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

                             ----------------------

                                    FORM 10-K

                             ----------------------

    |X|           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1999

    |_|         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

               For the transition period from ........ to ........

                         Commission File Number 0-24752

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

              Delaware                                          13-3477246
   (State or other jurisdiction of                           (I.R.S. Employer
   incorporation or organization)                           Identification No.)

         480 Pleasant Street
         Lee, Massachusetts                                        01238
(Address of principal executive offices)                        (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)

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

      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. |_|

      The aggregate market value of the shares of Common Stock of the registrant
held by non-affiliates as of March 3, 2000 was $1,794,828,772 (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 3, 2000, there were 40,283,701 shares of the registrant's
Class A Common Stock and 1,957,507 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 THE COMPANY'S ACTUAL RESULTS OR OUTCOMES TO BE
MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, THE
COMPANY OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE
AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND THE COMPANY'S
CONTROL. IMPORTANT FACTORS THAT THE COMPANY BELIEVES MIGHT CAUSE SUCH
DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE
FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN THE COMPANY'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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                                     PART I

Item 1. Business

      Wave Systems Corp. offers powerful, next-generation solutions for
electronic commerce, making the process easier, versatile, and more secure for
consumers as well as business-to-business applications. We are involved in the
research, development, and market testing of the Wave System, which performs the
buying transactions in a range of consumer electronic devices, including
computers, personal digital assistants, and interactive televisions, for the use
of electronic content and services. Electronic content and services refers to
any data, graphic, software, video or audio sequence that can be digitally
transmitted or stored, as well as access to services such as broadcast or
telecommunications services. Examples include archived newspaper and magazine
articles, on-line books, music selections, clip-art, photographs and video
games. Under our model, electronic content and service providers use the Wave
System to allow consumers to purchase one-time, multiple or permanent use of
their content or service, using a wide range of payment models including rental,
pay-for-use, or outright purchase, much like a phone card or a pay-per-view
cable system. We believe that the Wave System can fundamentally change today's
centralized e-commerce model by creating a de-centralized distribution and
security system under which consumers will be able to make individual purchases
of images, text, music or video, or make use of software, all from the
consumer's computer or other interactive device. This means that content and
services can be consumed with more efficient and flexible pricing, broader
distribution opportunities, greater protection against unauthorized usage and
with better privacy protection of the consumer's sensitive information.

      We believe that the Wave System can fundamentally change today's
centralized e-commerce model by creating a distributed trust and security
system, where transactions are executed and recorded in the consumer's devices,
at the consumer's location. This means that electronic content and services can
be consumed with more efficient and flexible pricing, broader distribution
opportunities, greater protection against unauthorized usage and secure,
low-cost, and accurate data on the usage of the products and services.

      The Wave System consists of an EMBedded Application Security SYstem in
consumer devices that provides a core hardware and software foundation for
consumers to purchase electronic content and access services on a flexible
purchase basis. The EMBASSY platform is a programmable, low cost "system within
a system" that can perform independent transactions such as meter pay-per-use of
electronic content, store sensitive information such as identities, credit
information and account balances, and run secure applications for pay-per-use
access to software. The EMBASSY platform is an open model based on security
hardware originally designed for use with "smart cards" that can be integrated
into personal computers and peripherals, interactive televisions or used as
independent components. The WaveMeter application running in the EMBASSY
platform allows e-commerce transactions to occur without the expense of a
real-time network connection for every transaction.

      The EMBASSY securely stores electronic funds and transaction information
about the usage of electronic content to be transmitted securely to a WaveNet
central transaction processing center periodically. The WaveNet application
manages electronic codes for scrambling and unscrambling electronic content,
processes credit and usage charges, automatically obtains credit authorization,
calculates royalty distributions, and provide user and usage data to electronic
content owners. The Wave System is designed to be compatible with existing
content delivery system, such as CD-ROMs and the Internet. Using these
Wave-enabled distribution systems, electronic content providers can distribute
their products in a secure format and offered them for sale through the EMBASSY
platform, which in turn allows consumers to purchase and access the electronic
content on an as-desired basis.


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      In order to achieve broad market acceptance of the Wave System, we pursue
strategic relationships with major computer manufacturers and technology
suppliers, and promote the use of the EMBASSY platform to electronic content
owners, particularly developers and distributors of entertainment, audio,
broadcast and educational software. We believe that the EMBASSY platform can
manage subscribers and usage of electronic content independent of the type of
content or network on which it is delivered. This means that electronic content
can be delivered on CD-ROM, high-speed wired and wireless broadcasting, and
other forms of transmission.

      We believe that the Wave System provides a powerful merchandising
interface for electronic content and services at the point of purchase. This is
an enticement to consumers to sample electronic content that they are
considering purchasing. The Wave System provides the consumer with enhanced
control of their individual privacy and secure storage of sensitive information.
The Wave System facilitates the payment of royalties to content providers and
service partners while allowing both customized and broad, inexpensive
distribution to customers.

      We recently enhanced the Wave System to make it acceptable as an open
industry standard for a broad range of security and e-commerce functions in end
user-devices. We have been successful in attracting other companies to port
their applications and services to the Wave System and our EMBASSY platform,
which we believe will increase the value of the system to potential deployment
partners. These strategic relationships have generated what we believe to be
significant joint marketing benefits in our efforts to promote the Wave System
to manufacturers of computers and electronic consumer goods and the electronic
content industry.

