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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

|ý                                                            | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2002                 
|o                                                            | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                            to

Commission file number 0-24752

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

|Delaware(State or other jurisdiction of
incorporation or organization)         |  | 13-3477246(I.R.S. Employer
Identification No.)
|------------------------------------------------------------------------------ |  | ----------------------------------------------
|480 Pleasant StreetLee, Massachusetts
(Address of principal executive offices) |  | 01238(Zip Code)                               

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

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

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

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

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

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

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

The
aggregate market value of the shares of Common Stock of the registrant held by non-affiliates as of December 31, 2002 was $67,479,663 (For purposes of this
calculation, the market value of a share of Class B Common Stock was assumed to be the same as a share of Class A Common Stock, into which it is convertible.)

As
of March 20, 2003, there were 51,781,918 shares of the registrant's Class A Common Stock and 314,225 shares of the registrant's Class B Common Stock outstanding.

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EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE U.S. SECURITIES LITIGATION REFORM ACT OF 1995. THESE
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES THAT MAY CAUSE 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.

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Table of Contents

|PART I       |                                 | 2 
|------------ | ------------------------------- | --
|             | Item 1.                         |   
|             | Item 2.                         |   
|             | Item 3.                         |   
|             | Item 4.                         |   
|PART II      |                                 | 12
|             | Item 5.                         |   
|             | Item 6.                         |   
|             | Item 7.                         |   
|             | Item 7A.                        |   
|             | Item 8.                         |   
|             | Item 9.                         |   
|PART III     |                                 | 29
|             | Item 10.                        |   
|             | Item 11.                        |   
|             | Item 12.                        |   
|             | Item 13.                        |   
|             | Item 14.                        |   
|PART IV      |                                 | 37
|             | Item 15.                        |   
|EXHIBIT 23.1 |                                 |   
|             | CONSENT OF INDEPENDENT AUDITORS |   

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PART I

Item 1.    Business

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

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

EMBASSY Products and Services

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

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

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

Wave Commerce System

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

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

Digital Signature and Electronic Document Management

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

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

Data Broadcast

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

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

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

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Markets and Business Strategy

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



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



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



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



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



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

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



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

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



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

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

|Customer                    |  | Product or Service Sold |  | Market Segment      |  | Percentage of
Total Revenue
in 2002 |  
|--------------------------- |  | ----------------------- |  | ------------------- |  | ----------------------------------- | -
|SSP Solutions, Inc.         |  | Development contract    |  | Government          |  | 44                                  | %
|CIBC World Markets Corp.USA |  | Services contract       |  | Banking and Finance |  | 21                                  | %
|BV Hagenuk CPS              |  | Hardware                |  | Device Manufacturer |  | 14                                  | %

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

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

Backlog

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

Competition

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

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

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

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

International Market

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

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

Proprietary Rights and Licenses and Intellectual Property

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

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

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

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

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

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

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

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

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

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

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

Research and Development

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

Recent Developments

Contract with SSP Solutions, Inc.

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

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

10

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Acquisition of 60% of GlobalWave Ltd

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

Introduction of TCPA Compliant Products

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

Employees

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

11

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Item 2.    Properties

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

Facility

Sq. Ft.

Monthly Base Rent

Utility/Common Costs

Lease ExpiresLee, MA

16,548

$
8,356

$
4,247

Aug. 2004New York, NY

4,500


7,500


0

Mar. 2003Nashville, TN

5,757


3,512


545

Sept. 2003Princeton, NJ

11,000


22,000


1,238

Jun. 2003Cupertino, CA

10,028


14,039


8,019

Feb. 2008New York, NY

7,169


25,360


4,936

Apr. 2006Orvault, France

1,000


7,681


0

Sept. 2010


Item 3.    Legal Proceedings

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

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

None.

PART II

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

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

High

LowYear Ended December 31, 2002First Quarter

$
2.92

$
1.58Second Quarter


2.51


1.17Third Quarter


2.08


1.18Fourth Quarter


1.90


1.20Year Ended December 31, 2001First Quarter

$
9.34

$
3.47Second Quarter


5.37


3.26Third Quarter


4.19


1.69Fourth Quarter


3.48


1.52


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

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

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

12

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Item 6.    Selected Financial Data

Statement of Operations Data

|                                                                       |                                                           | Year-ended December 31, |            
|---------------------------------------------------------------------- | --------------------------------------------------------- | ----------------------- | -----------
|
|Revenues, Net                                                          |                                                           | $                       | 446,588    
|                                                                       | Cost of Sales                                             |                         |            
|                                                                       |                                                           |                         |            
|                                                                       | Gross Margin                                              |                         |            
|                                                                       |                                                           |                         |            
|Operating expenses:                                                    |                                                           |                         |            
|                                                                       | Selling, general and administrative                       |                         |            
|                                                                       | Research and development                                  |                         |            
|                                                                       | Restructuring and other special charges                   |                         |            
|                                                                       | Acquisition Costs                                         |                         |            
|                                                                       | Amortization of Goodwill                                  |                         |            
|                                                                       | Write-off of Goodwill                                     |                         |            
|                                                                       | Write-off Impaired Assets                                 |                         |            
|                                                                       | In-Process Research & Development                         |                         |            
|                                                                       |                                                           |                         |            
|                                                                       |                                                           |                         | 33,495,070 
|                                                                       |                                                           |                         |            
|Other income (expense):                                                |                                                           |                         |            
|                                                                       | ITG Technology License Fee                                |                         |            
|                                                                       | License ITG Warrant Cost                                  |                         |            
|                                                                       | Loss on Other than Temporary Decline in Equity Securities |                         |            
|                                                                       | Equity in net losses of GlobalWave                        |                         |            
|                                                                       | Gain on termination of development contract               |                         |            
|                                                                       | Provision for loss on officer note receivable             |                         |            
|                                                                       | Net interest and other income (expense)                   |                         |            
|                                                                       |                                                           |                         |            
|Net loss                                                               |                                                           |                         | (43,467,405
|Accrued dividends on preferred stock                                   |                                                           |                         |           
|Assured incremental yield                                              |                                                           |                         |           
|                                                                       |                                                           |                         |            
|Net loss to common stockholders                                        |                                                           | $                       | (43,467,405
|                                                                       |                                                           |                         |            
|Weighted average number of common shares outstanding during the period |                                                           |                         | 51,135,548 
|Loss per common share-basic and diluted                                |                                                           | $                       | (0.85      
|                                                                       |                                                           |                         |            
|Cash dividends declared per common share                               |                                                           |                         | -0-        

See Notes to Financial Statements

13

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Balance Sheet Data

|                              |  | As of December 31 |           
|----------------------------- |  | ----------------- | ----------
|
|Working capital (deficiency). |  | $                 | 8,754,620 
|Total assets                  |  |                   | 18,209,372
|Long-term liabilities         |  |                   |          
|Total Liabilities             |  |                   | 3,667,533 
|Redeemable preferred stock    |  |                   |          
|                              |  |                   |           
|Total stockholders' equity    |  | $                 | 14,541,839
|                              |  |                   |           

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

Overview

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

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

14

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

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

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

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

15

---

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

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

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

Critical Accounting Policies

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

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

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

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

16

---

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

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

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

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



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.

17

---

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

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

Wave
follows the provisions of statement of position "SOP" 97-2,Software Revenue Recognitionas 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

18

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

Comparison of the years ended December 31, 2002 and 2001

Results of Operations

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

2002

2001

Increase/(Decrease)

% ChangeProduct

$
121,974

$
192,506

$
(70,532
)
(37
%)Services


310,573


430,724


(120,151
)
(28
%)Licensing and Other


14,041


68,895


(54,854
)
(80
%)Total Net Revenues


446,588


692,125

$
(245,537
)
(35
%)


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

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

19

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

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

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

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

20

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

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

Other Income and Expenses

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

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

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

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

21

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

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

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

Comparison of the years ended December 31, 2001 and 2000

Results of Operations

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

2001

2000

Increase/(Decrease)

% ChangeProduct

$
192,506

$
4,400

$
188,106

4275
%Services


430,724





430,724

Licensing and Other


68,895


328,122


(259,227
)
(79
)%Total Net Revenues


692,125


332,522


359,603

108
%


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

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

22

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

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

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

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

23

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

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

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

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

Other Income and Expenses

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

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

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

Liquidity and capital resources

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

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

24

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

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

|                     |  | 2003 |           | 2004 |   | 2005    |  | 2006 |         | 2007 |   | Thereafter |  | Total
|-------------------- |  | ---- | --------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ---------- |  | -----
|Leases               |  | $    | 702,000   |      | $ | 589,000 |  | $    | 574,000 |      | $ | 376,000    |  | $    
|Software Development |  |      | 300,000   |      |   |        |  |      |        |      |   |           |  |      
|                     |  |      |           |      |   |         |  |      |         |      |   |            |  |      
|Total Commitments    |  | $    | 1,002,000 |      | $ | 589,000 |  | $    | 574,000 |      | $ | 376,000    |  | $    
|                     |  |      |           |      |   |         |  |      |         |      |   |            |  |      

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

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

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

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

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

25

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

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

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

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

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

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

Recent Accounting Pronouncements

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

26

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

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

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

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

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

Item 7A.    Quantitative and Qualitative Disclosure about Market Risk

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

27

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

|                                                     |  | Fair Market Value
("FMV") at the lowest
closing price from
January 1, 2001 through
March 20, 2003 |           | FMV as of
December 31, 2002 |   | FMV at the highest
closing price from
January 1, 2001
through
March 20, 2003
|---------------------------------------------------- |  | ------------------------------------------------------------------------------------------------- | --------- | --------------------------- | - | ----------------------------------------------------------------------------
|Corporate Equities                                   |  | $                                                                                                 | 2,636,865 |                             | $ | 2,881,016                                                                   
|Percentage decrease from highest closing price       |  |                                                                                                   | 87        | %                           |   | 86                                                                          
|Percentage decrease from FMV as of December 31, 2002 |  |                                                                                                   | 8         | %                           |   |                                                                            

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

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

Item 8.    Financial Statements and Supplementary Data

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

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

Not Applicable.

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PART III

Item 10.    Directors and Executive Officers of the Registrant

|Name                                        |  | Age |  | Business Experience and Principal Occupation or
Employment During Past 5 Years; Positions held with
Wave Systems Corp.; Other Directorships                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Director
Since
|------------------------------------------- |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------
|Peter J. Sprague(1)(4)                      |  | 64  |  | Chairman of the Board since 1988; Chief Executive Officer Wave from July 1991 to March 2000; Director of WaveXpress, (a majority-owned subsidiary of Wave), uWink.com, Inc. and SemEquip, Inc.; President of KWI, Inc.;
Trustee of the Strang Clinic; Member of Academy of Distinguished Entrepreneurs, Babson College. Mr. Sprague is the father of Steven Sprague, President and Chief Executive Officer of Wave. Mr. Sprague has resigned as an officer and a director of Wave,
effective March 31, 2003.                                                                                                                                                                                                                                                                                                                                     |  | 1988          
|John E. Bagalay, Jr., Ph.D.
(1)(2)(3)(4)(5) |  | 69  |  | Senior Advisor to the Chancellor of Boston University since January 1998; Chief Operating Officer of Eurus Technologies, Inc. from January 1999 to December 1999 and Chief Financial Officer of Eurus International, Limited
(formerly known as Eurus Technologies, Inc.) since January 1999; President and CEO of Cytogen Corporation from January 1998 to January 1999 and Chief Financial Officer from October 1997 to September 1998; Managing Director, Community Technology Fund,
venture capital affiliate of Boston University from September 1989 to December 1997; former General Counsel of Lower Colorado River Authority, Texas Commerce Bancshares, Inc. and Houston First Financial Group; Director of Cytogen Corporation,
Decorize, Inc., and several privately held companies. Mr. Bagalay's term as director expires in 2003. |  | 1993          
|Nolan Bushnell(3)                           |  | 60  |  | Chairman and Chief Executive Officer of uWink.com, Inc. since December 1999 where he is leading the development of streaming media distribution models for internet entertainment. Mr. Bushnell's term as director expires in
2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | 1999          
|George Gilder(4)                            |  | 63  |  | Chairman of the Executive Committee of Wave since 1996; Senior Fellow at the Discovery Institute in Seattle, Washington; author of several books, including Life After Television, Microcosm, The Spirit of Enterprise,
Wealth and Poverty and most recently Telecosm; contributing editor to Forbes Magazine; Chairman of Gilder Technology Group, Inc. (publisher of monthly technology reports); former chairman of the Lehrman Institute Economic Roundtable; former Program
Director for the Manhattan Institute; recipient of White House award for Entrepreneurial Excellence from President Reagan. Mr. Gilder's term as director expires in 2003.                                                                                                                                                                                       |  | 1993          

29

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|John E. McConnaughy, Jr.
(1)(2)(3)(4)(5) |  | 73 |  | Chairman and Chief Executive Officer of JEMC Corporation; Director of Varsity Brands Inc., Levcor International, Inc., Fortune Natural Resources, Inc., Overhill Farms, Inc. and Consumer Portfolio Services Inc. Mr.
McConnaughy is also Chairman of the Board of Trustees of the Strang Clinic and the Chairman Emeritus of the Board of the Harlem School of the Arts. Mr McConnaughy's term as director expires in 2003.                                                                                                                |  | 1988
|---------------------------------------- |  | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|Steven Sprague                           |  | 38 |  | President and Chief Executive Officer of Wave since March 2000; President and Chief Operating Officer of Wave from May 1996 to March 2000; President of Wave Interactive Network from June 1995 to December 30, 1996; Chief
Executive Officer and Chairman of the Board of Directors of WaveXpress, (a majority-owned subsidiary of Wave) and Vice President and director of Specialty Broadcast Networks, Inc. Mr. Sprague is the son of Peter J. Sprague, former Chairman of the
Company. Mr. Sprague's term as director expires in 2003. |  | 1997

Biographical Information Regarding Executive Officer Who Is Not A Director

|Name             |  | Age |  | Business Experience and Principal Occupation or
Employment During Past 5 Years; Positions held with
Wave Systems Corp.; Other Directorships                                                                                                                                     |  | Officer
Since
|---------------- |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------
|Gerard T. Feeney |  | 44  |  | Secretary of Wave since February 1999, Senior Vice President of Finance and Administration, and Chief Financial Officer of Wave since June 1998; Vice President of Finance and Operations and Chief Financial Officer of
Xionics Document Technologies, Inc. from 1991 to 1998. |  | 1998         

---

Involvement in Certain Legal Proceedings

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

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

Item 11.    Executive Compensation



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

30

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

|                                                                                 |  |                |  |    |                         |  |                         | Long-Term
Compensation
Awards
|-------------------------------------------------------------------------------- |  | -------------- |  | -- | ----------------------- |  | ----------------------- | -----------------------------
|
|
|
|Peter J. Sprague(1) Chairman                                                     |  | 2002
2001
2000 |  | $$ | 185,000
185,000
185,000 |  | 200,391
105,000
150,000 |                              
|Steven Sprague(2) President and Chief Executive Officer                          |  | 2002
2001
2000 |  |    | 250,000
250,000
250,000 |  | 161,500
175,000
250,000 |                              
|Gerard T. Feeney(3) Senior Vice President, Chief Financial Officer
and Secretary |  | 2002
2001
2000 |  |    | 185,000
185,000
185,000 |  | 102,000
105,000
150,000 |                              

---



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

|                 |  |         |  |      |   |   |      |  |        | Potential Realizable Value at
Assumed Annual Rates of
Stock Price Appreciation
For Option Term (1)
|---------------- |  | ------- |  | ---- | - | - | ---- |  | ------ | --------------------------------------------------------------------------------------------------
|
|
|
|Peter J. Sprague |  | 200,000 |  | 12.4 | % | $ | 2.01 |  | 2/1/12 |                                                                                                   
|Steven Sprague   |  | 252,500 |  | 15.7 | % | $ | 2.01 |  | 2/1/12 |                                                                                                   
|Gerard T. Feeney |  | 150,000 |  | 9.3  | % | $ | 2.01 |  | 2/1/12 |                                                                                                   

---

31

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The following table sets forth information regarding the aggregate number and value of options held by the Named Executive Officers as of December 31,
2002, and the aggregate number and value of options exercised by the Named Executive Officers during 2002.

|                 |  |     |  |   |     | Number of Shares
Underlying
Unexercised Options
at December 31, 2002(#) |           |  |         | 
|---------------- |  | --- |  | - | --- | ----------------------------------------------------------------------- | --------- |  | ------- | 
|
|
|
|Peter J. Sprague |  | -0- |  | $ | -0- |                                                                         | 955,833   |  | 366,667 | 
|Steven Sprague   |  | -0- |  |   | -0- |                                                                         | 1,336,172 |  | 585,833 | 
|Gerard T. Feeney |  | -0- |  |   | -0- |                                                                         | 466,667   |  | 283,333 | 

---

Employment Contracts

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

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

32

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Compensation Interlocks and Insider Participation

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

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

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

|Plan Category                                                         |  | Number of
Securities to be
issued upon
exercise of
outstanding
options warrants
and rights |  | Weighted
Average
exercise price
of outstanding
options,
warrants and
rights |      | Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
|--------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------- | ---- | -------------------------------------------------------------------------------------------------------------------------------------------
|
|Equity compensation plans approved by security holders                |  | 10,183,243                                                                                 |  | $                                                                           | 5.94 |                                                                                                                                            
|Wave equity compensation plans not approved by security holders       |  | 85,000                                                                                     |  |                                                                             | 5.50 |                                                                                                                                            
|                                                                      |  |                                                                                            |  |                                                                             |      |                                                                                                                                            
|Total Wave plans                                                      |  | 10,268,243                                                                                 |  | $                                                                           | 5.94 |                                                                                                                                            
|WaveXpress equity compensation plans not approved by security holders |  | 1,402,841                                                                                  |  | $                                                                           | 1.21 |                                                                                                                                            

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

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

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

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

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

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

33

---

Common Stock will have five votes per share in cases where one or more directors are nominated for election by persons other than Wave's Board of Directors and where there is a vote on any merger,
consolidation or other similar transaction which is not recommended by Wave's Board of Directors. In addition, holders of Class B Common Stock will have five votes per share on all matters
submitted to a vote of the stockholders in the event that any person or group of persons acquires beneficial ownership of 20% or more of the outstanding voting securities of Wave. Shares of
Class B Common Stock are convertible into shares of Class A Common Stock on a one-for-one basis at the option of the holder.

