Wave has sold approximately 1,020,000 at an average price of $1.73 in the first quarter of 2004, therefore was able to realize gains on a portion of its portfolio, subsequent to December 31, 2003.

        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

(a)

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



(b)

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

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PART III

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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, 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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, 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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, 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 will be posted on Wave's Internet website at www.wave.com before the 2004 annual meeting of stockholders. 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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, 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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, 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 2004 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2004, under the caption "Certain Relationships and Related Transactions." Such information is incorporated herein by reference.

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PART IV

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

(a)

(1)    Financial Statements:

(a)

(2)    Financial Statement Schedules:

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

(a)

(3)    Exhibits:

38

39

40

41

*

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

Form 8-K filed on December 19, 2003.
Form 8-K filed on November 25, 2003.

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SIGNATURES

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

Dated: March 18, 2004

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

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Index to Consolidated Financial Statements

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
Wave Systems Corp.:

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

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

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wave Systems Corp. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 and for the period from February 12, 1988 (date of inception) to December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

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

KPMG LLP

Boston, Massachusetts
March 12, 2004

F-2

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

Consolidated Balance Sheets

December 31, 2003 and 2002

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, 2003, 2002, 2001 and the
period from February 12, 1988 (date of inception)
through December 31, 2003