      During 1998 and 1999, we established relationships with RSA Data Security,
NEC Technologies, Pollex Technology, Hewlett-Packard's VerSecure division, Sun
Microsystems, SMSC, ITE, IGST, Sarnoff, Hauppauge Computer Systems, Compaq
Computer, National Semiconductor, KiSS Nordic, Cyber-COMM, Lego Media and
WavePhore. We also received payments of $1 and $4 million pursuant to a joint
venture agreement with Internet Technology Group, PLC ("ITG"), a United Kingdom
company.

      Additionally, we have also developed the WaveMeter server, a production
software version of the WaveMeter application that offers some of the features
of the hardware version and has been implemented as part of our Internet
commerce server. The WaveMeter server enables content owners to secure and sell
their intellectual property from a web site. The e-commerce services offered
through the WaveMeter server do not require the consumer or publisher to install
any additional hardware or software.

      We were 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.

      We are a development stage company and have realized minimal operating
revenues since our inception. At December 31, 1999 we had an accumulated deficit
of approximately $93.3 million. There can be no assurance that we will ever be
successful in achieving commercial acceptance of the Wave System.

The Wave System

      The Wave System is designed to create new revenue streams for owners of
electronic content by improving upon existing distribution systems for
electronic content. Using existing


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distribution systems such as CD-ROM and the Internet, electronic content owners
distribute their products to customers in the encrypted Wave-enabled form so it
can be offered for sale through the EMBASSY E-Commerce System. Customers are
then able to purchase and access the electronic content on an as-desired basis.
We believe that the Wave System allows electronic content owners to deliver
their products to a larger market because the efficient and secure metering
technology facilitates greater flexibility in content distribution and pricing.
We believe that greater flexibility in electronic distribution and pricing makes
the Wave System particularly attractive to developers, distributors and
consumers of entertainment and educational software. Currently, the two primary
mechanisms of delivery of electronic content to the end user are the Internet
and CD-ROM. The Wave System, however, will work with point-to-multi-point data
broadcasting via satellite, broadcast TV, FM radio, floppy disc, DVD and cable
modem and similar high-speed networking.

      In addition, the programmable EMBASSY platform is capable of supporting
multiple secure applications from a range of service providers, applications
vendors, and security companies. We believe that our expansion of the EMBASSY
platform has provided a source of increased interest in Wave's technology as a
general-purpose solution for adoption by a wide range of companies in their
platforms and as a mechanism for the secure delivery of electronic content.

      The Wave System consists of the EMBASSY E-Commerce System, the WaveMeter
application, a subsystem that records and communicates the usage of electronic
content, and WaveNet, a central transaction processing network. The EMBASSY
platform controls the simultaneous loading and execution of multiple
applications, all on a secure basis. The WaveMeter controls and monitors the
customer's access to encrypted electronic information and software. The Wave
System is well suited to low-cost processing of very-low-priced, rental and
rent-to-own electronic content transactions. We have completed a prototype
incorporating the rental and rent-to-own functionality into the Wave System
using Wave's current chip technology. This is currently being integrated into a
WinTV tuner card from Hauppauge Computer Systems. This product was introduced to
the market in May, 1999. With this version of the WaveMeter, application
transactions are executed within the electronic device itself, against a source
of funds stored in the WaveMeter secure memory. The WaveMeter retains this
pricing and licensing information, downloaded from WaveNet, for use in the
execution of these transactions. Transactions are securely stored in the usage
log of the WaveMeter for eventual uploading and reporting to WaveNet. The
WaveMeters and WaveNet communicate using Wave's secure communications protocol.

      WaveNet consists of the WaveNet Transaction Processing System ("TXP") and
the WaveNet Information Clearing House ("ICH"). TXP acts as the principal
interface with the EMBASSY. Every EMBASSY-equipped device will contact TXP on a
periodic basis. During this secure communication, all stored event information,
such as purchase logs, are uploaded to TXP, additional credit may be requested,
pending events are delivered to the device, and a routine audit check is
performed. There may be a number of TXP systems to distribute access around the
globe. TXP routes all event logs to ICH where they are processed against Wave's
royalty contracts. ICH calculates royalties due to each partner and handles the
billing and reporting services, ensuring that all Wave partners are properly
compensated. WaveNet is presently in operation.

      The Wave System is installed into the customer's computer or integrated
into an attached peripheral device. It is based on a semiconductor device that
uses secure certified integrated circuit technology to unscramble data and to
store credit and usage data. At present, the WaveMeter, based on our own silicon
chip, is packaged on an accessory board to be installed in a personal computer.
In 2000, we plan to deliver a new version of the EMBASSY hardware with a USB
interface, which should easily integrate into a broad range of products,
including separate attachments for portable interactive devices. We also offer a
production


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software version of the WaveMeter application, which is compatible with the use
of the hardware version.

      We believe that the hardware version of the Wave System with EMBASSY is
the most secure form of content licensing management and metering technology
available today. The EMBASSY hardware and software contain a wide range of
security features. Tampering results in the device automatically locking out
users, and is readily detected. The codes used to unscramble data are loaded at
the time we manufacture the EMBASSY device, and are unique and specific to each
device. Every piece of electronic content is protected using a unique code key.
Services are controlled by secure applications running in the EMBASSY platform.
We believe we have designed a security architecture where the value of breaking
into an individual computer system to ascertain the code keys is low, since
there are no common keys that allow the use of such code keys on other systems.