|Beneficial
Owner(1)                                              |  | Number of
Shares
of Class A
Common
Stock
Owned(2) |  | Percent
of
Class |  | Number of
Shares
of Class B
Common
Stock
Owned |  | Percent
of
Class |  | Percent
of All
Outstanding
Common
Stock(3)
|---------------------------------------------------------------- |  | ------------------------------------------------- |  | ---------------- |  | ---------------------------------------------- |  | ---------------- |  | ------------------------------------------
|Peter J. Sprague (4), (12)                                       |  | 1,928,834                                         |  | 3.2              |  | 161,000                                        |  | 49.7             |  | 3.5                                       
|John E. Bagalay, Jr.(5)                                          |  | 126,000                                           |  | *                |  | 0                                              |  | *                |  | *                                         
|Nolan Bushnell (6)                                               |  | 56,316                                            |  | *                |  | 4,316                                          |  | 1.3              |  | *                                         
|George Gilder (7)                                                |  | 206,000                                           |  | *                |  | 2,000                                          |  | *                |  | *                                         
|John E. McConnaughy, Jr. (8)                                     |  | 66,750                                            |  | *                |  | 0                                              |  | *                |  | *                                         
|Steven Sprague (9), (12)                                         |  | 1,898,327                                         |  | 3.3              |  | 42,102                                         |  | 13.0             |  | 3.4                                       
|Gerard T. Feeney (10)                                            |  | 800,000                                           |  | 1.4              |  | 0                                              |  | *                |  | 1.4                                       
|All executive officers and directors as a group (7 persons) (11) |  | 4,860,727                                         |  | 8.3              |  | 209,418                                        |  | 64.6             |  | 8.8                                       

---

34

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Item 13.    Certain Relationships and Related Transactions

Note Receivable from Director/Officers

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

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

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

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

35

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Specialty Broadcast Networks

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

Compensation to Michael Sprague

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

Item 14.    Controls and Procedures



36

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PART IV

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

|                                                                                                                                                                                                                                                |  | Page(s)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------
|Index to Consolidated Financial Statements                                                                                                                                                                                                      |  | F-1    
|Independent Auditors' Report                                                                                                                                                                                                                    |  | F-2    
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                                                                                                                                    |  | F-3    
|Consolidated Statements of Operations for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31, 2002                                                              |  | F-4    
|Consolidated Statements of Stockholders' Equity (Deficiency) and Other Comprehensive Income (Loss) for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31,
2002 |  | F-5    
|Consolidated Statements of Cash Flows for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31, 2002                                                              |  | F-13   
|Notes to Consolidated Financial Statements                                                                                                                                                                                                      |  | F-15   



|Exhibit No. |  |   |  | Description of Exhibit                                                                                                                                                                                                                                             
|----------- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*        |  |  |  | Restated Certificate of Incorporation of Wave (incorporated by reference to Exhibit 3.1 of Wave's Registration Statement on Form S-1, File No. 33-75286)                                                                                                           
|3.2*        |  |  |  | Bylaws of Wave (incorporated by reference to Exhibit 3.2 of Wave's Registration Statement on Form S-1, File No. 33-75286)                                                                                                                                          
|4.1*        |  |  |  | Form of Stock Certificate of Class A Common Stock (incorporated by reference to Exhibit 4.1 of Wave's Registration Statement on Form S-1, File No. 33-75286)                                                                                                       
|4.2*        |  |  |  | Form of Representative's Warrant Agreement, including the form of Representative's Warrant (incorporated by reference to Exhibit 4.2 of Wave's Registration Statement on Form S-1, File No. 33-75286).                                                             
|4.3*        |  |  |  | Certificate of Designation of Series B Preferred Stock of Wave as filed with the Delaware Secretary of State on May 24, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K filed on May 30,
1996, File No. 0-24752)               
|4.4*        |  |  |  | Certificate of Designation of Series C Convertible Preferred Stock of as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on
Form 8-K filed on January 8, 1997, File No. 0-24752)
|4.5*        |  |  |  | Certificate of Designation of Series D Convertible Preferred Stock of as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on
Form 8-K filed on June 3, 1997, File No. 0-24752)   

37

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|4.6*    |  |  |  | Certificate of Designation of Series F Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 9, 1997 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on
Form 8-K filed on October 15, 1997, File No. 0-24752)
|------- |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.7*    |  |  |  | Certificate of Designation of Series G Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on March 5, 1998 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K
filed on March 19, 1998, File No. 0-24752)    
|+10.1*  |  |  |  | Joint Technology Development Agreement, dated as of May 1, 1992, between The Titan Corporation and Cryptologics International, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Registration Statement on Form S-1,
File No. 33-75286)                        
|+10.2*  |  |  |  | License and Cross-License Agreement, dated as of May 1, 1992, between The Titan Corporation and Cryptologics International, Inc. (incorporated by reference to Exhibit 10.3 of Wave's Registration Statement on Form S-1,
File No. 33-75286)                           
|10.3*   |  |  |  | Amendment to License and Cross-License Agreement, dated as of August 27, 1993, between The Titan Corporation and Wave (incorporated by reference to Exhibit 10.4 of Wave's Registration Statement on Form S-1, File No.
33-75286)                                      
|10.4*   |  |  |  | Amended and Restated License Agreement, dated February 14, 1994, by and among Wave, Peter J. Sprague and John R. Michener (incorporated by reference to Exhibit 10.5 of Wave's Registration Statement on Form S-1, File
No. 33-75286)                                  
|10.5*  |  |  |  | Wave 1994 Stock Option Plan (incorporated by reference to Exhibit 10.6 of Wave's Registration Statement on Form S-1, File No. 33-75286)                                                                                                                                
|10.6*  |  |  |  | Wave Non-Employee Directors Stock Option Plan (incorporated by reference to Exhibit 10.7 of Wave's Registration Statement on Form S-1, File No. 33-75286)                                                                                                              
|10.7*  |  |  |  | Wave 1996 Performance Stock Option Plan (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                                      
|10.8*   |  |  |  | Addendum to License and Cross-License Agreement, dated February 28, 1997, between The Titan Corporation and Wave (incorporated by reference to Exhibit 10.10 of Wave's Annual Report on Form 10-K filed on March 24, 1997,
file No. 0-24752).                          
|10.9*  |  |  |  | Employment Contract, dated June 8, 1998, between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 10.18 of Wave's Annual Report on Form 10-K filed on April 1, 1999, file No. 0-24752).                                                                 
|10.10* |  |  |  | Employment Contract, dated November 10, 1998, between Steven Sprague and Wave (incorporated by reference to Exhibit 10.19 of Wave's Annual Report on Form 10-K filed on April 1, 1999, file No. 0-24752).                                                              
|10.11*  |  |  |  | Asset Purchase Agreement dated August 13, 2000, by and among Wave and Indigo Networks, LLC (incorporated by reference to Exhibit 99.1 of Wave's current report on Form 8-K, filed on September 15, 2000 (File #0-24752)                                                
|10.12*  |  |  |  | Consulting Services Agreement dated September 14, 2001, by and between Wave and Archon Technologies, Inc. (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002
(File #0-24752))                                    
|10.13   |  |  |  | Office Building Lease dated October 20, 2002 between Stevens Creek Investors, LLC and Wave                                                                                                                                                                             

38

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|10.14* |  |  |  | Form of Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                 
|------ |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.15* |  |  |  | First Amendment to Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002
(File #0-24752))                                                      
|10.16* |  |  |  | Termination Agreement and Mutual Release between Wave Systems Corp. and SSP Solutions, Inc. date September 30, 2002 (Incorporated herein by referenced to Wave's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002, filed on November 14, 2002 (File #0-24752)) 
|10.17* |  |  |  | Subordinated Convertible Promissory Note between Wave Systems Corp. and SSP Solutions, Inc. dated September 30, 2002 (Incorporated herein by referenced to Wave's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002, filed on November 14, 2002 (File #0-24752))
|10.18* |  |  |  | Share Purchase Agreement between Redwave plc, GlobalWave Group plc and Wave Systems Corp. dated June 19, 2002 (Incorporated herein by referenced to Wave's Quarterly Report on Form 10-Q for the quarter ended September 30,
2002, filed on November 14, 2002 (File #0-24752))       
|10.19* |  |  |  | GlobalWave Group plc Notice of Extraordinary General Meeting dated June 20, 2002 (Incorporated herein by referenced to Wave's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14,
2002 (File #0-24752))                                    
|21.1*  |  |  |  | Subsidiaries of Registrant (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                                                                 
|23.1   |  |  |  | Consent of Independent Auditors  KPMG LLP                                                                                                                                                                                                                                           
|99.1*  |  |  |  | Demand Note, dated March 26, 2001 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                        
|99.2*  |  |  |  | Demand Note, dated February 27, 2001 between Peter J. Sprague and Wave(incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                      
|99.3*  |  |  |  | Demand Note, dated July 25, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                         
|99.4*  |  |  |  | Demand Note, dated September 5, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 10.12 of Wave's annual report on Form 10-K, filed on April 1, 2002 (File #0-24752))                                                                                     
|99.5   |  |  |  | Section 906 Certification                                                                                                                                                                                                                                                            

---

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

39

---



SIGNATURES

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

Dated:
March 30, 2003

| |  | WAVE SYSTEMS CORP.
| |  | ------------------
| |  | By:               

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

|Signature                                           |  | Title                                                                                                                                                                |  | Date          
|--------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|                                                    |  |                                                                                                                                                                      |  |               
|/s/PETER J. SPRAGUEPeter J. Sprague                 |  | Chairman                                                                                                                                                             |  | March 30, 2003
|/s/STEVEN SPRAGUESteven Sprague                     |  | President, Chief Executive Officer
and Director                                                                                                                      |  | March 30, 2003
|/s/JOHN E. BAGALAY, JR.John E. Bagalay, Jr.         |  | Director                                                                                                                                                             |  | March 30, 2003
|/s/GEORGE GILDERGeorge Gilder                       |  | Director                                                                                                                                                             |  | March 30, 2003
|/s/JOHN E. MCCONNAUGHY, JR.John E. McConnaughy, Jr. |  | Director                                                                                                                                                             |  | March 30, 2003
|/s/NOLAN BUSHNELLNolan Bushnell                     |  | Director                                                                                                                                                             |  | March 30, 2003
|/s/GERARD T. FEENEYGerard T. Feeney                 |  | Senior Vice President, Finance
and Administration, Chief Financial
Officer and Secretary (Principal
Financial Officer and Duly Authorized
Officer of the Registrant) |  | March 30, 2003

40

---



CERTIFICATIONS

I,
Steven K. Sprague, certify that:





|Dated: March 31, 2003 |  | /s/STEVEN K. SPRAGUESteven K. Sprague, President
and Chief Executive Officer
|--------------------- |  | ----------------------------------------------------------------------------

41

---

I, Gerard T. Feeney, certify that:





|Dated: March 31, 2003 |  | /s/GERARD T. FEENEYGerard T. Feeney,
Chief Financial Officer
|--------------------- |  | ------------------------------------------------------------

42

---



Index to Consolidated Financial Statements

|                                                                                                                                                                                                                                                |  | Page(s)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------
|Independent Auditors' Report                                                                                                                                                                                                                    |  | F-2    
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                                                                                                                                    |  | F-3    
|Consolidated Statements of Operations for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31, 2002                                                              |  | F-4    
|Consolidated Statements of Stockholders' Equity (Deficiency) and Other Comprehensive Income (Loss) for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31,
2002 |  | F-5    
|Consolidated Statements of Cash Flows for each of the years ended December 31, 2002, 2001 and 2000 and for the period from February 12, 1988 (inception) through December 31, 2002                                                              |  | F-13   
|Notes to Consolidated Financial Statements                                                                                                                                                                                                      |  | F-15   

F-1

---



INDEPENDENT AUDITORS' REPORT

The
Board of Directors and Stockholders
Wave Systems Corp.:

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

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

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

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



Boston,
Massachusetts
March 31, 2003

F-2

---



WAVE SYSTEMS CORP. AND SUBSIDIARIES  (a development stage corporation)        Consolidated Balance Sheets        December 31, 2002 and 2001

|                                                                                                                                               |                                        | 2002                       |              | 2001       |           
|---------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------- | -------------------------- | ------------ | ---------- | ----------
|Assets                                                                                                                                         |                                        |                            |              |            |           
|Current assets:                                                                                                                                |                                        |                            |              |            |           
|                                                                                                                                               | Cash and cash equivalents              |                            | $            | 10,221,124 |           
|                                                                                                                                               | Cash Collected on Behalf of Charities  |                            |              | 235,553    |           
|                                                                                                                                               | Marketable securities                  |                            |              |           |           
|                                                                                                                                               | Notes Receivable from Officers         |                            |              | 278,342    |           
|                                                                                                                                               | Inventories                            |                            |              | 1,112,818  |           
|                                                                                                                                               | Prepaid expenses and other receivables |                            |              | 574,316    |           
|                                                                                                                                               |                                        |                            |              |            |           
|                                                                                                                                               |                                        | Total current assets       |              |            | 12,422,153
|                                                                                                                                               | Marketable Equity Securities           |                            |              | 2,881,016  |           
|                                                                                                                                               | Property and equipment, net            |                            |              | 2,542,765  |           
|                                                                                                                                               | Other assets                           |                            |              | 363,438    |           
|                                                                                                                                               |                                        |                            |              |            |           
|                                                                                                                                               |                                        | Total Assets               |              |            | 18,209,372
|                                                                                                                                               |                                        |                            |              |            |           
|Liabilities and Stockholders' equity                                                                                                           |                                        |                            |              |            |           
|Current liabilities:                                                                                                                           |                                        |                            |              |            |           
|                                                                                                                                               | Accounts payable and accrued expenses  |                            |              | 3,404,377  |           
|                                                                                                                                               | Due to Charities                       |                            |              | 263,156    |           
|                                                                                                                                               | Deferred Revenue                       |                            |              |           |           
|                                                                                                                                               |                                        |                            |              |            |           
|                                                                                                                                               |                                        | Total current liabilities  |              |            | 3,667,533 
|Stockholders' Equity:                                                                                                                          |                                        |                            |              |            |           
|Common Stock, $.01 par value. Authorized 75,000,000 shares as Class A; 51,771,918 shares issued and outstanding in 2002 and 49,996,506 in 2001 |                                        |                            | 517,720      |            |           
|Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 324,225 shares issued and outstanding in 2002 and 357,083 in 2001       |                                        |                            | 3,242        |            |           
|Capital in excess of par value                                                                                                                 |                                        |                            | 247,112,405  |            |           
|Deficit accumulated during the development stage                                                                                               |                                        |                            | (233,091,528 | )          |           
|Accumulated Other Comprehensive Incomeunrealized gain (loss) on marketable securities                                                         |                                        |                            |             |            |           
|                                                                                                                                               |                                        |                            |              |            |           
|                                                                                                                                               |                                        | Total stockholders' equity |              |            | 14,541,839
|                                                                                                                                               |                                        |                            |              |            |           
|Total Liabilities and Stockholders' Equity                                                                                                     |                                        | $                          | 18,209,372   |            | $         
|                                                                                                                                               |                                        |                            |              |            |           

See
accompanying notes to consolidated financial statements.

F-3

---



WAVE SYSTEMS CORP. AND SUBSIDIARIES  (a development stage corporation)        Consolidated Statements of Operations        Years ended December 31, 2002, 2001, 2000, and  period from
February 12, 1988 (date of inception)  through December 31, 2002

|                                                                       |                                                    | 2002                                                                 |             | 2001       |             | 2000        |            | Period from
February 12, 1988
(date of inception)
through
December 31,
2002 |            
|---------------------------------------------------------------------- | -------------------------------------------------- | -------------------------------------------------------------------- | ----------- | ---------- | ----------- | ----------- | ---------- | --------------------------------------------------------------------------- | -----------
|Net Revenues:                                                          |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Product                                                                |                                                    | $                                                                    | 121,974     |            | $           | 192,506     |            | $                                                                           | 4,400      
|                                                                       | Services                                           |                                                                      |             | 310,573    |             |             | 430,724    |                                                                             |            
|                                                                       | Licensing and Other                                |                                                                      |             | 14,041     |             |             | 68,895     |                                                                             |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       |                                                    | Total Net Revenues                                                   |             |            | 446,588     |             |            | 692,125                                                                     |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       | Cost of sales:                                     |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       | Product                                            |                                                                      |             | 64,769     |             |             | 135,134    |                                                                             |            
|                                                                       | Services                                           |                                                                      |             | 132,582    |             |             | 227,124    |                                                                             |            
|                                                                       | Licensing and Other                                |                                                                      |             | 4,857      |             |             | 7,701      |                                                                             |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       |                                                    | Total Cost of Sales                                                  |             |            | 202,208     |             |            | 369,959                                                                     |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Gross margin                                                           |                                                    |                                                                      | 244,380     |            |             | 322,166     |            |                                                                             | 273,658    
|Operating expenses:                                                    |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       | Selling, general and administrative                |                                                                      |             | 19,188,046 |             |             | 24,184,317 |                                                                             |            
|                                                                       | Research and development                           |                                                                      |             | 12,009,713 |             |             | 17,691,051 |                                                                             |            
|                                                                       | Amortization of Goodwill                           |                                                                      |             |           |             |             | 1,720,632  |                                                                             |            
|                                                                       | Write-off of Intangibles and other Impaired Assets |                                                                      |             | 1,571,031  |             |             | 1,761,917  |                                                                             |            
|                                                                       | Restructuring Costs and other special charges      |                                                                      |             | 726,280    |             |             |           |                                                                             |            
|                                                                       | Write-off of Goodwill                              |                                                                      |             |           |             |             | 2,284,570  |                                                                             |            
|                                                                       | In Process research and development expense        |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | Acquisition Costs                                  |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | Aladdin license expense                            |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       |                                                    |                                                                      | 33,495,070  |            |             | 47,642,487  |            |                                                                             | 50,169,233 
|Other income (expense):                                                |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       | Interest income                                    |                                                                      |             | 477,902    |             |             | 2,688,105  |                                                                             |            
|                                                                       | Interest expense                                   |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | Equity in net losses of GlobalWave                 |                                                                      |             |           |             |             | (2,332,159 | )                                                                           |            
|                                                                       |                                                    | Loss on Other than Temporary Decline in Marketable Equity Securities |             |            | (11,513,099 | )           |            | (1,736,682                                                                  | )          
|                                                                       | Gain on Sale of Marketable Securities              |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | Gain on termination of development contract        |                                                                      |             | 1,818,000  |             |             |           |                                                                             |            
|                                                                       | Provision for loss on officer note receivable      |                                                                      |             | (919,518   | )           |             |           |                                                                             |            
|                                                                       | License fee                                        |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | License warrant cost                               |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       | Other (expense)                                    |                                                                      |             |           |             |             |           |                                                                             |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       |                                                    |                                                                      | (10,216,715 | )          |             | (1,380,736  | )          |                                                                             | 2,239,682  
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Net loss                                                               |                                                    |                                                                      | (43,467,405 | )          |             | (48,701,057 | )          |                                                                             | (47,655,893
|Accrued dividends on preferred Stock                                   |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Net loss to common stockholders                                        |                                                    | $                                                                    | (43,467,405 | )          | $           | (48,701,057 | )          | $                                                                           | (47,655,893
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Loss per common sharebasic and diluted                                |                                                    | $                                                                    | (0.85       | )          | $           | (0.97       | )          | $                                                                           | (1.03      
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            
|Weighted average number of common shares outstanding during the period |                                                    |                                                                      | 51,135,548  |            |             | 49,949,875  |            |                                                                             | 46,149,587 
|                                                                       |                                                    |                                                                      |             |            |             |             |            |                                                                             |            

See accompanying notes to consolidated financial statements.