Markets and Business Strategy

      Our long-term strategy is to achieve broad market acceptance of the Wave
System as a distributed trust platform for commerce performed in user devices.
To achieve this goal, we pursue strategic relationships with hardware
manufacturers and companies involved in the development of commerce in
electronic content and services. In addition, we believe that, since the Wave
System permits greater flexibility in pricing and distribution of electronic
content, it is particularly well-suited for merchandising consumer content,
entertainment and educational software. Therefore we are vigorously targeting
this market segment as a means of rapidly achieving the broad installed base of
the Wave System. We believe that once there is a broad installed base of the
Wave System and EMBASSY, electronic content owners from other market segments
are likely to be attracted to the Wave System. However, we cannot assure you
that the Wave System will achieve any significant market acceptance.

      We have focused on forming agreements with strategic partners that will
help us promote the broad-based acceptance of the Wave System as a platform for
commerce in electronic content. We are currently in discussion with original
equipment manufacturers regarding the incorporation of the Wave System and
EMBASSY into their products. We have also focused on pursuing strategic
relationships with companies seeking to distribute electronic content via the
Internet. The compatibility of the Wave System with the Web has provided us with
a product that has already attracted the attention of leaders in the development
of electronic commerce solutions and particularly commerce in electronic
content. We will continue to focus on developing other strategic relationships
to seek to achieve the broad acceptance of the Wave System as a platform for
electronic commerce.

      We have focused on promoting the acceptance of the Wave System by
electronic content owners. The initial target market is entertainment and
educational software developers and distributors. We believe that the Wave
System will provide the home consumer with a new way of acquiring interactive
content and can offer electronic content developers and distributors benefits
similar to those provided by video rental in the film industry. We have invested
heavily in developing relationships with entertainment and educational software
providers. Today, we have over 100 titles functional for demonstration and are
actively preparing others to be launched in 2000.

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 and technical
resources. Also, many current and potential competitors have greater name
recognition and more extensive customer bases that could be leveraged, thereby
gaining market share or product acceptance to our detriment. The Wave


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System competes with conventional information delivery systems, such as on-line
services like AOL, subscription services on CD-ROM, and services on the
Internet. However, we believe that its metering capability is competitive with
other electronic content delivery systems in a number of applications due to its
superior protection against unauthorized usage, accurate and detailed
information on content usage, and transparent operation. Further, we believe
that it will be competitive with existing distribution systems, including
traditional retail outlets for entertainment and educational software, due to
its ability to offer these innovative merchandising mechanisms.

      We are aware of other metering systems that compete directly with the Wave
System, and other current and evolving technologies that provide some of the
functionality of the Wave System. There are other companies that have developed
or are in the process of developing technologies that are, or in the future may
be, the basis for competitive products in the field of electronic content
distribution. Some of those technologies may have an entirely different approach
or means of accomplishing the desired effects of the products being developed by
us. We cannot assure you that either existing or new competitors will not
develop products that are superior to or that otherwise achieve greater market
acceptance than our products.

      The Wave System is subject to competition from producers of hardware-based
controllers such as hardware-based key systems and software unlocking systems.
We will compete with well-established producers of hardware-based unlocking
systems such as Rainbow Technologies, Inc. We also compete with developers of
software unlocking systems such as Portland Software. We also provide basic
security services that compete with companies such as QPass and PrivaSeek in
providing electronic wallets and certain e-commerce capabilities. We believe
that the Wave System is superior to existing hardware-based and software
unlocking systems in several ways. These systems primarily operate as "on/off
switches" to control the use of electronic content and services, but are very
limited in their ability to measure and record usage information. We believe
that the Wave System offers superior protection from unauthorized usage, low
operating costs (because it does not require constant communication with and
authorization from a centralized processor), and fast operation that is
convenient and essentially transparent to the end user. Both hardware
controllers and software unlocking systems offer only part of the functionality
of the Wave System. Our products also provide a superior solution for the
broadcasting and multicasting of data. Distinct from the existing software
unlocking systems, WaveNet provides centralized back-office support to owners of
electronic content.

      Many large information industry players are forming alliances and
attempting to capitalize on the information delivery options offered by the
Internet. In electronic content delivery via the Internet, the Wave System
competes with electronic commerce payment technologies developed and offered by
IBM Micropayment Service, Broadvision, Connect, CyberCash, and Open Market.
However, we believe that many of the electronic commerce payment technologies
may be used as acceptable currency through the Wave System and may be
complementary to, rather than competitive with, the Wave System.

      We believe that the interoperability of the Wave System with currently
available and developing distribution media makes the Wave System attractive to
both distributors and consumers of electronic content. A consumer with an
installed EMBASSY platform will be able to purchase Wave-enabled electronic
content from sources on CD-ROM and/or the Internet, as well as from sources
distributing electronic content via other developing media. In addition, with
the incorporation of the rental and rent-to-own functionality, the Wave System
will offer greater merchandising flexibility than is possible using currently
available electronic commerce solutions. We caution you, however, that the Wave
System may never achieve the broad-based acceptance necessary to make it a
viable competitor with existing and developing electronic commerce solutions.


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International Market

      Our technologies are controlled under various United States export control
laws and regulations and will require export licenses for certain exports
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
DES products. We have also received an export license for our triple-key data
encryption standard products under the provisions of a License Exception KMI,
granted by the Bureau of Export Administration of the U.S. Department of
Commerce. We cannot assure you that that we will have patent protection or that
it will not infringe patents of third 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 Wave System may not be permitted in any particular foreign
jurisdiction.

      Wave Systems formed a strategic alliance in 1998 with HP VerSecure in the
development of the underlying architecture of the EMBASSY platform. HP VerSecure
provides a security management framework for EMBASSY that controls security
functions in the device. The primary function of the VerSecure system is to
provide a management system that enables the EMBASSY hardware to have strong
security features that can be selectively enabled or disabled in order to comply
with the regulations of various countries. This capability is intended to allow
computer manufacturers to build a single, consistent product, which can be
shipped worldwide, regardless of local restrictions.

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 or
circumvented. Furthermore, you should understand that our activities may
infringe patents owned by others.

      In addition, we may be required to obtain licenses to patents or other
proprietary rights of third 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 attempted 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. 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 owner of this patent,
who has the right to exploit, or to license to third parties, this patent,
including in a manner competitive with us. The joint owner of this patent may
compete with us or license this patent to a competitor of ours, and 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 we
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 market segment. Under this


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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 or license such claims. 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
assure you 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 assure you 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 have engaged in
preliminary negotiations with the holder of the Third Party Patents to obtain a
license under the Third Party Patents. The negotiations have so far not produced
any agreement and a license may not be obtainable on acceptable terms, if at
all. The inability to obtain a license, if needed, on commercially reasonable
terms would have a material adverse effect on our business and our future
operations.

      We have been issued three United States patents relating to encryption and
to our proprietary WaveMeter and WaveNet technology. We also have one patent
pending before the United States Patent Office and three corresponding foreign
patent applications pending before the European Patent Office. Our patents are
material to protecting some of our technology. Our patent rights derive from a
license from Mr. Peter J. Sprague, our Chairman and Chief Executive Officer, 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. We cannot assure you,
however, that we will enjoy exclusive rights to these patents under such
agreements.

      On January 26, 1996, we received notice from E-Data Corporation (formerly
Interactive Gift Express, Inc.), claiming that our practice of our technology
infringes U.S. and foreign patents owned by E-Data Corporation, and offering to
license such patents to us. We are currently obtaining information needed to
investigate the merits of this claim. We believe that there is a viable argument
for non-infringement. The patents owned by E-Data Corporation are currently
being litigated by third parties. We are not involved in these proceedings.


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      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 is such a breach occurs. Furthermore, we
cannot assure you that our trade secrets will not otherwise become known or be
independently discovered by competitors.

      We also rely on copyright 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 cannot assure you that copyright laws will adequately protect
our technology.

      We have registered trademark and service mark registrations with the
United States Patent and Trademark Office for the marks WaveMeter and WaveNet,
Great Stuff Network, Second Shift (the Wave juggler logo), WaveCommerce, Wave
Interactive Network, WaveDirect, WINPublish, WINPurchase and CablePC. We have
submitted trademark registrations for EMBASSY, EMBASSY System and EMBASSY
E-Commerce System and intend 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

      The Wave System incorporates semiconductor, encryption/decryption,
software transaction processing and other technologies in which we have made a
substantial investment in research and development. We expect that we will be
required to continue to make substantial investments in the design of the Wave
System, including EMBASSY, the WaveMeter, WaveNet and software interfaces. For
years ended December 31, 1999, 1998, and 1997and since our inception, we
expended approximately $10.7 million, $6.2 million, $4.7 million and $33.4
million respectively, on research and development activities (which amounts
include the value of stock issued). In addition to our ongoing research and
development activities, in July 1997 we licensed technology and in-process
research and development from Aladdin Knowledge Systems for cash and warrants
valued at $3.9 million. The success of the Wave System depends to a large extent
on our ability to adapt the Wave System for use with various methods for the
distribution of electronic content, the ability of the Wave technology to
interface with various platform environments, and the ability of the Wave System
to work in many application environments. Incorporation of Aladdin's Hasp
technology furthered these efforts and illustrates the adaptive capabilities of
the Wave System. We believe that a significant portion of our future research
and development expenditures will be used to adapt the Wave System accordingly.

      We will also continue to expend a significant amount of resources on the
development of new iterations of the EMBASSY and the WaveMeter application. We
believe that by providing various means of linking the EMBASSY to the customer's
computer or network, we will be more likely to achieve broad acceptance of the
Wave System. We are currently developing other forms of the EMBASSY to target
other market needs.

      We are now focusing increased resources on developing our operational
infrastructure. We are placing greater emphasis on developing internal
production and fulfillment systems and marketing infrastructure to distribute
the Wave System. We will also increase the resources available to WaveNet to
adapt to changing market requirements. We plan to expand WaveNet to handle more
end users, to implement more sophisticated pricing methodologies and to add
greater financial system flexibility.