F-4

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)

|                                                                                                                  |  | Class A
Common Stock |  | Class B
Common Stock |   |  |           | Deficit
accumulated
during the
development
stage |   |        |  |   |           |   |  
|----------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- | - |  | --------- | ------------------------------------------------ | - | ------ |  | - | --------- | - | -
|
|
|
|Shares issued to founders at $.003 per share                                                                      |  |                     |  | $                    |  |  | 4,680,000 |                                                  | $ | 46,800 |  | $ | (31,200   | ) | $
|Shares issued at $1.25 per share, net of expenses of $36,574 from September through November 1988                 |  |                     |  |                      |  |  | 300,000   |                                                  |   | 3,000  |  |   | 335,426   |   |  
|Net loss for period ended December 31, 1988                                                                       |  |                     |  |                      |  |  |          |                                                  |   |       |  |   |          |   |  
|                                                                                                                  |  |                      |  |                      |   |  |           |                                                  |   |        |  |   |           |   |  
|Balance at December 31, 1988                                                                                      |  |                     |  |                      |  |  | 4,980,000 |                                                  |   | 49,800 |  |   | 304,226   |   |  
|Shares issued at $1.25 per share, net of expenses of $68,750, from January through December 1989                  |  |                     |  |                      |  |  | 270,000   |                                                  |   | 2,700  |  |   | 266,050   |   |  
|Shares issued at $1.25 per share in July 1989 as compensation for services rendered                               |  |                     |  |                      |  |  | 1,920     |                                                  |   | 19     |  |   | 2,381     |   |  
|Shares issued by principal stockholders at $1.25 per share in December 1989 as compensation for services rendered |  |                     |  |                      |  |  |          |                                                  |   |       |  |   | 374,000   |   |  
|Net loss for year ended December 31, 1989                                                                         |  |                     |  |                      |  |  |          |                                                  |   |       |  |   |          |   |  
|                                                                                                                  |  |                      |  |                      |   |  |           |                                                  |   |        |  |   |           |   |  
|Balance at December 31, 1989                                                                                      |  |                     |  |                      |  |  | 5,251,920 |                                                  |   | 52,519 |  |   | 946,657   |   |  
|Shares issued by principal stockholder at $1.25 per share in March 1990 as compensation for services rendered     |  |                     |  |                      |  |  |          |                                                  |   |       |  |   | 56,250    |   |  
|Shares issued by principal stockholder at $.50 per share in March 1990 as compensation for services rendered      |  |                     |  |                      |  |  |          |                                                  |   |       |  |   | 60,000    |   |  
|Shares issued at $1.67 per share in May 1990 as compensation for services rendered                                |  |                     |  |                      |  |  | 6,000     |                                                  |   | 60     |  |   | 9,940     |   |  
|Shares issued at $1.67 per share, net of expenses of $5,000 in March, April, November and December 1990           |  |                     |  |                      |  |  | 390,000   |                                                  |   | 3,900  |  |   | 641,100   |   |  
|Net loss for year ended December 31, 1990                                                                         |  |                     |  |                      |  |  |          |                                                  |   |       |  |   |          |   |  
|                                                                                                                  |  |                      |  |                      |   |  |           |                                                  |   |        |  |   |           |   |  
|Balance at December 31, 1990                                                                                      |  |                     |  |                      |  |  | 5,647,920 |                                                  |   | 56,479 |  |   | 1,713,947 |   |  
|Shares issued at $1.67 per share from March through November 1991                                                 |  |                     |  |                      |  |  | 315,000   |                                                  |   | 3,150  |  |   | 521,850   |   |  
|Shares issued at $1.67 per share in November 1991 as compensation for services rendered                           |  |                     |  |                      |  |  | 19,800    |                                                  |   | 198    |  |   | 32,802    |   |  
|Net loss for year ended December 31, 1991                                                                         |  |                     |  |                      |  |  |          |                                                  |   |       |  |   |          |   |  
|                                                                                                                  |  |                      |  |                      |   |  |           |                                                  |   |        |  |   |           |   |  
|Balance at December 31, 1991 (carried forward)                                                                    |  |                     |  |                      |  |  | 5,982,720 |                                                  |   | 59,827 |  |   | 2,268,599 |   |  

See accompanying notes to consolidated financial statements.

F-5

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                                                                                                         |  | Class A
Common Stock |  | Class B
Common Stock |  |           |   | Deficit
accumulated
during the
development
stage |   |            |   |             |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- |  | --------- | - | ------------------------------------------------ | - | ---------- | - | ----------- | - | -------- | -
|
|
|
|Balance at December 31, 1991 (brought forward)                                                                                                                                           |  |                     |  |                     |  | 5,982,720 |   | 59,827                                           |   | 2,268,599  |   | (3,496,515  | ) |         |  
|Shares issued at $1.67 per share from January through October 1992                                                                                                                       |  |                     |  |                     |  | 708,000   |   | 7,080                                            |   | 1,172,920  |   |            |   |         |  
|Shares issued at $1.67 per share in May 1992 in connection with License and Cross-License Agreement                                                                                      |  |                     |  |                     |  | 674,976   |   | 6,750                                            |   | 1,118,210  |   |            |   |         |  
|Shares issued at $1.67 per share in May 1992 as compensation for services rendered                                                                                                       |  |                     |  |                     |  | 18,000    |   | 180                                              |   | 29,820     |   |            |   |         |  
|Shares issued at $2.50 per share in May and November 1992 as compensation for services rendered                                                                                          |  |                     |  |                     |  | 771,000   |   | 7,710                                            |   | 1,919,790  |   |            |   |         |  
|Shares issued at $2.50 per share, net of expenses of $7,500, in November and December 1992                                                                                               |  |                     |  |                     |  | 323,001   |   | 3,230                                            |   | 796,773    |   |            |   |         |  
|Shares issued by principal stockholder in December 1992 at $2.50 per share as compensation for services rendered                                                                         |  |                     |  |                     |  |          |   |                                                 |   | 75,000     |   |            |   |         |  
|Shares canceled in October and December 1992                                                                                                                                             |  |                     |  |                     |  | (75,000   | ) | (750                                             | ) | 750        |   |            |   |         |  
|Issuance of stock options at $.003 exercise price per share in June 1992                                                                                                                 |  |                     |  |                     |  |          |   |                                                 |   | 798,400    |   |            |   | (398,660 | )
|Amortization of deferred compensation                                                                                                                                                    |  |                     |  |                     |  |          |   |                                                 |   |           |   |             |   | 155,455  |  
|Accrued dividends on preferred stock                                                                                                                                                     |  |                     |  |                     |  |          |   |                                                 |   | (6,383     | ) |            |   |         |  
|Note receivable and accrued interest from stockholder                                                                                                                                    |  |                     |  |                     |  |          |   |                                                 |   |           |   |            |   |         |  
|Net loss for the year ended December 31, 1992                                                                                                                                            |  |                     |  |                     |  |          |   |                                                 |   |           |   | (4,182,638  | ) |         |  
|                                                                                                                                                                                         |  |                      |  |                      |  |           |   |                                                  |   |            |   |             |   |          |  
|Balance at December 31, 1992                                                                                                                                                             |  |                     |  |                     |  | 8,402,697 |   | 84,027                                           |   | 8,173,879  |   | (7,679,153  | ) | (243,205 | )
|Shares issued at $1.67 per share in February 1993                                                                                                                                        |  |                     |  |                     |  | 30,000    |   | 300                                              |   | 49,800     |   |            |   |         |  
|Shares issued at $3.50 per share, net of expenses of $82,427, from April through December 1993                                                                                           |  |                     |  |                     |  | 550,359   |   | 5,504                                            |   | 1,838,294  |   |            |   |         |  
|Shares issued at $3.50 per share from May to December 1993 as compensation for services rendered, for the acquisition of property and equipment and as additional interest on borrowings |  |                     |  |                     |  | 73,319    |   | 733                                              |   | 255,884    |   |            |   |         |  
|Issuance of warrants to purchase Class B Common Stock from September to December 1993 in conjunction with the issuance of convertible debt                                               |  |                     |  |                     |  |          |   |                                                 |   | 72,893     |   |            |   |         |  
|Amortization of deferred compensation                                                                                                                                                    |  |                     |  |                     |  |          |   |                                                 |   |           |   |            |   | 243,205  |  
|Accrued dividends on preferred stock                                                                                                                                                     |  |                     |  |                     |  |          |   |                                                 |   | (38,467    | ) |            |   |         |  
|Note receivable and accrued interest from stockholder                                                                                                                                    |  |                     |  |                     |  |          |   |                                                 |   |           |   |            |   |         |  
|Net loss for year ended December 31, 1993                                                                                                                                                |  |                     |  |                     |  |          |   |                                                 |   |           |   | (3,959,334  | ) |         |  
|                                                                                                                                                                                         |  |                      |  |                      |  |           |   |                                                  |   |            |   |             |   |          |  
|Balance at December 31, 1993                                                                                                                                                             |  |                     |  |                     |  | 9,056,375 |   | 90,564                                           |   | 10,352,283 |   | (11,638,487 | ) |         |  

See accompanying notes to consolidated financial statements.

F-6

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                                                                      |  | Class A
Common Stock |  | Class B
Common Stock |  |            |   | Deficit
accumulated
during the
development
stage |   |            |   |             |   |   | 
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- |  | ---------- | - | ------------------------------------------------ | - | ---------- | - | ----------- | - | - | 
|
|
|
|Balance at December 31, 1993                                                                                                                          |  |                     |  |                     |  | 9,056,375  |   | 90,564                                           |   | 10,352,283 |   | (11,638,487 | ) |  | 
|Shares issued at $3.50 per share in January and February 1994                                                                                         |  |                     |  |                     |  | 95,715     |   | 957                                              |   | 334,046    |   |            |   |  | 
|Shares issued at $3.50 per share in February 1994 as additional interest on borrowings                                                                |  |                     |  |                     |  | 5,700      |   | 57                                               |   | 19,893     |   |            |   |  | 
|Issuance of warrants to purchase Class B Common Stock in January and February 1994 in conjunction with the issuance of convertible debt               |  |                     |  |                     |  |           |   |                                                 |   | 115,234    |   |            |   |  | 
|Accrued dividends on preferred stock                                                                                                                  |  |                     |  |                     |  |           |   |                                                 |   | (39,484    | ) |            |   |  | 
|Accrual of interest on note receivable from stockholder                                                                                               |  |                     |  |                     |  |           |   |                                                 |   |           |   |            |   |  | 
|Sale of warrants to underwriter in September 1994                                                                                                     |  |                     |  |                     |  |           |   |                                                 |   | 4          |   |            |   |  | 
|Conversion of notes payable                                                                                                                           |  |                     |  |                     |  | 599,507    |   | 5,995                                            |   | 2,079,131  |   |            |   |  | 
|Shares issued at $5.00 per share in initial public offering in September 1994, net of expenses of $2,929,835                                          |  | 3,728,200            |  | 37,282               |  |           |   |                                                 |   | 15,673,883 |   |            |   |  | 
|Net loss for year ended December 31, 1994                                                                                                             |  |                     |  |                     |  |           |   |                                                 |   |           |   | (4,271,501  | ) |  | 
|                                                                                                                                                      |  |                      |  |                      |  |            |   |                                                  |   |            |   |             |   |   | 
|Balance at December 31, 1994                                                                                                                          |  | 3,728,200            |  | 37,282               |  | 9,757,297  |   | 97,573                                           |   | 28,534,990 |   | (15,909,988 | ) |  | 
|Shares issued at prices ranging from $1.00 per share to $3.13 per share as compensation for services rendered                                         |  | 31,559               |  | 315                  |  |           |   |                                                 |   | 57,184     |   |            |   |  | 
|Exercise of options to purchase Class B Common Stock                                                                                                  |  |                     |  |                     |  | 681,700    |   | 6,817                                            |   | 429,413    |   |            |   |  | 
|Accrued dividends on preferred stock                                                                                                                  |  |                     |  |                     |  |           |   |                                                 |   | (40,600    | ) |            |   |  | 
|Accrual of interest on note receivable from stockholder                                                                                               |  |                     |  |                     |  |           |   |                                                 |   |           |   |            |   |  | 
|Exchange of Class B Common Stock for Class A Common Stock                                                                                             |  | 2,855,859            |  | 28,559               |  | (2,855,859 | ) | (28,559                                          | ) |           |   |            |   |  | 
|Net loss for the year ended December 31, 1995                                                                                                         |  |                     |  |                     |  |           |   |                                                 |   |           |   | (6,832,866  | ) |  | 
|                                                                                                                                                      |  |                      |  |                      |  |            |   |                                                  |   |            |   |             |   |   | 
|Balance at December 31, 1995                                                                                                                          |  | 6,615,618            |  | 66,156               |  | 7,583,138  |   | 75,831                                           |   | 28,980,987 |   | (22,742,854 | ) |  | 
|Exercise of options to purchase Class A Common Stock                                                                                                  |  | 214,091              |  | 2,141                |  |           |   |                                                 |   | 420,366    |   |            |   |  | 
|Shares issued at prices ranging from $2.06 per share to $3.44 per share as compensation for services rendered                                         |  | 42,077               |  | 421                  |  |           |   |                                                 |   | 123,029    |   |            |   |  | 
|Issuance of unregistered Class B Common Stock to acquire Wave Interactive Network valued at approximately $.98 per share                              |  |                     |  |                     |  | 375,000    |   | 3,750                                            |   | 364,688    |   |            |   |  | 
|Issuance of warrants to purchase unregistered shares of Class A Common Stock in conjunction with the issuance of convertible debt and preferred stock |  |                     |  |                     |  |           |   |                                                 |   | 283,455    |   |            |   |  | 
|Conversion of Class B Preferred Stock                                                                                                                 |  | 2,960,303            |  | 29,603               |  |           |   |                                                 |   | 3,078,921  |   |            |   |  | 
|Accrual of interest on note receivable                                                                                                                |  |                     |  |                     |  |           |   |                                                 |   |           |   |            |   |  | 
|Accrued dividends on preferred stock                                                                                                                  |  |                     |  |                     |  |           |   |                                                 |   | (199,014   | ) |            |   |  | 
|Exchange of Class B Common Stock for Class A Common Stock                                                                                             |  | 1,749,997            |  | 17,500               |  | (1,749,997 | ) | (17,500                                          | ) |           |   |            |   |  | 
|N*ABLE APIC in connection with the issuance of Class A Common Stock due to merger                                                                     |  | 873,317              |  | 8,733                |  |           |   |                                                 |   | 1,296,241  |   |            |   |  | 
|Net loss for the year ended December 31, 1996                                                                                                         |  |                     |  |                     |  |           |   |                                                 |   |           |   | (10,126,546 | ) |  | 
|                                                                                                                                                      |  |                      |  |                      |  |            |   |                                                  |   |            |   |             |   |   | 
|Balance at December 31, 1996                                                                                                                          |  | 12,455,403           |  | 124,554              |  | 6,208,141  |   | 62,081                                           |   | 34,348,673 |   | (32,869,400 | ) |  | 
|                                                                                                                                                      |  |                      |  |                      |  |            |   |                                                  |   |            |   |             |   |   | 

See accompanying notes to consolidated financial statements.

F-7

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                              |  | Class A
Common Stock |  | Class B
Common Stock |         |  |            | Deficit
accumulated
during the
development
stage |   |         |   |   |            |   |  
|------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- | ------- |  | ---------- | ------------------------------------------------ | - | ------- | - | - | ---------- | - | -
|
|
|
|Balance at December 31, 1996                                                                                  |  | 12,455,403           |  |                      | 124,554 |  | 6,208,141  |                                                  |   | 62,081  |   |   | 34,348,673 |   |  
|Exercise of options to purchase Class A and B Common Stock                                                    |  | 70,326               |  |                      | 703     |  | 10,330     |                                                  |   | 104     |   |   | 139,081    |   |  
|Shares issued at prices ranging from $1.00 per share to $3.00 per share as compensation for services rendered |  | 126,885              |  |                      | 1,269   |  |           |                                                  |   |        |   |   | 304,227    |   |  
|Conversion of preferred stock into Common Stock                                                               |  | 7,998,860            |  |                      | 79,989  |  |           |                                                  |   |        |   |   | 6,703,028  |   |  
|Issuance of Class A Common Stock and warrants to purchase Class A Common Stock to Aladdin                     |  | 500,000              |  |                      | 5,000   |  |           |                                                  |   |        |   |   | 3,834,000  |   |  
|Issuance of Class A Common Stock and warrants to purchase Class A Common Stock                                |  | 799,964              |  |                      | 8,000   |  |           |                                                  |   |        |   |   | 792,000    |   |  
|Reduction in note receivable                                                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Accrual of interest on note receivable                                                                        |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Issuance of warrants to purchase Class A Common Stock in conjunction with the issuance of preferred stock     |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 386,462    |   |  
|Accrued dividend on preferred stock including accretion of assured incremental yield                          |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | (1,372,984 | ) |  
|Assured incremental yield on issuance of Series F convertible preferred stock and debt                        |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 682,000    |   |  
|N*ABLE APIC in connection with the issuance of Class A Common Stock due to merger                             |  | 1,404,723            |  |                      | 14,047  |  |           |                                                  |   |        |   |   | 10,133,497 |   |  
|Net loss                                                                                                      |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Exchange of Class B Common Stock for Class A Common Stock                                                     |  | 1,796,518            |  |                      | 17,965  |  | (1,796,518 | )                                                |   | (17,965 | ) |   |           |   |  
|                                                                                                              |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |            |   |  
|Balance at December 31, 1997                                                                                  |  | 25,152,679           |  | $                    | 251,527 |  | 4,421,953  |                                                  | $ | 44,220  |   | $ | 55,949,984 |   | $

See accompanying notes to consolidated financial statements.