Recent Developments


-9-
<PAGE>


      In April 1999, we joined with Sarnoff Corporation to announce the
formation of a new joint venture, WaveXpress. WaveXpress aims to provide
secure data broadcast architecture, infrastructure and content services to
broadcasters and content providers. WaveXpress is developing technology and
services that will allow content providers to send electronic content to
properly equipped PCs by utilizing unused bandwidth in the Digital Television
(DTV) spectrum. Consumers will be able to purchase this electronic content
directly through a secure network connection, thus enabling a significant new
revenue stream for broadcasters. On October 15, 1999 Wave and Sarnoff signed
a Joint Venture Agreement which formally established WaveXpress. Under this
agreement Sarnoff and affiliates received a 40% equity stake in WaveXpress.
Wave and its affiliates that purchased founders stock in April 1999 own the
remaining 60% of the outstanding capital stock. The affiliates of Wave
include Peter Sprague and Steven Sprague, the Chief Executive Officer and
President of Wave, respectively, certain members of the Board of Directors of
Wave and certain employees of Wave. This affiliate group purchased for a
nominal amount, founders stock representing, in the aggregate, 7% of the
outstanding capital stock of WaveXpress. In addition, Wave is currently
funding WaveXpress through a convertible note. This note can be converted
into equity at a predetermined conversion rate. Through December 31, 1999,
Wave has loaned WaveXpress approximately $3.2 million. Neither Sarnoff nor
any of the other minority shareholders are obligated to provide any funding
to the venture. For the year ended December 31, 1999, WaveXpress has been
consolidated with the Company.

      We also announced, in April 1999, the first fee-free internet commerce
service for digital content distribution. MyPublish will allow individuals and
small businesses to harness the Internet to publish, promote, and sell various
types of electronic content, such as newsletters, subscriptions, images, audio,
video, and software. MyPublish is a complete, simple-to-use community commerce
solution that can be easily integrated into any Web service.


      On July 27, 1999, we completed the acquisition of N*ABLE Technologies,
Inc., a security solutions company that produces 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. We paid the shareholders of N*ABLE the aggregate consideration of
2,280,821shares of Class A Common stock (subject to certain post-closing
adjustments through April 2000) for their shares. 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.


      In September 1999, we entered into an agreement with Cyber-COMM, a banking
consortium led by France's largest banks, to license our EMBASSY technology for
the development of a European network of enhanced smart card readers, to be used
for conducting various types of e-commerce.

      In November 1999, we launched CharityWave, a free online charitable
contribution service that guarantees participating non-profit organizations 100
percent of all monies donated. Through CharityWave, visitors to the Web sites of
participating charities can make instant secure donations electronically, at any
hour. CharityWave is initially providing this service to thirty prominent
charities, including United Way International, National Wildlife Federation,
National Conference for Community and Justice, National Center for Missing and
Exploited Children, and World Monuments Fund.

Employees


-10-
<PAGE>


      As of December 31, 1999, we employed 144 full-time employees, 57 of whom
were involved in sales, marketing and administration and 86 of whom were
involved in research and development. As of December 31, 1999 we had retained
the services of 40 full-time consultants. We believe our employee relations are
satisfactory.



-11-
<PAGE>

Item 2. Properties

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

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
Facility                   Sq. Ft.               Monthly Base Rent       Utility / Common       Lease Expires
                                                                         Costs
----------------------------------------------------------------------------------------------------------------------
<S>                        <C>                   <C>                     <C>                    <C>
Lee, MA                    14,215                $ 10,373                - 0 -                  Jul. 2002
----------------------------------------------------------------------------------------------------------------------
Danvers, MA                 3,510                   4,826                  350                  Sep. 2002
----------------------------------------------------------------------------------------------------------------------
New York, NY                4.500                  12,000                - 0 -                  May  2001
----------------------------------------------------------------------------------------------------------------------
Princeton, NJ              21,673                  21,673                2,308                  Dec. 2002
----------------------------------------------------------------------------------------------------------------------
Cupertino, CA              12,329                  38,741                1,240                  Oct. 2002
----------------------------------------------------------------------------------------------------------------------
New York, NY (1)            9,087                  31,805                2,272                  Apr. 2010
----------------------------------------------------------------------------------------------------------------------
San Jose, CA                2,728                   6,138                - 0 -                  Dec. 2001
----------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) WaveXpress facility leased beginning Feb. 2000

Item 3. Legal Proceedings

      From time to time, we are party to litigation arising in the ordinary
course of business. We believe that no pending legal proceeding will have a
material adverse effect on our business, financial condition or results of
operations.


-12-
<PAGE>

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

      On November 22, 1999, the Company held its Annual Meeting of shareholders.
At the Annual Meeting, the shareholders voted on the following matters:

      1. The election of seven directors to hold office until the next Annual
Meeting and until their successors are duly elected and qualified. The previous
board was re-elected with the following results:

DIRECTOR                            FOR                     WITHHELD
--------                            ---                     --------

Peter J. Sprague                34,868,997                   48,408

John E. Bagalay, Jr.            34,868,997                   48,408

Philippe Bertin                 34,868,897                   48,508

George Gilder                   34,868,997                   48,408

John E. McConnaughy, Jr.        34,868,897                   48,508

Steven Sprague                  34,868,997                   48,408

Nolan Bushnell                  34,868,997                   48,408

Item 5. Price Range Of Common Stock

      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                     Low
                                            ----                     ---
Year Ended December 31, 1997
  First Quarter                             $3.00                    1.56
  Second Quarter                             1.81                    1.25
  Third Quarter                              2.00                    0.94
  Fourth Quarter                             2.00                    0.63

Year Ended December 31, 1998
  First Quarter                             $1.68                   $0.97
  Second Quarter                             4.75                    1.56
  Third Quarter                              4.56                    2.25
  Fourth Quarter                             5.63                    2.44

Year Ending December 31, 1999
  First Quarter                            $27.50                   $3.72
  Second Quarter                           $26.19                 $13.375
  Third Quarter                            $20.00                   $8.00
  Fourth Quarter                           $16.88                   $9.00

      As of March 03, 2000, there were approximately 592 holders of our Class A
common stock. As of such date, there were 30 holders of our Class B common
stock.

      On March 03, 2000, the last sale price reported on the Nasdaq National
Market for the Class A common stock was $44.00.


-13-
<PAGE>

      We have never declared or 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.

Recent Sales of Unregistered Securities

      On December 15, 1999 the Company sold 69,626 shares of its Class A Common
Stock, at a price of $14.36 in exchange for a license of the Hewlett-Packard
Company's VerSecure software technology. These securities were registered on
December 23, 1999.

      On November 5, 1999, ITG exercised the remainder of a warrant for 800,000
shares of Class A common stock. This was in conjunction with Wave who exercised
a warrant in ITG for 1,000,000 shares. During the year ITG had previously
exercised the initial portion of a warrant for 200,000 shares of Class A common
stock.

      On March 30, 1999 the Company issued 181,818 shares of its Class A Common
Stock, at a price of $11.00 per share, in satisfaction of the then outstanding
principal amount of $2,000,000 on a note it had issued to Carriage Partners,
LLC, pursuant to a conversion provision of the note.

      On March 23, 1999 the Company sold 2,090,954 shares of it Class A Common
Stock, at a price of $11.00 per share, for an aggregate purchase price of
$23,000,494. The shares were sold to a group of accredited investors pursuant to
Regulation D promulgated under the Act. Pacific Growth Equities, Inc. acted as
sole placement agent for the private placement.

      On March 31, 1999 Aladdin Knowledge Systems Ltd. exercised a portion of
their warrant for 1,216,136 Class A common stock. During June of 1998, Aladdin
also exercised a portion of the second warrant to purchase 1,000,000 shares of
common stock. Aladdin still has the right to acquire shares approximating 3.45%
of the Company's Class A common stock.

      On January 26, 1999 the Company issued warrants to purchase 275,000 shares
of its Class A Common Stock at an exercise price of $4.00 per share, exercisable
until January 26, 2004, (the "Warrants") to one (1) accredited investor. If,
over any sixty (60) consecutive day period, the average of the averaged daily
high and low prices of the Class A Common Stock, as reported by Bloomberg
Information Services, Inc., exceeds seven dollars ($7.00), the Company may force
the conversion of the Warrants. The Warrants were issued as consideration for a
$2,000,000 promissory note, bearing no interest, due January 26, 2002.

      On March 6, 1998 the Company issued 150,000 shares of newly created Series
G Convertible Preferred Stock, par value $.01 ("Series G Convertible Preferred
Stock") at a price of $20 per share, for an aggregate purchase price of
$3,000,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series G Convertible Preferred Stock
is convertible into Class A Common Stock, par value $.01 ("Class A Common
Stock") at an effective conversion price of the lower of (a) $1.12 and (b) 80%
of the average of the five (5) lowest trading prices of the Class A Common Stock
during (x) a day on which the Class A Common Stock is traded on The Nasdaq
National Market or The Nasdaq SmallCap Market or principal national securities
exchange or market on which the Class A Common Stock has been listed, or (y) if
the Class A Common Stock is not listed on The Nasdaq National Market or The
Nasdaq SmallCap Market or any stock exchange or market, a day on which the Class
A Common Stock is traded in the over-the-counter market, as reported by the OTC
Bulletin Board, or (z) if the Class A Common Stock is not quoted on the OTC


-14-
<PAGE>

Bulletin Board, a day on which the Class A Common Stock is quoted in the
over-the-counter market as reported by the National Quotation Bureau
Incorporated (or any similar organization or agency succeeding its functions of
reporting prices) ("Trading Days"), as reported by Bloomberg Information
Services, Inc. during the ten (10) Trading Days immediately preceding the
Conversion Date, as defined in the Certificate of Designation of the Series G
Convertible Preferred Stock. In addition to the Series G Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 225,000 shares of
Class A Common Stock at an exercise price of $1.38 per share, exercisable until
October 9, 2002. As of February 18, 1999, all of the shares of the Series G
Convertible Preferred Stock have been converted into Class A Common Stock.