F-8

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                                                        |  | Class A
Common Stock |  | Class B
Common Stock |         |  |            | Deficit
accumulated
during the
development
stage |   |         |   |   |            |   |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- | ------- |  | ---------- | ------------------------------------------------ | - | ------- | - | - | ---------- | - | -
|
|
|
|Balance at December 31, 1997                                                                                                            |  | 25,152,679           |  | $                    | 251,527 |  | 4,421,953  |                                                  | $ | 44,220  |   | $ | 55,949,984 |   | $
|Exercise of options to purchase Class A Common Stock                                                                                    |  | 77,558               |  |                      | 775     |  |           |                                                  |   |        |   |   | 151,180    |   |  
|Options issued to employees below fair market-value                                                                                     |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 234,723    |   |  
|Exercise of warrants to purchase Class A Common Stock                                                                                   |  | 1,652,770            |  |                      | 16,528  |  |           |                                                  |   |        |   |   | 3,945,740  |   |  
|Warrants to purchase Class A Common Stock to be issued as part of technology licensing agreement and issued to consultants for services |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 1,546,824  |   |  
|Shares issued at prices ranging from $1.00 per share to $5.00 per share as compensation for services rendered                           |  | 121,400              |  |                      | 1,214   |  |           |                                                  |   |        |   |   | 647,274    |   |  
|Reduction in note receivable                                                                                                            |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Issuance of Series G Convertible Preferred stock and Common Stock warrants, net of issuance costs of $222,500                           |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 218,250    |   |  
|Assured incremental yield on issuance of Series G convertible preferred stock and debt                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 750,000    |   |  
|Accrual of interest on note receivable                                                                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Accrued dividend on preferred stock including accretion of assured incremental yield                                                    |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | (858,863   | ) |  
|Conversion of Series G Preferred Stock                                                                                                  |  | 2,394,494            |  |                      | 23,945  |  |           |                                                  |   |        |   |   | 2,274,756  |   |  
|N*ABLE's APIC in connection with the issuance of Class A Common Stock due to the merger                                                 |  | 2,781                |  |                      | 28      |  |           |                                                  |   |        |   |   | 59,182     |   |  
|Net loss                                                                                                                                |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Adjustment for net loss of N*ABLE for the six months ended June 30, 1998                                                                |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |           |   |  
|Exchange of Class B Common Stock for Class A Common Stock                                                                               |  | 1,281,288            |  |                      | 12,813  |  | (1,281,288 | )                                                |   | (12,813 | ) |   |           |   |  
|                                                                                                                                        |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |            |   |  
|Balance at December 31, 1998                                                                                                            |  | 30,682,970           |  | $                    | 306,830 |  | 3,140,665  |                                                  | $ | 31,407  |   | $ | 64,919,050 |   | $
|                                                                                                                                        |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |            |   |  

See accompanying notes to consolidated financial statements.

F-9

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                          |  | Class A
Common Stock |  | Class B
Common Stock |         |  |            | Deficit
accumulated
during the
development
stage |   |         |   |   |             |   |   |              |  
|--------------------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- | ------- |  | ---------- | ------------------------------------------------ | - | ------- | - | - | ----------- | - | - | ------------ | -
|
|
|
|Balance at December 31, 1998                                                                              |  | 30,682,970           |  | $                    | 306,830 |  | 3,140,665  |                                                  | $ | 31,407  |   | $ | 64,919,050  |   | $ | (65,214,601  | )
|Net loss                                                                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   | (28,052,572  | )
|Unrealized gain on Marketable Securities                                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|                                                                                                          |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |             |   |   |              |  
|Comprehensive loss                                                                                        |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|Exercise of options to purchase Class A Common Stock                                                      |  | 964,000              |  |                      | 9,640   |  |           |                                                  |   |        |   |   | 1,622,431   |   |   |             |  
|Warrants exercised to purchase Class A Common Stock                                                       |  | 3,370,238            |  |                      | 33,702  |  |           |                                                  |   |        |   |   | 6,708,057   |   |   |             |  
|Shares Issued at $11.00 per share, net of issuance costs                                                  |  | 2,090,405            |  |                      | 20,904  |  |           |                                                  |   |        |   |   | 21,481,665  |   |   |             |  
|Conversion of Bridge to Loan to purchase Class A Common Stock                                             |  | 787,349              |  |                      | 7,874   |  |           |                                                  |   |        |   |   | 2,567,380   |   |   |             |  
|Warrants to Purchase Class A Common Stock                                                                 |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |             |   |   |              |  
|For services rendered                                                                                     |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 1,075,240   |   |   |             |  
|Shares issued as compensation for services rendered                                                       |  | 83,461               |  |                      | 834     |  |           |                                                  |   |        |   |   | 1,149,486   |   |   |             |  
|Accrual of interest on note receivable                                                                    |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|Conversion of Series G Preferred Stock                                                                    |  | 377,102              |  |                      | 3,771   |  |           |                                                  |   |        |   |   | 344,041     |   |   |             |  
|Accrued dividend on preferred stock                                                                       |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | (13,239     | ) |   |             |  
|Exchange of Class B Common Stock for Class A stock                                                        |  | 1,090,158            |  |                      | 10,902  |  | (1,090,158 | )                                                |   | (10,902 | ) |   |            |   |   |             |  
|                                                                                                          |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |             |   |   |              |  
|Balance at December 31, 1999                                                                              |  | 39,445,683           |  | $                    | 394,457 |  | 2,050,507  |                                                  | $ | 20,505  |   | $ | 99,854,111  |   | $ | (93,267,173  | )
|Net loss                                                                                                  |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   | (47,655,893  | )
|Unrealized gain (loss) on marketable securities                                                           |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|                                                                                                          |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |             |   |   |              |  
|Comprehensive loss                                                                                        |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|Shares issued at $34.00 per share, net of issuance costs                                                  |  | 3,600,800            |  |                      | 36,008  |  |           |                                                  |   |        |   |   | 114,941,407 |   |   |             |  
|Shares issued in exchange for substantially all of the assets of Indigo Networks, LLC at $19.30 per share |  | 374,889              |  |                      | 3749    |  |           |                                                  |   |        |   |   | 7,231,609   |   |   |             |  
|Shares issued as compensation for services at $13.75 per share                                            |  | 7,879                |  |                      | 79      |  |           |                                                  |   |        |   |   | 108,254     |   |   |             |  
|Exercise of warrants to purchase Class A Common Stock                                                     |  | 319,692              |  |                      | 3,197   |  |           |                                                  |   |        |   |   | 1,331,048   |   |   |             |  
|Exercise of Options to purchase Class A Common Stock                                                      |  | 2,030,958            |  |                      | 20,309  |  |           |                                                  |   |        |   |   | 4,950,872   |   |   |             |  
|Compensation on Employee Options issued                                                                   |  |                     |  |                      |        |  |           |                                                  |   |        |   |   | 318,609     |   |   |             |  
|Exchange of Class B Common Stock for Class A Common Stock                                                 |  | 1,271,296            |  |                      | 12,713  |  | (1,271,296 | )                                                |   | (12,713 | ) |   |            |   |   |             |  
|Repayment of note receivable from stockholder                                                             |  |                     |  |                      |        |  |           |                                                  |   |        |   |   |            |   |   |             |  
|                                                                                                          |  |                      |  |                      |         |  |            |                                                  |   |         |   |   |             |   |   |              |  
|Balance at December 31, 2000                                                                              |  | 47,051,197           |  | $                    | 470,512 |  | 779,211    |                                                  | $ | 7,792   |   | $ | 228,735,910 |   | $ | (140,923,066 | )

See accompanying notes to consolidated financial statements.

F-10

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                                |  | Class A
Common Stock |  | Class B
Common Stock |         |  |          | Deficit
accumulated
during the
development
stage |   |        |   |   |             |  |   |              |  
|----------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------- | ------- |  | -------- | ------------------------------------------------ | - | ------ | - | - | ----------- |  | - | ------------ | -
|
|
|
|Balance at December 31, 2000                                                                    |  | 47,051,197           |  | $                    | 470,512 |  | 779,211  |                                                  | $ | 7,792  |   | $ | 228,735,910 |  | $ | (140,923,066 | )
|Net loss                                                                                        |  |                     |  |                      |        |  |         |                                                  |   |       |   |   |            |  |   | (48,701,057  | )
|Investment Loss on Marketable Securities                                                        |  |                     |  |                      |        |  |         |                                                  |   |       |   |   |            |  |   |             |  
|                                                                                                |  |                      |  |                      |         |  |          |                                                  |   |        |   |   |             |  |   |              |  
|Comprehensive loss                                                                              |  |                     |  |                      |        |  |         |                                                  |   |       |   |   |            |  |   |             |  
|Shares issued in exchange for 3,600,000 shares of BIZ Interactive Zone, Inc. at $7.16 per share |  | 2,000,000            |  |                      | 20,000  |  |         |                                                  |   |       |   |   | 14,292,800  |  |   |             |  
|Exercise of Options                                                                             |  | 523,181              |  |                      | 5,232   |  |         |                                                  |   |       |   |   | 749,721     |  |   |             |  
|Compensation on Employee Options Issued                                                         |  |                     |  |                      |        |  |         |                                                  |   |       |   |   | 552,554     |  |   |             |  
|Exchange of Class B Common Stock for Class A Common Stock                                       |  | 422,128              |  |                      | 4,221   |  | (422,128 | )                                                |   | (4,221 | ) |   |            |  |   |             |  
|                                                                                                |  |                      |  |                      |         |  |          |                                                  |   |        |   |   |             |  |   |              |  
|Balance at December 31, 2001                                                                    |  | 49,996,506           |  | $                    | 499,965 |  | 357,083  |                                                  | $ | 3,571  |   | $ | 244,330,985 |  | $ | (189,624,123 | )
|                                                                                                |  |                      |  |                      |         |  |          |                                                  |   |        |   |   |             |  |   |              |  

See accompanying notes to consolidated financial statements.

F-11

---

WAVE SYSTEMS CORP. AND SUBSIDIARIES(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)(Continued)

|                                                                                           |  | Class A
Common Stock |  | Class B
Common Stock |         |  |         | Deficit
accumulated
during the
development
stage |   |       |   |   |             |  |   |              |  
|------------------------------------------------------------------------------------------ |  | -------------------- |  | -------------------- | ------- |  | ------- | ------------------------------------------------ | - | ----- | - | - | ----------- |  | - | ------------ | -
|
|
|
|Balance at December 31, 2001                                                               |  | 49,996,506           |  | $                    | 499,965 |  | 357,083 |                                                  | $ | 3,571 |   | $ | 244,330,985 |  | $ | (189,624,123 | )
|Net loss                                                                                   |  |                     |  |                      |        |  |        |                                                  |   |      |   |   |            |  |   | (43,467,405  | )
|Investment Loss on Marketable Securities                                                   |  |                     |  |                      |        |  |        |                                                  |   |      |   |   |            |  |   |             |  
|                                                                                           |  |                      |  |                      |         |  |         |                                                  |   |       |   |   |             |  |   |              |  
|Comprehensive loss                                                                         |  |                     |  |                      |        |  |        |                                                  |   |      |   |   |            |  |   |             |  
|Issuance of Class A Common Stock to acquire 60% of the Remaining assets of GlobalWave, Ltd |  | 1,700,000            |  |                      | 17,000  |  |        |                                                  |   |      |   |   | 2,227,000   |  |   |             |  
|Exercise of Options                                                                        |  | 42,554               |  |                      | 426     |  |        |                                                  |   |      |   |   | 43,673      |  |   |             |  
|Issuance of warrants to purchase Class A Common Stock                                      |  |                      |  |                      |         |  |         |                                                  |   |       |   |   | 143,500     |  |   |              |  
|Compensation on Expense Employee Options Issued                                            |  |                     |  |                      |        |  |        |                                                  |   |      |   |   | 367,247     |  |   |             |  
|Exchange of Class B Common Stock for Class A Common Stock                                  |  | 32,858               |  |                      | 329     |  | (32,858 | )                                                |   | (329  | ) |   |            |  |   |             |  
|                                                                                           |  |                      |  |                      |         |  |         |                                                  |   |       |   |   |             |  |   |              |  
|Balance at December 31, 2002                                                               |  | 51,771,918           |  | $                    | 517,720 |  | 324,225 |                                                  | $ | 3,242 |   | $ | 247,112,405 |  | $ | (233,091,528 | )
|                                                                                           |  |                      |  |                      |         |  |         |                                                  |   |       |   |   |             |  |   |              |  

See accompanying notes to consolidated financial statements.

F-12

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WAVE SYSTEMS CORP. AND SUBSIDIARIES  (a development stage corporation)        Consolidated Statements of Cash Flows        Years ended December 31, 2002, 2001, 2000, and the Period  From
February 12, 1988 (Date of Inception) through December 31, 2002

|                                                                            |                                                                                 | 2002                                  |             | 2001       |             | 2000        |            | Period from
February 12, 1988
(date of inception)
through
December 31, 2002 |            
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | ------------------------------------- | ----------- | ---------- | ----------- | ----------- | ---------- | --------------------------------------------------------------------------- | -----------
|Cash flows from operating activities:                                       |                                                                                 |                                       |             |            |             |             |            |                                                                             |            
|Net loss                                                                    |                                                                                 | $                                     | (43,467,405 | )          | $           | (48,701,057 | )          | $                                                                           | (47,655,893
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                                 |                                       |             |            |             |             |            |                                                                             |            
|Write-off of goodwill                                                       |                                                                                 |                                       |            |            |             | 2,284,570   |            |                                                                             |           
|Goodwill Amortization                                                       |                                                                                 |                                       |            |            |             | 1,720,632   |            |                                                                             | 573,544    
|Depreciation and amortization                                               |                                                                                 |                                       | 2,000,705   |            |             | 2,531,324   |            |                                                                             | 2,593,594  
|Reserve for note from affiliate                                             |                                                                                 |                                       |            |            |             |            |            |                                                                             |           
|Provision for loss on officer note receivable                               |                                                                                 |                                       | 919,518     |            |             |            |            |                                                                             |           
|Non-cash expenses:                                                          |                                                                                 |                                       |             |            |             |             |            |                                                                             |            
|                                                                            | Accretion of assured incremental yield on convertible debt                      |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Common stock issued in connection with License Agreement                        |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Realized gain on marketable securities                                          |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Net losses realized on GlobalWave investment                                    |                                       |             |           |             |             | 2,332,159  |                                                                             |            
|                                                                            | Common stock issued for services rendered and additional interest on borrowings |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Warrants issued as compensation for services                                    |                                       |             | 143,500    |             |             |           |                                                                             |            
|                                                                            | Issuance of warrants to Aladdin                                                 |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Accrued interest on note payable                                                |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | In Process research and development                                             |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Write-off of Impaired Assets                                                    |                                       |             | 1,571,031  |             |             | 1,761,917  |                                                                             |            
|                                                                            | Loss on Other than Temporary Decline in Marketable Equity Securities            |                                       |             | 11,513,099 |             |             | 1,736,682  |                                                                             |            
|                                                                            | Gain on termination of development contract with SSP                            |                                       |             | (1,818,000 | )           |             |           |                                                                             |            
|                                                                            | Preferred stock issued for services rendered                                    |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Compensation associated with issuance of Stock Options                          |                                       |             | 367,247    |             |             | 552,554    |                                                                             |            
|                                                                            | Amortization of deferred compensation                                           |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Amortization of discount on notes payable                                       |                                       |             |           |             |             |           |                                                                             |            
|                                                                            | Common stock issued by principal stockholder for services                       |                                       |             |           |             |             |           |                                                                             |            
|Changes in assets and liabilities:                                          |                                                                                 |                                       |             |            |             |             |            |                                                                             |            
|                                                                            | Increase (decrease) in deferred revenue                                         |                                       |             | (197,965   | )           |             | 197,965    |                                                                             |            
|                                                                            | Increase in accrued interest on note receivable                                 |                                       |             | (62,129    | )           |             | (80,410    | )                                                                           |            
|                                                                            | (Increase) Decrease in inventories                                              |                                       |             | (530,906   | )           |             | 43,236     |                                                                             |            
|                                                                            | (Increase) decrease in prepaid expenses and other receivables                   |                                       |             | 50,219     |             |             | 92,478     |                                                                             |            
|                                                                            | (Increase) decrease in other assets                                             |                                       |             | 1,026,365  |             |             | (112,278   | )                                                                           |            
|                                                                            | Increase (decrease) in accounts payable and accrued expenses                    |                                       |             | (655,264   | )           |             | (2,638,780 | )                                                                           |            
|                                                                            | Increase in amounts due to charities                                            |                                       |             | (159,897   | )           |             | 423,053    |                                                                             |            
|                                                                            | Increase in cash restricted on behalf of Charities                              |                                       |             | 122,978    |             |             | (358,531   | )                                                                           |            
|                                                                            |                                                                                 |                                       |             |            |             |             |            |                                                                             |            
|                                                                            |                                                                                 | Net cash used in operating activities |             |            | (29,096,904 | )           |            | (38,214,486                                                                 | )          

F-13

---

|Cash flows from investing activities:                |                                                                         |                                                     |             |            |            |             |            |            |            |             |             |            |            
|---------------------------------------------------- | ----------------------------------------------------------------------- | --------------------------------------------------- | ----------- | ---------- | ---------- | ----------- | ---------- | ---------- | ---------- | ----------- | ----------- | ---------- | -----------
|                                                     | Acquisition of property and equipment                                   |                                                     |             | (1,148,723 | )          |             | (1,507,598 | )          |            | (3,829,300  | )           |            | (11,443,477
|                                                     | Investment in GlobalWave joint venture                                  |                                                     |             | (1,559,250 | )          |             |           |            |            | (4,142,000  | )           |            | (5,701,250 
|                                                     | Cash received in GlobalWave acquisition                                 |                                                     |             | 1,380,464  |            |             |            |            |            |             |             |            | 1,380,464  
|                                                     | Purchase of intangible assets                                           |                                                     |             |           |            |             |           |            |            | (750,000    | )           |            | (2,500,000 
|                                                     | Short-term loans to affiliate                                           |                                                     |             |           |            |             |           |            |            |            |             |            | (1,672,934 
|                                                     | Organizational costs                                                    |                                                     |             |           |            |             |           |            |            |            |             |            | (14,966    
|                                                     | Proceeds from sale of marketable securities                             |                                                     |             |           |            |             |           |            |            | 2,162,457   |             |            | 2,162,457  
|                                                     | Exercise of warrant to acquire marketable securities-available for sale |                                                     |             |           |            |             |           |            |            |            |             |            | (1,620,000 
|                                                     |                                                                         |                                                     |             |            |            |             |            |            |           
|                                                     |                                                                         | Net cash used in investing activities               |             |            | (1,327,509 | )           |            | (1,507,598 | )          |             | (6,558,843  | )          |            
|Cash flows from financing activities:                |                                                                         |                                                     |             |            |            |             |            |            |            |             |             |            |            
|                                                     | Net proceeds from issuance of common stock                              |                                                     |             | 44,099     |            |             | 754,953    |            |            | 121,072,842 |             |            | 192,536,220
|                                                     | Net proceeds from issuance of preferred stock and warrants              |                                                     |             |           |            |             |           |            |            |            |             |            | 12,283,027 
|                                                     | Payment on (issuance of) note receivable from stockholder               |                                                     |             | 164,319    |            |             | (1,299,640 | )          |            | 48,175      |             |            | (1,135,321 
|                                                     | Proceeds from notes payable and warrants to Stockholders                |                                                     |             |           |            |             |           |            |            |            |             |            | 4,083,972  
|                                                     | Repayments of notes payable to stockholders                             |                                                     |             |           |            |             |           |            |            |            |             |            | (1,069,972 
|                                                     | Proceeds from notes payable and warrants                                |                                                     |             |           |            |             |           |            |            |            |             |            | 1,284,254  
|                                                     | Repayments of note payable                                              |                                                     |             |           |            |             |           |            |            |            |             |            | (255,000   
|                                                     | Redemption of Preferred Stock                                           |                                                     |             |           |            |             |           |            |            |            |             |            | (506,440   
|                                                     |                                                                         |                                                     |             |            |            |             |            |            |           
|                                                     |                                                                         | Net cash provided by (used in) financing activities |             |            | 208,418    |             |            | (544,687   | )          |             | 121,121,017 |            |            
|Net increase (decrease) in cash and cash equivalents |                                                                         |                                                     | (30,215,995 | )          |            | (40,266,771 | )          |            | 74,413,845 |             |             | 10,221,124 |            
|Cash and cash equivalents at beginning of period     |                                                                         |                                                     | 40,437,119  |            |            | 80,703,890  |            |            | 6,290,045  |             |             |           |            
|                                                     |                                                                         |                                                     |             |            |            |             |            |            |           
|Cash and cash equivalents at end of period           |                                                                         | $                                                   | 10,221,124  |            | $          | 40,437,119  |            | $          | 80,703,890 |             | $           | 10,221,124 |            
|                                                     |                                                                         |                                                     |             |            |            |             |            |            |           

Supplemental information about noncash investing and financing activities:

On July 24, 2002, 1,700,000 shares of our commons stock were issued to acquire 60% of GlobalWave, Ltd., see Note 15.

On
February 2, 2001, 2,000,000 shares of our common stock were issued to acquire 3,600,000 shares of BIZ Interactive Zone, Inc. for $14,312,800. See Note 13.

On
August 31, 2000, 374,889 shares of our common stock were issued to acquire substantially all of the assets of Indigo Networks, LLC for $7,445,358, including acquisition costs
of $210,000. See Note 4.

See
accompanying notes to consolidated financial statements.

F-14

---



WAVE SYSTEMS CORP. AND SUBSIDIARIES  (a development stage corporation)        Notes to Consolidated Financial Statements

(1) Business of the Company

Wave is a leading developer of the next generation of computer security solutions. Wave provides a complete end-to-end suite of products
and services that support hardware-based security products and create a Trusted Computing environment when implemented exclusively or in conjunction with traditional security solutions. Wave's
products allow authentication, authorization and other security processes to be implemented in hardware at the PC or other platform level, creating a much more secure computing environment. The
financial statements of Wave have been presented in the development stage format as prescribed by Statement of Financial Accounting Standards No. 7. Management has determined that Wave meets
the criteria of a development stage enterprise as prescribed in Statement of Financial Accounting Standard No. 7 because it has devoted substantially all of its efforts since inception toward
research and development activities and establishing a new business; and although planned principal operations have commenced, there has been no significant revenue from those operations.

(2) Liquidity

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has incurred substantial operating
losses since its inception, and as of December 31, 2002 has an accumulated deficit of approximately $233 million. We also expect we will incur an operating loss for the calendar year of
2003. Although we currently have working capital of approximately $8.8 million, we expect our operating and research and development expenditures over the next two fiscal quarters will exceed
this amount. We do not anticipate sufficient revenue over this same period to fund our operations. As a result, we will need to raise additional capital in order to continue operating beyond this
period. Considering our current cash balance and Wave's projected operating cash requirements, we anticipate that we will need $11 million of additional cash to satisfy our current forecasted cash
flow requirements for the twelve-month period ending December 31, 2003.
In addition to what we are forecasting in gross margins for fiscal 2003, we estimate having to raise a minimum of approximately $5 million in capital, in order to fund our operations through 2003. In
order to raise the additional cash required for Wave's operations, Wave has engaged an investment banking firm and is exploring a number of financing alternatives which include debt or equity
financing (or a combination of both) or one or more commercial or strategic transactions. In addition to raising additional capital, our operating plan for the calendar year of 2003 includes the
realization of a particular level of sales revenue, and an operating expense budget that must be met in order to achieve our plan. Should sales be less than forecast, expenses higher than forecast or
if the availability of financing is less than the amount in our operating plan, Wave will not have adequate resources to fund our operations.

These
factors raise substantial doubt about Wave's ability to continue as a going concern. If Wave is not successful in raising additional capital or is not successful executing its
business plan, it could be forced to cease operations or merge with another company. No assurance can be provided that any of these initiatives will be successful.

F-15

---

(3) Significant Accounting Policies

(a) Basis of Consolidation

The consolidated financial statements include the financial statements of Wave, Wave Systems Holdings, Inc., a wholly owned subsidiary and
WaveXpress, Inc. a majority-owned joint venture. All significant intercompany accounts and transactions have been eliminated in consolidation.

(b) Use of Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, depreciation and
amortization, charges for other than temporary declines in value of marketable equity securities and other special charges, inventory allowances and contingencies. Actual results could differ from
those estimates.

(c) Method of Accounting for Joint Ventures

Wave accounts for its investments in joint ventures using the equity method of accounting when its ownership interest in the joint venture is less than fifty
percent and it is determined that Wave has the ability to exercise significant influence over the joint venture's operating and financial policies. The financial statements of joint ventures in which
Wave owns greater than a fifty percent interest are consolidated with Wave's financial statements pursuant to APB Opinion No. 18. (see note 15)

(d) Cash and Cash Equivalents

Wave considers all highly liquid instruments with an original or remaining maturity of three months or less to be cash equivalents. Substantially all cash and
cash equivalents are custodial with two major financial institutions.

(e) Marketable Securities

Investments, which consist solely of equity securities, are accounted for under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity 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

F-16

---

are intended to be held to maturity and are recorded at amortized cost. As of December 31, 2002, all of Wave's investments have been classified as available-for-sale.

(f) 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. Wave provides inventory allowances based on excess and obsolete inventories

(g) Property and Equipment

Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation. Depreciation and amortization are computed using
the straight-line method over the estimated useful lives of the assets which range from between three to five years. Amortization of leasehold improvements is computed using the remaining
lease terms.

(h) Goodwill and Purchased Intangible Assets

In July 2001, FASB issued SFAS No. 142,Goodwill and Other Intangible Assets("SFAS 142")
which is effective for all fiscal years beginning after December 15, 2001. SFAS No. 142 replaces the requirement to amortize intangible assets with indefinite lives and goodwill with a
requirement for an impairment test. SFAS No. 142 also requires an evaluation of intangible assets and their useful lives and a transitional impairment test for goodwill and certain intangible
assets. After transition, the impairment tests must be performed annually. Because Wave does not have any goodwill and/or other intangible assets which qualify for the prescribed treatment under SFAS
No. 142, there is no impact from the adoption of SFAS No. 142 to Wave's financial position or results of operations as of December 31, 2002.

For
the years ended 2001 and 2000, goodwill was amortized using the straight-line method, generally over a period of 2 to 3 years.

(i) Income Taxes

Wave accounts for income taxes under the asset and liability method. As such, deferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

(j) Stock Option Plan

Statement of Financial Accounting Standards ("SFAS") No. 123,"Accounting for Stock-based Compensation,"as
amended by SFAS No. 148"Accounting for Stock-Based Compensation Transition and Disclosurean amendment to FASB Statement
No. 123,"allows companies to recognize expense for the fair value of stock-based awards or to continue to apply the provisions of Accounting Principles Board

F-17

---

("APB") Opinion No. 25 "Accounting for Stock Issued to Employees," and disclose the effects of SFAS No. 123 as if the fair-valuebased method defined in SFAS
No. 123 had been applied. Under APB Opinion No. 25, compensation expense is recognized only if on the measurement date the fair value of the underlying stock exceeds the exercise price.
Wave has elected to apply the provisions of APB Opinion No. 35 and provide the pro forma disclosure provisions of SFAS No. 123 and No. 148.

The
following table shows Wave's pro forma net loss and loss per share if the company had accounted for stock options under SFAS No. 123 for the years ended December 31:

|                                            |  | 2002 |             | 2001 |   | 2000        |  
|------------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | -
|Net loss to Common stockholdersas reported |  | $    | (43,467,405 | )    | $ | (48,701,057 | )
|Net loss to Common shareholderspro forma   |  |      | (50,876,578 | )    |   | (69,720,636 | )
|Loss per Common shareas reported           |  |      | (0.85       | )    |   | (0.97       | )
|Loss per Common sharepro forma             |  | $    | (0.99       | )    | $ | (1.40       | )

(k) Research and Development and Software Development Costs

Research and development costs are expensed as incurred. Software development costs are accounted for pursuant to Statement of Financial Accounting Standards
No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" which requires software development costs for products that have achieved commercial
marketability to be capitalized subsequent to the establishment of a product's technological feasibility and prior to general release of the product. Wave capitalized software development costs of
$610,413 and $770,469 during the years ended December 31, 2002 and 2001, respectively. There were no software development costs capitalized during 2000.

(l) Loss Per Share

Basic net loss per common share has been calculated based upon the weighted average number of shares of common stock outstanding during the period. Diluted net
loss per share is also computed using the weighted average number of common shares and excludes dilutive potential common shares outstanding, as their effect is anti-dilutive. Dilutive
potential common shares consist primarily of employee stock options. Diluted net loss per share is equal to basic net loss per share and is therefore not presented separately in the financial
statements.

(m) 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,"Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed". Wave is required to assess the recoverability of long-lived assets and capitalized software
development costs basis whenever events and circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include the
following:



F-18

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

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.

(n) Revenue Recognition

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

Wave
follows the provisions of statement of position "SOP" 97-2,Software Revenue Recognitionas 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 collectability is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales
rebates when such amounts can be estimated. When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements
that have significant customizations and modification of the software product is deferred and recognized in a manner that approximates the percentage of completion
method. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

F-19

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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 period 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.

F-20

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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. Payment terms vary by contract.

In
October 2000, we entered into a $10 million comprehensive development agreement with SSP Solutions, Inc. (formerly BIZ Interactive Zone, Inc.) 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 2002 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 Solutions agreed to place with Wave an open $5,000,000 purchase order for
EMBASSY products. Payment terms of the agreement provide that SSP Solutions make payments of $277,778 per month for eighteen months. In addition, the parties agreed that in the event that SSP
Solutions fails to pay any monthly installment, within 30 days of receiving written notice by Wave that it is in default, the unpaid portion of the installment shall automatically convert into
a stock acquisition right allowing Wave to acquire a number of shares in SSP Solutions to be determined by dividing the unpaid amount by the fair market value of SSP Solutions common stock. As the
contract was for a discrete project to integrate our technology with the SSP platform, revenue under the development services agreement has been recognized on a percentage of completion basis in
accordance with SOP 97-2 as it relates to contract accounting under SOP 81-1. Percentage complete is determined based upon the actual costs incurred compared to the total
estimated costs to complete,subject to cash received and milestones accomplished. Milestones include specific software development objectives that must
be completed and accepted by SSP Solutions. As of December 31, 2002 Wave has received $555,556 in cash and has not exercised any stock appreciation rights. We have recognized approximately
$197,556 and $358,000 in revenue under the development agreement for the years ended December 31, 2002 and 2001, respectively.

(o) Recent Accounting Pronouncements

In April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the
classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS
No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the
Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. Earlier application of these provisions is encouraged. The provisions of
the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 is not
expected to have a material effect on Wave's financial statements.

F-21

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

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

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

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

(4) Business Combinations

(a) Pooling of Interests

On July 27, 1999, Wave acquired N*ABLE. The transaction was accounted for as a pooling of interests and the historical financial information for all
periods presented prior to the date of acquisition were restated. Wave exchanged 2,280,821 shares of its Class A Common Stock for all the outstanding shares of N*ABLE for a fair value of
approximately $23.7 million.

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(b) Purchase Acquisition

On August 31, 2000, Wave purchased substantially all of the assets of Indigo and its e-commerce shopping network, iShopHere.com. The aggregate
purchase price totaled $7,445,000, which consisted of 374,889 shares of Class A Common Stock priced at $19.30 per share, for a total value of $7,235,000 plus transaction costs of $210,000. The
purchase price was based on the average closing price of Wave's Class A Common Stock for the ten trading days immediately preceding the date of the purchase, in accordance with the purchase
agreement. The following is a summary of the allocation of the purchase price:

Fair market value of tangible assets

$
690,000In-Process R&D


2,176,000Goodwill and purchased intangible assets


4,579,000Total consideration

$
7,445,000


The
amount allocated to in-process research and development totaling $2,176,000 was determined using established valuation techniques and was expensed upon acquisition as
technological and/or commercial feasibility had not been established. The amount allocated to goodwill and purchased intangible assets amounted to $4,578,746 and is being amortized on a
straight-line basis over periods not exceeding three years. The following table sets forth the goodwill and purchased intangible asset values as of December 31, 2001:

2001Developed Technology

$
779,000Assembled Workforce


310,000Contracts


77,300Goodwill and purchased intangible assets


3,412,446Total Goodwill and purchased intangible assets

$
4,578,746Accumulated Amortization


(2,294,176
)Net Book Value before impairment charge


2,284,570Impairment Charge


(2,284,570
)Net Book Value

$
-0-


Amortization
expense associated with goodwill and purchased intangibles was $0, $1,720,632, and $573,544 for the years ended December 31, 2002, 2001 and 2000, respectively.

The
consolidated financial statements include the operating results of iShopHere.com from the date of acquisition, which consisted of a net loss of approximately $0 in 2002, $1,561,000
in 2001 and $846,000 in 2000. The selected unaudited pro forma condensed consolidated financial information presented below has been derived from the audited and unaudited historical financial
statements of Wave and Indigo, and reflects management's estimate of pro forma adjustments. This pro forma presentation does not purport to represent what our results of operations would actually have
been if such transactions and events had in fact occurred on those dates or to project our results of operations for any future period. The unaudited pro forma consolidated statements of operations
give effect to the

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acquisition of Indigo as if it had occurred on January 1, 1999. (Pro-forma information for 2002 and 2001 are not presented as there are no pro-forma adjustments
applicable to 2002 or 2001.)

Dollars in thousands except per share data

2000Net revenues

$
372Net loss


(50,363
)Net loss per share

$
(1.08
)


Due
to the decline in current business conditions, Wave had realigned resources to focus on what it considered high-growth markets and core opportunities. As a result, Wave
recorded a charge of $2,284,570 related to the impairment of goodwill and purchased intangible assets associated with the Indigo asset purchase in 2001. This amount is equal to the carrying amount of
the assets prior to the impairment charge.

(5) Related Party Transactions

(a) Notes Receivable from Officers

Prior to the enactment of the Sarbanes-Oxley Act of 2002 ("SOX"), from time to time Wave made loans to its executive officers. Wave had outstanding loans
receivable from officers totaling $1,277,860 less a reserve for uncollectibility of $999,518 for a net balance of $278,342 as of December 31, 2002. Notes receivable from officers were
$1,380,050 with no reserve as of December 31, 2001. These loans were granted to the officers to allow them to satisfy certain personal financial obligations that would otherwise have required
them to liquidate some of their holdings of Wave shares. The loans were granted as a means to mitigate a potential unfavorable impact to Wave's share price as a result of the officers selling large
blocks of shares. The officer loans consist of the following:

On
March 26, 2001 Wave made a personal loan to Mr. Gerard T. Feeney, Senior Vice President, Chief Financial Officer and Secretary of Wave as evidenced by a demand note for
$250,000, which sum was due and payable to Wave on March 26, 2002 and bears interest at a rate per annum equal to 1% over the prime interest rate. The due date of the demand note was
subsequently extended until March 26, 2003. As of December 31, 2002 the loan balance, including accrued interest thereon was $278,000. On March 27, 2003, the Compensation
Committee approved an extraordinary bonus in an amount equal to Mr. Feeney's obligations with respect to such loan and accrued interest. Proceeds of this extraordinary
bonus will be used to repay the loan and all interest accrued on such loan. Wave intends to take this extraordinary bonus into account when considering future bonus awards to Mr. Feeney.

Also
during 2001, Wave made personal loans to Mr. Peter J. Sprague, former Chairman of Wave evidenced by demand notes for $713,000 dated February 27, 2001, $185,000 dated
July 25, 2001 and $164,000 dated September 5, 2001 for a total of $1,062,000. These notes carry terms of one year and bear interest at a rate per annum equal to 1% over the prime rate of
interest. Two of the demand notes in the amount of $713,000 and $185,000 plus accrued interest came due on February 27, 2002 and July 25, 2002, respectively and were extended for an
additional year beyond their original due dates. As of December 31, 2002, the balances of these two notes including accrued interest were approximately $799,000 and $201,000, respectively for a
total of approximately $1,000,000, in notes that

F-24

---

are due in 2003. The remaining loan that had an original face value of $165,000, the balance of which was approximately $174,000 including accrued interest, came due in September 2002. On
November 12, 2002, the Compensation Committee approved the payment of an extraordinary bonus that Mr. Sprague used to repay the $165,000 balance of the note plus accrued interest of
$9,000. The remaining loans, including one that has a balance of $799,000 and came due on February 27, 2003, remain outstanding. In the quarter ended December 31, 2002, Wave has recorded
a reserve for uncollectibility of approximately $1,000,000 in respect to these notes. The Company has determined that Mr. Sprague is unable to repay the loan promptly. Mr. Sprague
resigned as Chairman of Wave as of March 31, 2003. Wave intends to engage Mr. Sprague as Chairman and Chief Executive Officer of WaveXpress. Wave intends to diligently pursue collection
of Mr. Sprague's loan.

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

(b) Payments to Related Party

In 1997, Wave paid $182,209 to Enterprise Engineering Associates ("EEA"), during which time Mr. Michael Sprague was an employee of EEA. On August 1,
1997, Michael Sprague became an employee of Wave, at an annual salary of $110,000. On November 1, 1999 he became an employee of WaveXpress at an annual salary of $120,000 and was paid $125,319
for the year ended December 31, 2002 and $120,000 for each of the years ended December 31, 2001 and 2000. Michael Sprague is the son of the Chairman and former Chief Executive Officer of
Wave

(c) Acquisition and Dispositions

In November 1995, Wave entered into a transaction with certain individuals whereby shares in its newly formed subsidiary, Wave Interactive
Network, Inc. ("WIN"), were transferred in exchange for a demand note. The amount of the demand note was based on the level of funding provided to WIN by Wave
during 1995. The demand note from WIN accrued interest at a rate of Prime plus 1% and, subject to certain limitations associated with WIN's ability to raise additional capital, was convertible into an
undiluted 20% of the common shares of WIN at the option of Wave. Wave retained a 1% ownership in WIN and transferred the remaining ownership to certain individuals, including former employees.
Approximately 65% of the ownership was transferred to Steven Sprague, President and CEO of WIN, and three other children of Mr. Peter J. Sprague, former Chairman and former CEO of Wave. The
note was fully reserved as its collectibility was dependent upon WIN's ability to raise additional capital. In addition, Wave entered into a separate commercial agreement that, among other things,
granted certain distribution rights to WIN in exchange for royalties and other consideration.

During
1996, Wave continued to finance the operations of WIN through additional demand notes with terms similar to the original demand note. The additional notes amounting to $1,004,000
were also fully reserved. On December 30, 1996, effective as of October 18, 1996, Wave entered into a merger agreement with WIN whereby Wave exchanged, for all of the outstanding WIN
common stock that it did not own, 375,000 shares of Class B Common Stock. These Class B shares are restricted securities within the meaning of Rule 144 of the Securities Act of
1933, as amended (the "Act"). Additionally, based on the attainment of a specified milestone, the shareholders of WIN were entitled to receive an additional 325,000 shares of Wave's Class B
Common Stock. During 1999, the time to attain the

F-25

---

milestone had expired as did the entitlement to additional shares and no additional shares were issued. Wave also issued a 10% convertible note and a warrant to refinance a convertible note
obligation of WIN amounting to approximately $456,000, which included accrued interest to October 18, 1996, and an outstanding warrant. Included in the results of operations are WIN's
operations from October 18, 1996. The acquisition was accounted for by the purchase method.