      On October 9, 1997 the Company issued 112,500 shares of newly created
Series F Convertible Preferred Stock, par value $.01 ("Series F Convertible
Preferred Stock"), at a price of $20 per share, for an aggregate purchase price
of $2,250,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series F Convertible Preferred Stock
is 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 the Class A Common Stock during (x) a day on which the Class A Common
Stock is traded on The Nasdaq National Market or The Nasdaq SmallCap Market or
principal national securities exchange or market on which the Class A Common
Stock has been listed, or (y) if the Class A Common Stock is not listed on The
Nasdaq National Market or The Nasdaq SmallCap Market or any stock exchange or
market, a day on which the Class A Common Stock is traded in the
over-the-counter market, as reported by the OTC Bulletin Board, or (z) if the
Class A Common Stock is not quoted on the OTC Bulletin Board, a day on which the
Class A Common Stock is quoted in the over-the-counter market as reported by the
National Quotation Bureau Incorporated (or any similar organization or agency
succeeding its functions of reporting prices) ("Trading Days"), as reported by
Bloomberg Information Services, Inc. during the ten (10) Trading Days
immediately preceding the Conversion Date, as defined in the Certificate of
Designation of the Series F Convertible Preferred Stock. In addition to the
Series F Convertible Preferred Stock, the Company also issued warrants to
purchase a total of 168,750 shares of Class A Common Stock at an exercise price
of $1.26 per share, exercisable until October 9, 2002. As of December 31, 1997,
all of the shares of the Series F Preferred stock have been converted into Class
A Common Stock.

      On September 16, 1997, the Company issued 800,000 shares of the Company's
Class A Common Stock, and warrants to purchase 160,000 shares of Class A Common
Stock, which may be exercised at an exercise price equal to $1.00, for an
aggregate purchase price of $800,000 pursuant to Regulation D promulgated under
the Securities Act of 1933, as amended (the "Act"), to six (6) accredited
investors.

      On May 30, 1997 the Company issued 80,000 shares of newly created Series D
Convertible Preferred Stock, at a price of $20 per share, for an aggregate of
$1,600,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series D Convertible Preferred Stock
is convertible into the Class A Common Stock of the Company 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 the Company's Class A Common
Stock for the five (5) trading days immediately preceding the Date of
Conversion, defined in the Certificate of Designation of the Series D
Convertible Preferred Stock. In addition to the Series D Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 120,000 shares of
Class A Common Stock at an exercise price of $1.62 per share, exercisable until
May 30, 2002. As of December 31, 1997, all of the shares of the Series D
Preferred Stock have been converted into Class A Common Stock.


-15-
<PAGE>

Item 6. Selected Financial Data

                          Statement of Operations Data

<TABLE>
<CAPTION>
                                                                                                          Period from
                                                                                                          February 12,
                                                                                                              1988
                                                                                                           (inception)
                                                                                                             through
                                                      Year ended December 31                               December 31
                          ----------------------------------------------------------------------------    ------------
                              1999            1998            1997            1996            1995            1999
                              ----            ----            ----            ----            ----            ----
<S>                       <C>             <C>             <C>             <C>             <C>             <C>
Revenues, Net .........   $    187,515    $     47,681    $     23,659    $      3,220    $               $    262,075
 Cost of Sales ........         93,170          37,488          12,947           1,762                         145,367
                          ------------    ------------    ------------    ------------    ------------    ------------
Gross Margin ..........         94,345          10,193          10,712           1,458                         116,708
                          ------------    ------------    ------------    ------------    ------------    ------------
Operating expenses:
Selling, general and
 administrative .......     16,749,276      11,945,273       9,557,198       6,553,003       4,080,185      57,733,962
Acquisition Costs .....      1,494,000                                                                       1,494,000
Write-off of Goodwill .             --              --         769,886              --              --         769,886
Aladdin Technology
 License Expense ......             --              --       3,889,000              --              --       3,889,000
Research and
 development ..........     10,697,971       6,247,105       4,715,334       3,751,871       3,324,735      33,395,870
                          ------------    ------------    ------------    ------------    ------------    ------------
                            28,941,247      18,192,378      18,931,418      10,304,874       7,404,920      97,282,718
                          ------------    ------------    ------------    ------------    ------------    ------------
Other income (expense):
ITG Technology License
 Fee ..................      1,250,000       2,750,000       1,000,000              --              --       5,000,000
License ITG Warrant
 Cost .................             --      (1,100,000)             --              --              --      (1,100,000)
Net interest and other
 income (expense) .....       (535,658)        (53,842)        (91,929)        176,870         572,054          (1,163)
                          ------------    ------------    ------------    ------------    ------------    ------------
Net loss ..............    (28,052,571)    (16,586,027)    (18,012,635)    (10,126,546)     (6,832,866)    (93,267,173)
Accrued dividends on
 preferred stock ......         13,239         108,863         809,982         199,614          40,600       1,256,632
                          ------------    ------------    ------------    ------------    ------------    ------------
Assured incremental
 yield ................             --         750,000       1,673,000         670,965              --       3,093,965
                          ------------    ------------    ------------    ------------    ------------    ------------
Net loss to common
 stockholders .........   $(28,065,810)   $(17,444,890)   $(20,495,617)   $(10,997,125)   $ (6,873,466)   $(97,617,770)
                          ============    ============    ============    ============    ============    ============
Weighted average
 number of common
 shares outstanding
 during the period ....     38,354,530      31,580,665      23,224,569      17,237,405      16,075,194      14,153,050
Loss per common
 share-basic and
 diluted ..............          $(.73)          $(.55)          $(.88)          $(.64)          $(.43)         $(6.90)
                          ============    ============    ============    ============    ============    ============
</TABLE>