The
purchase price of $952,438 was determined based on the estimated fair value of the consideration given to the WIN shareholders and note holders and was allocated to goodwill as WIN
had no net tangible assets. Subsequently, in 1997, Wave determined it was uncertain whether the current and expected future results of operations of WIN would be adequate to support the goodwill
capitalization, and wrote-off the goodwill as impaired.

(d) Sarnoff Corporation

For the years-ended December 31, 2002, 2001 and 2000, Wave incurred expenses for consulting and travel, payable to Sarnoff of approximately $0, $57,000 and
$924,000, respectively. Sarnoff is Wave's joint venture partner in WaveXpress and owns approximately 26% of WaveXpress, (7% on a fully diluted basis). Payments made to Sarnoff for the years-ended
December 31, 2002, 2001 and 2000 were $0, $396,000 and $986,000, respectively. As of December 31, 2002 and 2001, Wave had accounts payable to Sarnoff of $0 and $6,000, respectively.

(6) Property and Equipment

Property and equipment as of December 31 consisted of the following:

2002

2001Equipment

$
5,457,015

$
5,797,900Furniture, fixtures and improvements


882,492


1,914,405Computer software


4,230,605


3,192,28810,570,112


10,904,593Less: Accumulated depreciation


8,027,347


6,613,365Total

$
2,542,765

$
4,291,228


Computer
software includes $1,380,882 capitalized pursuant to SFAS 86. This asset has not yet been placed in service, therefore no amortization has been taken on these capitalized costs.
It is expected that these costs will be amortized over a three-year life, once the product is ready to bring to market.

Depreciation
expense on property and equipment amounted to approximately $2,001,000, $2,219,000, $1,969,000 and $8,695,000 for the years ended December 31, 2002, 2001, 2000 and
for the period from inception through December 31, 2002, respectively.

F-26

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(7) Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses as of December 31 consisted of the following:

2002

2001Accrual of costs related to the ITG agreement

$


$
188,986Accounts payable


1,189,889


1,631,430Accrued consulting and professional fees


360,728


405,346Accrued payroll and related costs


1,108,160


1,281,012Accrued Rent


142,595


87,836Annual Report and Shareholders Meeting


95,631


141,299Accrual of committed investment in GlobalWave





1,407,664Accrued loss contingency





200,000Franchise Tax Payable


39,133


Software Licenses


384,167


Other accrued liabilities


84,074


464,305Total

$
3,404,377

$
5,807,878


(8) Capital Stock

(a) Redeemable Preferred Stock

Wave has authorized 2,000,000 shares of preferred stock having a par value of $.01 per share. On October 19, 1992, the Board of Directors designated and
issued 360 shares of this preferred stock of Wave as "Series A Cumulative Redeemable Preferred Stock" ("Series A Preferred Stock").

The
Series A Preferred Stock was issued in settlement of compensation owed to a former officer of Wave for services provided to Wave. The holder of the Series A Preferred
Stock was entitled to receive a dividend at the rate of $60 per share per annum, when and as declared by the Board of Directors of Wave. Dividends were cumulative from the date of original issue, and
payable upon redemption. On August 11, 1999, Wave redeemed these shares for a total payment of $506,440, including accrued and unpaid dividends.

In
May of 1996, Wave raised $3,214,026, net of issuance costs of $285,974, through the placement of 350 shares of Series B Preferred Stock ("Series B Preferred Stock")
pursuant to Regulation S of the Securities Act of 1933 ("the Act"). The Series B Preferred Stock had a stated value of $10,000 per share, accrued dividends for liquidation and conversion
purposes at 6% per annum and ranked senior to Wave's Common Sock and Series C Convertible Preferred Stock ("Series C Preferred Stock") and junior to the Series A Preferred Stock.
Series B Preferred Stock was convertible by the holder, in increments, into Wave's Class A Common Stock. The Series B Preferred Stock was convertible at the lesser of 110% of the
average closing bid price for the five days immediately preceding the issue date or 85% of the average closing bid price for the five days immediately preceding the conversion date.

During
1996, 330 shares of Wave's Series B Preferred Stock were converted into 2,960,303 shares of Wave's Class A Common Stock and the remaining 20 shares of
Series B Preferred Stock were converted in 1997 into 117,240 shares of Wave's Class A Common Stock.

F-27

---

In
December of 1996, Wave raised $2,634,037 net of issuance costs of $365,963 ($101,964 of which related to the value ascribed to warrants issued) through the placement of 150,000 shares
of Series C Preferred Stock pursuant to Regulation D of the Act. The Series C Preferred Stock had a stated value of $20 per share, which accrued dividends payable quarterly in
cash at 6% per annum.

The
Series C Preferred Stock ranked senior to Wave's Common Stock and junior to the Series A and B Preferred Stock. Series C Preferred Stock was convertible by the
holder, in increments, into Wave's Class A Common Stock based on the market price of Wave's Class A Common Stock at the time of conversion. The Series C Preferred Stock was
convertible at the lesser of $2.31 per share or 80%, as adjusted, of the average of the fair value of the Class A Common Stock for the five days prior to the conversion date. During 1997 all of
the Series C Preferred Stock was converted into 2,850,439 shares of Wave's Class A Common Stock.

In
May of 1997 Wave raised approximately $1,316,000, net of issuance costs of $272,000 ($162,000 of which related to the value ascribed to warrants issued), through the placement of
80,000 shares of newly created Series D Convertible Preferred Stock. The Series D Preferred Stock had a stated value of $20 per share, which accrued dividends payable quarterly in cash
at 6%.

The
Series D Convertible Preferred Stock was convertible into the Class A Common Stock of Wave at an effective conversion price of the lower of (i) $1.35, or
(ii) 80% of the average closing bid price on the NASDAQ National Market System of Wave's Class A Common Stock for the five (5) trading days immediately preceding the date of
conversion. During 1997 all of the Series D Convertible Preferred Stock was converted into 2,070,095 shares of Wave's Class A Common Stock.

(b) Convertible Preferred Stock

In October 1997 Wave raised approximately $1,850,000, net of issuance costs of $397,000 ($224,000 of which related to the value ascribed to warrants
issued), through the private placement of 112,500 shares of newly created Series F Convertible Preferred Stock. The Series F Convertible Preferred Stock had a stated value of $20 per
share, which accrued dividends payable quarterly in cash at 6%. The Series F Convertible Preferred Stock was convertible into the Class A Common Stock at an effective conversion price of
the lower of (a) $1.05 and (b) 80% of the average of the five (5) lowest trading prices of Class A Common Stock. During 1997 all of the Series F Convertible
Preferred Stock was converted into 2,961,086 shares of Wave's Class A Common Stock.

During
March of 1998, Wave issued 150,000 shares of newly created Series G Convertible Preferred Stock for an aggregate purchase price of $3,000,000. The Series G
Convertible Preferred Stock was senior to Wave's classes of Common Stock, and was junior to Wave' Series A Preferred Stock in liquidation rights. The Series G Convertible Preferred Stock
accrued dividends at the rate of 6% per annum. The Series G Convertible Preferred Stock was convertible into Wave's unregistered Class A Common Stock at the lower of $1.12 or 80% of the
average of the five lowest closing bids for the 25 calendar days prior to conversion. In addition, Wave issued warrants to the purchaser and placement agent for 225,000 shares of Wave's Class A
Common Stock at an exercise price of $1.38. The Series G Convertible Preferred Stock was converted into 2,394,494 and 377,102 shares of Wave's Class A Common Stock during 1998 and 1999,
respectively.

F-28

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(c) Common Stock

In December 1989, March through October 1990, and November 1991, substantially all stockholders as of December 29, 1989 were offered
the right to acquire a number of shares equivalent to their pre-offering holdings at a price of $.003 per share. Substantially all stockholders that received the offer accepted this offer.
This was accounted for essentially as a stock split effected in the form of a rights offering, and all shares issued in conjunction with this offering were reflected in the accompanying consolidated
financial statements retroactively.

Two
principal stockholders did not acquire the full amount of shares to which they were entitled. Most of the additional proportionate shares that these stockholders would have been
credited with were offered instead to certain officers, employees and stockholders for $.003 per share. To the extent that these rights were offered to the individuals in compensation for services
rendered to Wave, compensation expense equal to the difference between the estimated fair value as of the date of issuance and the purchase price of the stock was recorded. The estimated fair value of
the Common Stock was determined based on sales to third parties near the date of issuance. Compensation expense associated with the issuance of these shares of $430,250 is included in the accompanying
consolidated statement of operations for the period from inception to December 31, 2001.

In
May and November, 1992, Wave issued 770,000 shares of Class B restricted Common Stock to certain employees, officers and stockholders of Wave for a purchase price of $.003 per
share, payable in the form of services to Wave. As these shares were issued for services rendered, compensation expense of $1,927,500 was recorded representing the estimated fair value of $2.50 per
share at the date of issuance, the price at which Common Stock was sold to third parties near the time of issuance.

In
February 1995, Wave agreed to grant 36,000 shares of Class A Common Stock, 12,000 of which were issued in 1995 with the remainder issued in 1996, to two consultants and
six non-employee directors as
compensation for services rendered. Expenses of $112,500 were recorded in 1995 representing the stock's fair value of $3.13 per share at the time of the agreement to grant.

In
July 1995, Wave issued 19,559 shares to two vendors in payment for services rendered. Costs of $20,000 were recorded representing the stock's fair value of approximately $1.00
per share at the time the services were rendered.

In
July and August 1996, Wave issued 15,000 and 3,077 shares of Class A Common Stock to two consultants as compensation for services rendered. Expenses of $40,938 have been
recorded representing the stock's fair value of $2.06 and $3.44 per share, respectively, at their dates of issuance.

During
1997 Wave issued 126,885 shares of Wave's Class A Common Stock to vendors or for the settlement of liabilities. Expenses of $305,496 have been recorded representing the
stocks' fair value at the date of issuance.

During
1997 Wave sold approximately 800,000 shares of Wave's Class A Common Stock and warrants to purchase 160,000 shares of Wave's Class A Common Stock, exercisable at an
exercise price of $1.00, for an aggregate purchase price of $800,000. The warrants were exercised or expired during 1999.

F-29

---

During
1997 Wave issued 500,000 shares of Wave's Class A Common Stock in connection with a license agreement with Aladdin Knowledge Systems, Ltd. for its proprietary
persistent encryption technology. The shares were issued at their fair value on the date of issuance.

On
March 23, 1999, Wave sold 2,090,954 shares of its Class A Common Stock at a price of $11.00 per share, for an aggregate purchase price of $23,000,494. These shares were
sold to a group of accredited investors pursuant to Regulation D promulgated under the securities act of 1933, as amended. Pacific Growth Equities, Inc. acted as sole placement agent for
the private placement, receiving a commission of 6% or approximately $1.2 million for their services.

In
January 2000, the Company issued 275,000 shares of its class A Common Stock to one (1) accredited investor, for an aggregate purchase price of $1,100,000. These
shares were issued upon the exercise of a warrant granted on January 26, 1999. The warrant to purchase 275,000 shares of the Company's Class A Common Stock at an exercise price of $4.00
per share, was exercisable until January 26, 2004. The Warrants were issued as consideration for a $2,000,000 promissory note, bearing no interest, due January 26, 2002.

On
March 7, 2000 Wave sold 3,600,800 shares of its Class A Common Stock at a price of $34.00 per share, for an aggregate purchase price of $122,427,200. The shares were
sold to a group of accredited investors pursuant to regulation D promulgated under the securities act of 1933, as amended. Pacific Growth Equities, Inc. acted as sole placement agent for
the private placement, receiving a commission of 6% or approximately $7.3 million for their services.

On
August 31, 2000 the Company sold 374,889 shares of its Class A Common Stock, at a price of $19.30 per share in exchange for substantially all of the assets of Indigo
Networks, LLC and its e-commerce shopping network, iShopHere.com. Additional costs to complete the transaction were $210,000. These Securities were registered on September 21, 2000.

On
February 2, 2001 Wave issued 2,000,000 shares of its Class A Common Stock, at a price of $7.16 per share, for an aggregate purchase price of $14,312,800 to acquire
3,600,000 shares of the Series B Preferred Stock of BIZ, then a privately held company. Wave's investment in BIZ represented approximately 17.8% of the outstanding capital stock of BIZ. On
August 24, 2001 Litronic, Inc. ("Litronic"), a provider of authentication and encryption security technology, completed a merger with BIZ to form SSP Solutions. SSP Solutions trades on
the NASDAQ National Stock Market as SSPX. As a result of the merger, Wave's 3,600,000 shares of BIZ were converted into 3,083,083 shares of common stock of SSP.

On
July 24, 2002 Wave issued 1,700,000 shares of its Class A Common Stock to Redwave plc in exchange for 60% of the remaining assets of GlobalWave Limited for a total
purchase price of approximately $2,244,000. Prior to this transaction, Wave owned 40% of GobalWave Limited (See Note 15 Joint Ventures).

(d) Recapitalization

In January 1994, the Board of Directors authorized Wave to amend and restate Wave's Certificate of Incorporation to reflect the authorization of 25,000,000
shares of a newly created Class A Common Stock, which stock has voting rights of one vote per share, and the reclassification of the then current outstanding shares of Common Stock into
Class B Common Stock. In June 1994, the Board of

F-30

---

Directors authorized that the Class B Common stock will have one vote per share, except that Class B Common Stock will have five votes per share in cases where one or more directors are
nominated for election by persons other than Wave's Board of Directors and where there is a vote on any merger, consolidation or other similar transaction, which is not recommended by Wave's Board of
Directors. In addition, the Class B Common Stock will have five votes per share on all matters submitted to a vote of the stockholders in the event that any person or group of persons acquires
beneficial ownership of 20% or more of the outstanding voting securities of Wave. The Class B Common Stock is convertible into
shares of Class A Common Stock at any time. The classes of Common Stock are alike in all other respects.

(9) Options and Warrants

1991 Plan

In September 1991, the Board of Directors authorized the establishment of a stock option plan (the "1991 Plan"). The total number of shares of
Class B Common Stock subject to the Plan was 2,700,000. Options terminate upon the earlier of the date of the expiration of the option or upon termination of the employment relationship between
Wave or a subsidiary and the optionee for any reason other than death, disability or retirement.

Under
the 1991 plan, employees are entitled to exercise their options on dates determined by the Compensation Committee of the Board of Directors. Vesting provisions for options granted
generally range from immediate vesting to pro rata vesting over a three-year period. Options granted under the 1991 Plan, at the discretion of the Compensation Committee, included the
right to acquire a reload option. A reload option provides for the automatic grant of a new option at the then-current market price in exchange for each previously owned share tendered by
an employee in a Stock-for-Stock exercise.

The
1991 plan terminated on September 26, 1991 in accordance with its termination provision. Accordingly, no further options may be granted under the 1991 Plan. All options
outstanding under the 1991 Plan continue in full force and effect subject to their original terms. As of December 31, 2002, there remained 203,532 options outstanding under the 1991 plan at an
exercise price of $1.15 per share.

1994 Plans

In January 1994, the Board of Directors authorized the establishment of the 1994 Employee Stock Option Plan (the "1994 Plan"). The initial number of shares
of Class A Common Stock subject to the 1994 Plan was 1,000,000. The terms of the 1994 Plan are similar to those of the 1991 Plan. Options are granted with exercise prices that approximate fair
market value at the date of grant. In May 1996, July 1997, November 1998 and June 2000 Wave's shareholders approved amendments to Wave's 1994 Plan to increase the number of
shares of Class A Common Stock reserved for issuance there under by 1,000,000, 1,000,000, 5,000,000 and 5,000,000, respectively. Therefore, the total number of shares of Class A Common
Stock reserved for issuance under the 1994 Plan is 13,000,000 shares. As of December 31, 2002, there were approximately 1,332,000 shares available for grant under the 1994 Plan.

In
January 1994, the Board of Directors authorized the establishment of the Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The total number of
shares of Class A Common

F-31

---

Stock subject to the Directors' Plan was initially 200,000. Pursuant to the Directors' Plan, each director who was not an employee of Wave received an initial grant of options to purchase 12,000
shares of Class A Common Stock Options are granted with exercise prices that approximate fair market value at the date of grant.

Any
person subsequently elected as a director who was not an employee of Wave received an initial grant of options to purchase 12,000 shares of Class A Common Stock on the day he
or she was elected a director. In addition, on the day immediately following each of the dates on which an incumbent director was reelected, he or she received an additional grant of options to
purchase 2,000 shares of Class A Common Stock.

The
Stockholders of Wave have since, authorized certain changes to the Directors' Plan. In February 1995, the annual option grant for directors was increased from a total of 2,000
shares of Class A Common Stock to 10,000 shares of Class A Common Stock. In July 1995, the Board authorized an increase to the total number of shares subject to the Directors'
Plan from 200,000 shares to 500,000 shares. In November 1998, the stockholders of Wave authorized an increase to the total number of shares subject to the Directors' Plan from 500,000 shares to
1,000,000 shares. The stockholders also amended the Directors' Plan to provide that options issued to non-employee directors under such plan vest on the day following the grant. (Initial
option grants under the Directors' Plan vested one-third upon grant, and one-third on each of the first and second anniversaries. Annual option grants vested 25% after each
three-month period following grant.)

Options
under the Directors' Plan are exercisable for a period of ten years from the date of grant. Options may not be exercised after the option holder ceases to be a director of Wave,
except that in the event of death or disability of the option holder, the option may be exercised for a period of one year after the date of death or disability, and, in the event of retirement of the
option holder, the option may be exercised for a period of three months after the date of retirement. As of December 31, 2002, there were approximately 405,000 shares available for grant under
the Director's Plan.

In
September 1996, the Board of Directors authorized the establishment of the 1996 Performance Stock Option Plan (the "1996 Plan"). The initial number of shares of Class A
Common Stock subject to the 1996 Plan was 800,000. The terms of the 1996 Plan are similar to those of the 1994 and 1991 Plans. Options are granted with exercise prices that approximate fair market
value at the date of grant. As of December 31, 2002, there were approximately 125,000 shares available for grant under the 1996 Plan.

The
per share weighted-average fair value of stock options under all plans granted during 2002, 2001 and 2000 was $1.62, $2.89 and $12.18 on the dates of grant using the Black Scholes
option-pricing model with the following weighted-average assumptions:

2002

2001

2000Expected Life (Years)

5

5

10Interest Rate

3.0
%
4.0
%
6.0
%Volatility

113
%
119
%
113
%Dividend Yield

0
%
0
%
0
%


F-32

---

Wave
applies APB Opinion No. 25 in accounting for its Plans. Compensation expense has been recognized in the financial statements for Stock options granted to employees at
exercise prices below the market value of $333,137 in 2002, $552,554 in 2001 and $318,609 in 2000. Deferred compensation for stock options granted to employees at exercise prices below market value
was approximately $372,000 and $1,000,000 as of December 31, 2002 and 2001, respectively; and is being recognized over a period of three years from the date of grant.

Summary of Option Activity

A summary of option activity through December 31, 2002 follows:

Class A and B shares
subject to option

Weighted average
exercise priceBalance at January 1, 1991



$
Options granted

30,000


1.67Balance at December 31, 1991

30,000


1.67Options granted

816,750


1.18Balance at December 31, 1992

846,750


1.20Options granted

949,186


3.10Balance at December 31, 1993

1,795,936


2.20Options granted

310,200


3.05Options canceled

(108,500
)

3.38Balance at December 31, 1994

1,997,636


2.27Options granted

777,850


2.22Options canceled

(349,205
)

2.11Options exercised

(681,700
)

.64Balance at December 31, 1995

1,744,581


2.92Options granted

1,342,075


2.65Options canceled

(503,879
)

3.20Options exercised

(214,091
)

1.97Balance at December 31, 1996

2,368,686


2.79Options granted

707,914


1.02Options canceled

(676,741
)

1.57Options exercised

(70,326
)

1.90Balance at December 31, 1997

2,329,533


2.38Options granted

5,756,893


2.47Options canceled

(707,384
)

2.48Options exercised

(78,653
)

1.94Balance at December 31, 1998

7,300,389


2.40


F-33

---

Options granted

1,925,447


10.15Options canceled

(450,378
)

3.51Options exercised

(964,000
)

1.69Balance at December 31, 1999

7,811,458


4.33Options granted

3,444,037


13.58Options canceled

(905,145
)

12.33Options exercised

(2,030,958
)

2.51Balance at December 31, 2000

8,319,392


7.90Options Granted

2,934,272


3.46Options Canceled

(1,128,327
)

8.16Options Exercised

(473,511
)

1.42Balance at December 31, 2001

9,651,826


6.85Options Granted

1,607,959


1.94Options Canceled

(1,033,989
)

8.44Options Exercised

(42,553
)

1.04Balance at December 31, 2002

10,183,243

$
5.94


At
December 31, 2002, there were approximately 6,349,221 options exercisable at prices ranging from $.49 to $37.50.

The
following table summarizes information about stock options outstanding at December 31, 2002:

|Range of
exercise prices |  | Number
outstanding |  | Number
exercisable |  | Weighted
average
exercise
price |       | Weighted
average
remaining
contractual
life
|------------------------ |  | ------------------ |  | ------------------ |  | ------------------------------- | ----- | -------------------------------------------
|$.490.74                |  | 2,032              |  | 2,032              |  | $                               | .49   |                                            
|0.751.12                |  | 242,264            |  | 242,264            |  |                                 | 1.10  |                                            
|1.131.69                |  | 1,344,008          |  | 843,256            |  |                                 | 1.33  |                                            
|1.702.55                |  | 1,659,596          |  | 166,429            |  |                                 | 1.96  |                                            
|2.563.84                |  | 1,841,486          |  | 1,808,153          |  |                                 | 3.64  |                                            
|3.855.78                |  | 2,192,572          |  | 1,152,200          |  |                                 | 4.09  |                                            
|5.798.68                |  | 246,928            |  | 169,928            |  |                                 | 6.64  |                                            
|8.6913.04               |  | 1,218,985          |  | 903,867            |  |                                 | 11.82 |                                            
|13.0519.58              |  | 1,178,642          |  | 889,939            |  |                                 | 15.00 |                                            
|19.5929.38              |  | 206,730            |  | 137,819            |  |                                 | 19.69 |                                            
|29.3937.50              |  | 50,000             |  | 33,334             |  |                                 | 33.75 |                                            

F-34

---

1999 WaveXpress Stock Incentive Plan

In April 2000, the board of directors of WaveXpress authorized the establishment of a stock option plan. The total number of shares of WaveXpress'
Class A Common Stock subject to the Plan is 2,500,000. Options terminate upon the earlier of the date of expiration of the option or upon termination of the employment relationship between
WaveXpress and the optionee for any reason other than death, disability or retirement.

Employees
are entitled to exercise their options on dates determined by WaveXpress' Compensation Committee of the Board of Directors. Vesting provisions for options granted generally
range from immediate vesting to pro rata vesting over a three-year period.

Stock
option activity during 2002 and 2001 is as follows:

|                                                     |  | 2002      |   | 2001 |      | 2000
|---------------------------------------------------- |  | --------- | - | ---- | ---- | ----
|
|Balance at Beginning of year                         |  | 1,029,975 |   | $    | 1.22 |     
|Granted                                              |  | 1,011,799 |   |      | 1.20 |     
|Exercised                                            |  |          |   |      |     |     
|Canceled                                             |  | (638,933  | ) |      | 1.20 |     
|                                                     |  |           |   |      |      |     
|Balance at end of year                               |  | 1,402,841 |   |      | 1.21 |     
|                                                     |  |           |   |      |      |     
|Exercisable at end of year                           |  | 658,156   |   |      | 1.23 |     
|                                                     |  |           |   |      |      |     
|Additional shares available for grant at end of year |  | 1,069,382 |   |      |      |     
|                                                     |  |           |   |      |      |     

The
per share weighted-average fair value of stock options granted during 2002, 2001 and 2000 was $0.85, $0.89 and $0.99, respectively, on the date of grant using a Black-Scholes
option-pricing model with the following weighted-average assumptions:

2002

2001

2000Expected dividend yield

0%

0%

0%Risk-free interest rate

3%

4%

6%Expected Volatility

119%

127%

149%Expected life

3 years

3 years

3 years


F-35

---

The
following table summarizes information about WaveXpress' fixed stock options outstanding at December 31, 2002:

Options Outstanding

Options ExercisableExercise
Price

Number
Outstanding

Weighted
Average
Remaining
Contractual Life
(in years)

Weighted
Average
Exercise Price

Number
Outstanding

Weighted
Average
Exercise Price$
1.20

1,394,644

9.0

$
1.20

649,959

$
1.20$
3.004.50

8,197

7.6

$
3.37

8,197

$
3.37$
1.204.50

1,402,841

8.9

$
1.21

658,156

$
1.23


Warrants

In 1993 and 1994, Wave issued warrants to acquire a total of 151,600 shares of Class B Common Stock at $3.50 per share in conjunction with sales of
Class B Common Stock to individuals and institutions. All warrants were exercisable for a period of five years from the date of issuance and were subsequently canceled or exercised in 1998 and
1999.

In
1993 and 1994, Wave issued warrants to acquire a total of 376,253 shares of Class B Common Stock at $3.50 per share in conjunction with the issuance of its 10% Convertible
Notes which have since been repaid and in 1994, Wave issued warrants to acquire a total of 46,799 shares of Class B Common Stock at $6.00 per share in conjunction with the issuance of its 15%
Notes, also which have since been
repaid. All warrants were exercisable for a period of five years from their dates of issuance. These warrants were exercised or canceled in 1998 and 1999.

Under
the terms of Wave's initial public offering, the underwriter acquired warrants to purchase 360,000 Class A Common Stock at a price of $6.50 per share for nominal
consideration. These warrants were exercisable for four years commencing in September 1995. These warrants were exercised during 1999.

As
a result of the successful placement of 350 shares of Series B Preferred Stock, a consultant from Digital Media Group, Inc. was issued warrants by Wave to purchase
15,000 Class A Common shares at a price of $3.09 per share. These warrants are exercisable for ten years commencing in March 1996, and are still outstanding.

Due
to the successful placement of 150,000 shares of Wave's Series C Convertible Stock, Wharton Capital Partners Ltd. and The Shemano Group, Inc., two financial
consulting firms, were issued warrants by Wave to purchase 37,500 Class A Common Stock each at a price of $2.54 per share. These warrants were exercised in 1999.

In
connection with the acquisition of WIN, Wave issued a warrant that allowed the holder the ability to purchase unregistered shares of Wave's Class A Common Stock at a price of
$1.25 per share at the earlier of the conversion of a note or April 18, 1998 for a period of five years. The number of shares able to be purchased under this warrant is based on a formula of
$170,000 divided by 80% of the fair market value of the Class A Common Stock at the time of conversion. This warrant was

F-36

---

subsequently extended one year by issuing 100,000 additional warrants to be exercised at prices ranging from $1.49 to $3.43. These warrants were exercised during July 1999.

As
a result of the successful placement of 80,000 shares of Wave's Series D Preferred Stock, JNC Opportunity Fund, the acquirer of the placement, received 80,000 warrants to
purchase Wave's unregistered Class A Common Stock, and financial consultants, primarily Wharton Capital Partners, received a total of 40,000 warrants. The warrants were exercised in 1999 at an
exercise price of $1.62.

As
a result of the successful placement of 112,500 shares of Wave's Series F Preferred Stock, Combination Inc., the acquirer of the placement, received 112,500 warrants to
Wave's unregistered Class A Common Stock, and Wharton Capital Partners received 56,250 warrants. The warrants had an exercise price of $1.26, and expire on October 9, 2002. The warrants
were exercised in 1998.

In
connection with the private placement of approximately 800,000 shares of Wave's Class A Common Stock, Wave issued 160,000 warrants to purchase shares of Wave's unregistered
Class A Common Stock at an exercise price of $1.00. The warrants were exercised or expired during 1999.

In
connection with a technology license agreement with Aladdin, Wave issued two warrants on July 18, 1997 to purchase Wave's Class A Common Stock. The first warrant was
exercisable in 100,000 share lots, and provided the holder with the right to acquire 1,216,136 shares of Wave's unregistered Class A Common Stock at an exercise price of $1.70 per share. The
first warrant had a life of two years. The second warrant provided the holder with the right to acquire 7% of Wave's Class A Common Stock on a fully diluted basis for the average closing price
for the 15 trading days prior to exercise and had a three year life. During June of 1998, Aladdin exercised a portion of the second warrant to purchase 1,000,000 shares of Common Stock. On
March 31, 1999 Aladdin exercised their entire first warrant for 1,216,136 Class A Common Stock. Associated with the second warrant, Aladdin had the right to acquire shares approximating
3.45% of Wave's Class A Common Stock. The remaining shares under the second warrant were not exercised, and expired July 17, 2001.

In
connection with a $2,000,000 convertible promissory note, warrants to acquire 275,000 shares of Class A Common Stock were issued. Wave incurred a non-cash charge to
interest expense for approximately $666,000. These warrants were subsequently exercised in January 2000.

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

In
2001, 50,320 warrants were exercised at $1.83 per share. In 2000, 44,692 warrants were exercised at prices ranging from between $1.10 and $5.50 per share

A
summary of warrants outstanding at December 31, 2002, follows:

Class A and B shares
subject to warrants

Range of
exercise
prices

Weighted Average
Remaining
Contractual Life65,000

$
3.09$3.48

1.5 years20,000

$
10.00$14.73

4.5 years


At
December 31, 2002, warrants to acquire approximately 85,000 shares of Class A Common Stock were exercisable.

F-37

---



(10) Licensing Agreements

(a) Licensed Patents

In February 1994, Wave entered into an Amended and Restated License Agreement (the "Agreement") with Mr. Peter J. Sprague, the former Chairman and
former Chief Executive Officer of Wave, and Mr. John Michener, then a shareholder and officer of Wave, whereby Wave was granted an exclusive license to make, have made, use, lease, sell or
otherwise perform services covered by certain licensed patents which are a fundamental part of some of Wave's products. The Agreement amends and restates certain license agreements entered into by
Wave prior to February 1994.

The
Agreement provides for royalty payments to be made to the licensors in the aggregate amount of two percent of the total gross revenues derived by Wave and any sublicensee of Wave
from the exploitation of these licensed patents, less amounts paid, if any, to (i) information and database providers for information distributed to or through Wave or its sublicensees, and to
(ii) Wave's sublicensees for manufacturing the product or performing the services covered by these patents. Royalty payments are payable quarterly and are to be apportioned 75% to
Mr. Sprague and 25% to Mr. Michener.

Payment
of royalties is secured by a security interest in and to these licensed patents. Mr. Sprague assigned all of his right, title, and interest in the licensed patents to
Wave.

Wave
believes that the agreements as a whole provide it with exclusive rights under the patents. There can be no assurance that Wave will enjoy exclusive rights to the licensed patents
under these agreements. No payments have been made to date.

(b) Aladdin License Agreement

During the third quarter of 1997 Wave entered into a license agreement with Aladdin, an Israeli company, for technology and in-process research and
development related to Aladdin's proprietary persistent encryption system. Under the terms of the Aladdin license agreement, Wave is prohibited from using any other encryption technology for the first
five years. This technology will be incorporated into the Wave System to facilitate pay-per-view content distribution.

Wave
acquired the license for this technology in exchange for $950,000 plus two warrants to purchase Wave's Class A Common Stock valued at approximately $2.9 million (see
note 9). The cost of this license was expensed as research and development costs. Aladdin also is provided a royalty payment of 5% to 9% of Wave's net content revenues.

In
connection with this agreement, Aladdin acquired an equity position in Wave by purchasing 500,000 shares of Wave's Class A Common Stock for $900,000, which approximated the
fair market value of the shares on the date of purchase (see note 8).

(11) License and Cross-License Agreements

On May 1, 1992, Wave entered into a Joint Technology Development Agreement and License and Cross-License Agreement ("License and Cross-License Agreement")
with The Titan Corporation ("Titan") whereby Titan granted to Wave license rights to the use of certain patents which are co-owned or licensed by Titan. Wave granted to Titan the exclusive
right to make for, sell in, and lease in a "Retained Market," as defined in the agreement, the subject matter described in any Company

F-38

---

patent. The Retained Market is defined generally as the market for "Government Information," as defined in the agreement, used solely by a government entity, and the market for products used to
access such information. Wave issued to Titan 674,976 shares of Class B Common Stock in return for the license to Titan's patents. These shares were valued at $1.67 per share (total
$1,124,960), the estimated fair value of the shares at the time of issuance (based on the price at which shares were sold to third parties near the time of issuance), and were included in research and
development expense in the accompanying consolidated statement of operations for the period from February 12, 1988 through December 31, 2002.

The
License and Cross-License Agreement provides for royalties to be paid by Wave to Titan based upon Wave's "Net Revenues," as defined in the agreement. Net Revenues are defined
generally as gross product revenues less amounts paid to information providers and data base providers for
information provided to Wave for use in its products and services. Royalties are payable on a quarterly basis.

The
License and Cross-License Agreement also provides for royalties to be paid to Wave by Titan based upon Titan's "Allocable Net Revenues," as defined in the agreement. Allocable Net
Revenues are generally defined as that portion that a Company patent or information adds to Titan's gross amounts invoiced to purchasers for all products or information services making use of a
Company patent or know-how and information. Royalties are payable on a quarterly basis.

The
License and Cross-License Agreement specifies certain events of termination, some of which have already occurred but which have been waived or extended by Titan.

A
director of Wave, who resigned from the Board at the end of 1997, is also the President, Chief Executive Officer, and a director of Titan. Pursuant to the terms of a related
stockholders agreement, Titan has the right to designate a member of Wave's Board of Directors for as long as Titan continues to own at least 50% of the shares originally issued to Titan. As of
December 31, 2002, no royalties have been earned by Titan. On February 28, 1997, Wave and Titan executed an addendum to the License Agreement whereby Wave received a sole license to
Titan's patent to develop and distribute products to the in-home consumer microcomputers market segment. Under this addendum, Titan waived all defaults previously incurred by Wave as well
as extended the license agreement to expire at the time the patents expire.

(12) Revenue Sharing Agreements With Partners

Wave has, and intends to continue to, enter into revenue sharing arrangements with information providers, software developers, and hardware and systems
manufacturers. Such revenue sharing arrangements are expected to be negotiated between each of the partners and Wave. It is anticipated that revenue sharing arrangements will vary according to the
market in which the Wave system is adopted and from which revenues are derived. Generally, a significant portion of the revenue collected by Wave will be paid directly to the information provider or
software developer. Once these payments are made, the remainder of revenues will be shared between Wave and other partners. There can be no assurance that Wave will be successful in entering into
definitive agreements with these parties, or that the terms of such agreements will be favorable to Wave.

F-39

---

(13) Development Contract with SSP Solutions, Inc.

In October 2000, Wave entered into a $10 million comprehensive development agreement with BIZ Interactive Zone, Inc. to integrate Wave's
EMBASSY Trusted Client technology into BIZ's suite of products for deployment into 5 million digital set top boxes and integrated gateway products such as cable and DSL modems. The development
agreement outlined the broad objectives of the project but it required that the parties complete a more detailed plan with related milestones in order to guide the overall project.

In
February 2001, Wave entered into an unrelated stock purchase agreement with BIZ pursuant to which Wave purchased 3,600,000 shares of BIZ Series B preferred stock in
exchange for 2,000,000 shares of its Class A Common Stock. Subsequently, Litronic, Inc., a provider of authentication and encryption security technology, completed a merger with BIZ to
form SSP Solutions, Inc. (See Note 14). The intention of the cross investment was to add an additional incentive to both parties under the agreement and it was intended to be a swap of
shares of equal value.

In
May of 2001, the development agreement with BIZ discussed above, was amended whereby, 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 million purchase order for EMBASSY products. Payment terms of the agreement
provided that SSP make payments of $277,778 per month for eighteen months. In addition, the parties agreed that in the event that SSP failed to pay any monthly instalment within 30 days of
receiving written notice by Wave that it is in default, the unpaid portion of the instalment would automatically convert into a stock acquisition right allowing Wave to acquire a number of shares in
SSP to be determined by dividing the unpaid amount by the fair market value of SSP common stock. As the contract was for a discrete project to integrate our technology with the SSP platform, revenue
under the development services agreement had been recognized on a percentage of completion basis in accordance with SOP 97-2 as it relates to contract accounting under SOP
81-1. Percentage complete is determined based upon the actual costs incurred compared to the total estimated costs to complete, limited to cash received and milestones accomplished.
Milestones included specific software development objectives that must be accepted by SSP.

As
of December 31, 2001, Wave received $555,556 in cash and had not exercised any stock appreciation rights. Wave recognized approximately $358,000 in revenue under the
development agreement at December 31, 2001 under the percentage of completion method of accounting.

Effective
January 29, 2002, due to a refocus of SSP's development efforts, SSP formally requested Wave to suspend work on the Linux project. SSP further requested Wave to
(i) agree to amend the existing contract, (ii.) agree to identify any balance of development budget left from the Linux project commitment and (iii) agree to formally estimate the costs
to complete two other projects that SSP would like Wave to focus upon. At that time, Wave had ceased all work relating to SSP and recognized the remaining non-refundable cash received,
$198,000 in during the quarter ended March 31, 2002. Revenue was recognized under the percentage of completion method of accounting.

On
September 30, 2002 Wave and SSP executed a Termination Agreement and Mutual Release whereby Wave was issued an additional 1,600,000 shares of SSP Class A Common Stock
and a non-negotiable, non-interest bearing, subordinated convertible promissory note due December 31, 2005 in the principal amount of $270,000 (the "Note") as a fee for
the termination by SSP of the contract. The Note is convertible into SSP Class A common stock at the rate of $1.35 which is subject to

F-40

---

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 the 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. A
termination fee of $1,680,000 was recognized in Wave's statement of operations in connection with this transaction. On December 13, 2002 SSP exercised its right to convert the Note into 200,000
shares of SSP common stock. The 200,000 shares that Wave received from the Note conversion were initially recorded on the balance sheet at $0.69 per share, for an aggregate value of $138,000.

(14) Investments

On February 2, 2001 Wave issued 2,000,000 shares of its Class A Common Stock, at a price of $7.16 per share, for an aggregate purchase price of
$14,312,800 to acquire 3,600,000 shares of the Series B Preferred Stock of BIZ, then a privately held company. Wave's investment in BIZ represented approximately 17.8% of the outstanding
capital stock of BIZ. Accordingly, the investment had been accounted for under the cost method of accounting, because the investment was less than 20% of the outstanding capital stock of BIZ and
because Wave could not exercise significant influence over BIZ. On August 24, 2001, SSP was formed through a merger with Litronic. As a result of the merger, Wave was issued 3,083,083 shares
(14.95%) of the common stock of SSP in exchange for the BIZ shares it held, as noted above.

During
2002, SSP issued Wave an additional 1,800,000 shares of common stock in connection with the cancellation of a development agreement between the two parties and the conversion of
the Note. Wave has accounted for its investment in SSP as non-current marketable equity securities available for sale. Unrealized holding gains and losses on these securities are recorded
in other comprehensive income in stockholders' equity, unless the unrealized loss in the investment is deemed to be other than temporary, whereby the decline in value is recognized as a realized loss
in Wave's statement of operations. As of December 31, 2002 and 2001, Wave's investment in SSP was valued at $2,881,016 and $11,160,758. As detailed in the table below:

|                   |  |           |  |   |            | As of December 31, 2001 |   | As of December 31, 2002
|------------------ |  | --------- |  | - | ---------- | ----------------------- | - | -----------------------
|
|February 2, 2001   |  | 3,083,083 |  | $ | 14,312,800 |                         | $ | (1,736,685             
|September 30, 2002 |  | 1,600,000 |  |   | 1,680,000  |                         |   |                       
|December 13, 2002  |  | 200,000   |  |   | 138,000    |                         |   |                       
|                   |  |           |  |   |            |                         |   |                        
|                   |  | 4,883,083 |  | $ | 16,130,800 |                         | $ | (1,736,685             
|                   |  |           |  |   |            |                         |   |                        

In addition, Wave holds 107,975 common shares of XO Communications Corporation ("XO"). As of December 31, 2002 and 2001 the stock had a
market value of $0 and $10,366, respectively

F-41

---

(15) Joint Ventures

(a) GlobalWave, Ltd

In July of 1997, Wave entered into a joint venture with ITG, a United Kingdom Internet service provider. The joint venture was initially owned 25% by Wave and 75%
by ITG. Wave contributed its technical expertise and ITG contributed initial working capital and the commitment to fund all future working capital requirements of the joint venture. The objective of
the joint venture company, GlobalWave is to promote and commercialize Wave's technology in certain European, African and Middle Eastern markets. Pursuant to the joint venture agreement, Wave received
a license fee of $5 million in exchange for the joint venture's right to market Wave's technology in European, African and Middle Eastern markets. The license fee was paid by ITG as part of its
commitment to fund the joint venture. During the third quarter of 1997, Wave received $1.0 million from the joint venture representing partial payment of the license fee, with the remaining
payments to be made upon Wave's attaining certain milestones related to the number of Wave Meters distributed. The amount received was recorded as deferred license fee income in the third quarter of
1997 as it was uncertain whether Wave had met the contractual requirements required in order to have earned the first payment. During the fourth quarter of 1997, Wave met these requirements and began
recognizing the license fee ratably over the contractual period, and recorded the $1 million as a license fee income. Also Wave accrued $490,000 in the fourth quarter of 1997 for expenses
related to Wave's obligation to assist the joint venture in setting up the Wave system in the designated markets. In January 1998, the joint venture agreement was modified to extend the
milestone dates and provide for the payment of an additional $750,000 of the $5 million license fee to Wave. The payment of $750,000 was received in January 1998. Wave also received the
final payment of $3.25 million in June 1998. This payment and the $750,000 received in January 1998 totaled $4 million received in 1998. As part of the agreement, after the
final license fee was paid, the companies issued a warrant to each other to purchase approximately one million shares of each other's Common Stock. The exercise price of the Wave warrants was $1.75
per share. The exercise price of the ITG warrant was approximately .995 British pound per share. On June 5, 1998, the final milestone for the last payment on the license fee was attained and
Wave became obligated to issue its warrant to ITG pending approval by the shareholders of ITG for it to issue its reciprocal warrant. On this date the net fair market value of the exchange of warrants
represented a net cost to Wave of approximately $1.1 million. Wave recorded this cost as ITG net warrant cost in the Consolidated Statement of Operations.

On
November 5, 1999, Wave exercised its warrant for 1,000,000 shares in ITG at a total cost of $1,620,000. Also during 1999, ITG exercised its 1,000,000 warrants in Wave yielding
total proceeds of $1,750,000.

In
February, 2000, ITG was acquired by Concentric Network Corporation. As a result of this transaction, Wave received $2,162,457 in cash and 83,910 shares of Concentric Common Stock.
Subsequently, Concentric was acquired by XO, whereby Wave's 83,910 shares in Concentric were converted into 107,975 shares of XO. (See Note 13Investments). In addition, certain
assets of ITG,
namely the 1,000,000 shares of Wave Common Stock and ITG's interest in GlobalWave, were distributed to Redwave.

In
June, 2000, Wave increased its ownership percentage of GlobalWave from 25% to 40%. As part of the new joint venture agreement, Wave's partner in the venture, Redwave, agreed to
contribute $7.5 million and 500,000 shares of Wave Common Stock held by Redwave, in exchange for 600,000

F-42

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shares of GlobalWave class A Common Stock. Wave received 400,000 shares of GlobalWave class B Common Stock in exchange for a technology license granted by Wave to GlobalWave. Prior to
September 30, 2000, no value had been assigned to these shares, as Wave had not provided any funding to GlobalWave.

On
October 10, 2000, Wave entered into an agreement with GlobalWave and Redwave to subscribe for additional Class B shares of GlobalWave. Under the terms of the agreement,
Wave subscribed for 40,000 additional "B" shares of GlobalWave at £100 per share (approximately $142.80), the consideration for which consisted of £1.5 million
(approximately $2.14 million) in development costs incurred by Wave on behalf of GlobalWave, £1.4 million in cash ($2.0 million), and £1.1 million
(approximately $1.6 million) in cash and/or future development services, for total consideration of £4.0 million (approximately $5.7 million).    In
addition, Redwave has agreed to subscribe for an additional 60,000 GlobalWave "A" shares, the consideration for which will consist of the conversion of debt and cash totaling
£6.0 million (£5,966,615 in debt and £33,385 in cash; approximately $8.6 million). The resulting ownership interest in the venture will remain 60% for
Redwave and 40% for Wave.

Also,
in October 2000, Wave and Redwave formed a joint venture holding company, Wave European Technologies plc, ("WET") for their European interests, including their respective
40% and 60% stakes in GlobalWave. Subsequent to the formation of WET, WET's name changed to GlobalWave Group, plc.

As
of December 31, 2002, Wave has contributed its entire committed investment of approximately $5.7 million in the form of development costs incurred and cash. Pursuant to
the equity method of accounting, Wave had recognized its equity share (40%) of GlobalWave's net losses in its operating results for the years-ended December 31, 2002, 2001 and 2000 of $0,
$2.3 million and $3.4 million, respectively.

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

(b) WaveXpress

In April 1999, Wave joined with Sarnoff Corporation to form a new joint venture, WaveXpress. WaveXpress develops secure data broadcast architecture,
infrastructure and content services. This technology and these services will allow content providers to send digital content to properly equipped PC's by utilizing unused bandwidth in the Digital
Television Spectrum or broadcast over cable television

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lines. Consumers will be able to purchase this content directly through a secure network connection, thus enabling a significant new revenue stream for broadcasters or cable television operators. On
October 15, 1999, Wave and Sarnoff signed a joint venture agreement that formally established WaveXpress. Under this agreement, Sarnoff and its affiliates received a 40% equity stake in
WaveXpress. Wave received a 53% equity interest; and its affiliates, who purchased founders stock in April 1999 for a nominal amount, owned the remaining 7% of the outstanding capital stock.
The affiliates of Wave include Peter Sprague; former Chairman of Wave, and Steven Sprague; Chief Executive Officer of Wave, certain members of the Board of Directors of Wave and certain Wave
employees.

Wave
has funded WaveXpress through a series of convertible notes, some with attached warrants. The notes bear interest at rates of 2% to 3% above the prime rate of Chase Manhattan Bank.
Generally, the notes are convertible into shares of Common Stock of WaveXpress at varying prices per share. In addition, some of the notes carry attached warrants that allow Wave to purchase
additional shares of WaveXpress, generally at the conversion price of the notes. As of September 30, 2002, Wave owned 69% of WaveXpress while Sarnoff owned 26%. The equity interests of Wave,
Sarnoff and Wave's affiliates referred to above, assuming all of Wave's and Sarnoff's convertible securities are converted and warrants are exercised, would be approximately 83%, 8%, and 9%,
respectively. Through December 31, 2002, Wave has provided approximately $32.6 million in funds, including approximately $3.6 million in accrued interest. During 2001, some of the
notes, totaling $9.5 million matured and were converted into 1,826,570 shares of WaveXpress common stock. These amounts are eliminated in consolidation.

Neither
Sarnoff nor any of the other minority shareholders have provided or are obligated to provide funding to WaveXpress. Accordingly, the financial statements of WaveXpress have been
included in the consolidated financial statements of Wave as of December 31, 2002 and for the period then ended. In addition, Wave has not recorded a minority interest in WaveXpress in the
consolidated financial statements and therefore has reflected 100% of WaveXpress' balance sheet and operating results in its consolidated financial statements. WaveXpress has incurred net losses of
$6.3 million, $10.2 million, and $11.2 million for the years ended December 31, 2002, 2001 and 2000, respectively.

(16) Cash Collected on Behalf of Charities

As of December 31, 2002, Wave held cash received on behalf of charities of $235,553 in connection with Charitywave.com, Wave's on-line
charitable donation service. These donations were received primarily on behalf of donors to the New York Times Neediest Cases Fund. In addition, Wave had a receivable from its credit card processor of
$27,603 as of December 31, 2002, associated with these donations. The total of $263,156 is reflected as due to charities in the December 31, 2002 financial statements, and was paid to
the applicable charities within 30 days, in accordance with the standard Charitywave.com contracts with its member charities.

As
of December 31, 2001, Wave held cash received on behalf of charities of $358,531 in connection with Charitywave.com, Wave's on-line charitable donation service.
These donations were received primarily on behalf of donors to the New York Times 9/11 Disaster Relief Fund. In addition, Wave had a receivable from its credit card processor of $64,522
as of December 31, 2001, associated with these donations. The total of $423,053 is reflected as due to charities in the December 31, 2001 financial

F-44

---

statements, and was paid to the applicable charities within 30 days, in accordance with the standard Charitywave.com contracts with its member charities.

(17) Commitments and Contingencies

Litigation

Wave is a party to legal proceedings generally incidental to its business. Management believes that the outcome of such litigation will not have a material
adverse effect on the consolidated financial position of the Company.

Leases

Summarized below is a listing of properties leased by Wave pursuant to non-cancelable operating leases. Our principal research and development
activities are conducted at the Princeton and Cupertino facilities.

Location

Annual
Lease Cost

Lease Expiration
DateLee, MA

$
147,095

Aug. 2004New York, NY


90,000

MonthlyPrinceton, NJ


264,000

Jun. 2003Cupertino, CA


168,228

Feb. 2008Nashville, TN


47,233

Sep. 2003Orvault, France


92,172

Sep. 2010New York, NY(1)


304,317

Apr. 2006Total

$
1,113,045


---

Future
minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2002 are as
follows:

2003

$
701,9482004


589,1052005


573,7822006


375,7242007


280,098Thereafter


284,961Total minimum lease payments

$
2,805,617


Rent
expense for the years ended December 31, 2002, 2001, 2000 and for the period from inception through December 31, 2002 amounted to approximately $1,804,000, $2,101,000,
$1,960,000 and $8,984,000, respectively.

There
were no capital lease obligations as of December 31, 2002.

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(18) Income Taxes

The Company did not provide for any income tax expense or (benefit) for the years ending December 31, 2002, 2001 and 2000.

The
following table summarizes the significant differences between the United States federal statutory tax rate and the Company's effective tax rate for financial statement reporting
purposes:

2002

2001

2000Statutory tax rate

34
%
34
%
34
%Equity in loss from subsidiaries

(1
)
(2
)
(10
)Change in valuation allowance

(33
)
(32
)
(24
)Total


%

%

%


The
tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2002 and 2001 are as follows:

2002

2001Deferred tax assets:Net operating loss carryforwards

$
76,174,000

$
61,604,000Accrued expenses


383,000


831,000Intangibles


2,015,000


4,609,000Reserves


974,000


549,000Depreciation


845,000


786,000Other


5,631,000


Total gross deferred tax assets


86,022,000


68,421,000Less valuation allowance


(86,022,000
)

(68,421,000
)Net deferred tax asset

$


$



The
valuation allowance increased by approximately $17.6 million and $23.9 million, during the years ended December 31, 2002 and 2001, respectively.

Management
has concluded that it is more likely than not that Wave will not have sufficient taxable income of an appropriate character within the carryback and carryforward period
permitted by current law to allow for the utilization of certain of the deductible amounts generating the deferred tax assets and, therefore, a valuation allowance of $86,022,000 and $68,421,000 has
been established to reduce the deferred tax assets at December 31, 2002 and 2001 respectively.

Wave
has net operating loss carryforwards for tax return purposes of approximately $179 million, which expire beginning in 2003 through 2022. Pursuant to the Section 382 of the Internal
Revenue Code, the annual utilization of Wave's net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within a three year period. Wave has not
determined whether there has been such a cumulative change in ownership or the impact on the utilization of the loss carryforwards if such change has occurred.

F-46

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(19) Defined Contribution Plan

Wave adopted the Wave Systems Corp. 401(k) Savings and Investment Plan, a defined contribution plan, to which substantially all employees can contribute, on
January 1, 1995. Employees of Wave become eligible immediately on employment. Wave has the option to make discretionary matching contributions; no contributions were made in 2002, 2001 or 1999.

(20) Disclosures about the Fair Value of Financial Instruments

Cash and Cash Equivalents, Marketable Securities, Prepaid Expenses and Other Receivable, Accounts Payable and Accrued Expenses, and Note Payable

The carrying amounts of these instruments, other than marketable securities and the note payable, approximate fair value because of their short maturities.
Marketable securities are valued based on the value of the securities as traded on the Nasdaq Stock Exchange.

Fair
value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

(21) Restructuring Costs and Other Charges

During the quarter ended March 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 related 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 costs were incurred and paid during the quarter ended
March 31, 2002. Overall, Wave reduced its force by a total of thirty-six employees, nineteen of which were in research and development and seventeen that were in selling, general
and administrative departments. All employees were notified of the workforce reduction during the quarter ended March 31, 2002. In addition, Wave recorded an impairment charge of $905,390 for
leasehold improvements in the abandoned office and other tangible fixed assets that were disposed of or removed from operations in connection with this transaction.

Wave
also recorded a charge of approximately $488,000 in the quarter ended March 31, 2002, relating to a payment made to a former supplier as a settlement for a demand for
arbitration filed 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. The total settlement payment made by Wave was for $688,000, of which $200,000 was accrued for as of December 31, 2001. This charge is included in "selling, general and
administrative expense".

F-47

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(22) Segment Reporting

Effective December 31, 2000, Wave adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." SFAS 131
supercedes previously issued segment reporting disclosure rules and requires reporting of segment information that is consistent with the way in which management operates Wave. Prior to
December 31, 2000, SFAS 131 was not applicable because Wave only operated as one segment.

Wave's
products include the Wave EMBASSY® Trusted Client Platform and Services and WaveXpress Data Broadcasting Products and Services. These products and services constitute
Wave's reportable segments. Net Losses for reportable segments exclude interest income, interest expense, equity in losses of equity method investees and realized gains on marketable securities. These
items are not reported by
segment since they are excluded from the measurement of segment performance reviewed by Wave's management.

The
following sets forth reportable segment data:

For the years ended December 31,2002

2001

2000Operating Revenues:EMBASSY® Trusted Client Platform and Services

$
446,588

$
672,325

$
332,522WaveXpress Data Broadcasting





19,800


Total Operating Revenues


446,588


692,125


332,522(Net Loss):EMBASSY® Trusted Client Platform and Services (1)


(26,914,035
)

(37,068,320
)

(39,712,441
)WaveXpress Data Broadcasting


(6,336,655
)

(10,252,001
)

(10,183,134
)Total Segments Net Loss


(33,250,690
)

(47,320,321
)

(49,895,575
)Interest Income


477,902


2,688,105


5,103,716Interest Expense








Equity in net losses of equity method investees





(2,332,159
)

(3,406,491
)Gain on termination of development contract


1,818,000





Provision for loss on officer note receivable


(919,518
)




Loss for Other than Temporary Decline in Marketable Equity Securities


(11,513,099
)

(1,736,682
)

Gain on sale of marketable securities








542,457Net Loss

$
(43,467,405
)
$
(48,701,057
)
$
(47,655,893
)Depreciation and Amortization Expense:EMBASSY® Trusted Client Platform and Services (2)


1,563,987


3,281,547


2,228,078WaveXpress Data Broadcasting


436,718


970,408


939,060Total Depreciation Expense

$
2,000,705

$
4,251,955

$
3,167,138


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---

Capital Expenditures:EMBASSY® Trusted Client Platform and Services


1,083,877


1,307,271


1,323,485WaveXpress Data Broadcasting


73,755


200,327


4,275,815Total Capital Expenditures

$
1,157,632

$
1,507,598

$
5,599,300Assets:EMBASSY® Trusted Client Platform and Services


17,560,523


58,562,392


92,164,096WaveXpress Data Broadcasting


648,849


1,671,910


5,920,365Total Assets

$
18,209,372

$
60,234,302

$
98,084,461


---

(23) Selected Quarterly Financial Data

|                          |  | For Quarters-ended |           
|------------------------- |  | ------------------ | ----------
|
|Revenues                  |  | $                  | 53,336    
|Gross Profit              |  |                    | 23,927    
|Loss from Operations      |  |                    | (6,858,788
|Net loss                  |  |                    | (9,886,002
|Net loss per Common Share |  | $                  | (0.19     

|                          |  | For Quarters-ended |            
|------------------------- |  | ------------------ | -----------
|
|Revenues                  |  | $                  | 202,221    
|Gross Profit              |  |                    | 50,351     
|Loss from Operations      |  |                    | (9,922,017 
|Net loss                  |  |                    | (11,743,942
|Net loss per Common Share |  | $                  | (0.23      

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