                                      -16-
<PAGE>

                               Balance Sheet Data

<TABLE>
<CAPTION>
                                                           Year ended December 31
                                ----------------------------------------------------------------------------
                                    1999            1998            1997            1996            1995
                                    ----            ----            ----            ----            ----
<S>                             <C>             <C>             <C>             <C>             <C>
Working capital
   (deficiency) .............   $  4,870,444    $   (770,959)   $  4,772,873    $  3,197,519    $  5,458,512

Total assets ................     16,531,883       6,023,991       7,965,827       6,237,219       7,754,042

Current liabilities .........      6,823,643       5,289,634       1,820,402         937,163       1,210,778

Long-term liabilities .......             --              --         522,124         465,500              --

Series A Cumulative
   Redeemable Preferred
   Stock ....................             --         493,201         471,601         432,334         390,534


Series B Cumulative
   Convertible Preferred
   Stock ....................             --              --              --         195,520              --

Series C Cumulative
   Convertible Preferred
   Stock ....................             --              --              --       2,647,742              --

Deficit accumulated during
   the development stage ....    (93,267,173)    (65,214,601)    (50,882,035)    (31,426,669)    (22,742,854)
                                ------------    ------------    ------------    ------------    ------------

Total stockholders'
   equity (deficiency) ......   $  9,708,240    $   (241,156)   $ (5,151,700)   $  1,558,960    $  6,152,730
                                ============    ============    ============    ============    ============
</TABLE>

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

Overview

      Wave is creating a new electronic commerce model for digital information
and services based on client-side security, transactions and trust. 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 a distributed trust system that enables client based transactions,
including the metered usage of electronic content and services (the "Wave
System"). Electronic content and services refers to any data, graphic software,
video or audio sequence that can be digitally transmitted and/or stored. As our
research and development activities matured, we were able to devote increased
resources to the creation of content distribution services, market development
and the application of the Wave System to end-user services. During 1998 and
1999 we established relationships with RSA Data Security, NEC Technologies,
Pollex Technology, Hewlett-Packard's VerSecure division, Sun Microsystems, SMSC,
ITE, IGST, Sarnoff, Hauppauge Computer Systems, Compaq Computer, National
Semiconductor, KiSS Nordic, Cyber-COMM, Lego Media and WavePhore. We received
payments of $1 million and $4 million pursuant to a joint venture agreement with
Internet Technology Group, PLC ("ITG"), a


17
<PAGE>

United Kingdom company, and have recognized $5 million to date as license fees.
We also recorded a net cost of $1.1 million for an exchange of warrants between
ITG and us for 1,000,000 shares of common stock in each of the companies. From
inception through December 31, 1999, we have realized only minimal operating
revenues, and do not anticipate significant revenues in the near future. There
are numerous risks that could adversely affect our efforts to achieve
profitability.

      On July 27, 1999, we completed the acquisition of N*ABLE Technologies,
Inc., a security solutions company that produces 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. We paid the shareholders of N*ABLE the 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.

Results of operations

Years Ended December 31, 1999 and 1998

      For the twelve months ended December 31, 1999 and December 31, 1998, we
had revenues of $187,515 and 47,681 respectively. Revenue growth can be
attributed to the increased sales of hardware security co-processor and
associated software products. Cost of Sales for the twelve months ended December
31, 1999, was $93,170 compared with $37,488. This is a result of higher sales
associated with hardware products.

      Research and development expense for the twelve months ended December 31,
1999 were $10,697,971, as compared to $6,247,105 for the comparable period of
1998. This 71% increase in research and development expenses was primarily
attributable to an increase in headcount and consultant costs associated with
the design and development of our proprietary integrated circuit technology and
software. The Company continues to aggressively staff and fund additional
development initiatives, including WaveXpress, MyPublish and CharityWave.

      Selling, general and administrative expenses for the twelve months ended
December 31, 1999 were $16,749,276 as compared to $11,945,273 for the comparable
period of 1998. The 40% increase in selling, general and administrative expenses
was primarily attributable to an increase in personnel, consultants and
professional fees, trade shows, equipment and other related costs associated
with the development and marketing of new applications and new markets for our
technology. Acquisition costs related to the N*Able acquisition amounted to
$1,494,000.

      Interest income for the twelve months ended December 31, 1999 was
$617,306, as compared to $231,820 for the comparable period of 1998. The
increase in interest income is primarily attributable to an increase in
interest-bearing assets, which were a direct result of the private placement of
Class A common stock for an aggregate purchase price of $23,000,494.

      Interest expense for the twelve months ended December 31, 1999 was
$832,976, as compared to interest expense of $285,662 for the comparable period
of 1998. This increase in interest expense is primarily attributable to a
non-cash expense of approximately $666,000 for


18
<PAGE>

the value of warrants to acquire 275,000 shares of Class A common stock issued
as part of the bridge loan financing, and a non-cash interest charge of
approximately $151,000 on a note to Southeast Interactive Technologies Fund I.
On October 18, 1998, we amended the Southeast Interactive Technologies note so
that it was convertible at any time from April 1, 1999 to April 18, 1999,
reducing the conversion price to $0.95 per share. Additional warrants for 75,000
shares were issued as part of this amendment, and the fair value of these
warrants was $106,000. Additionally, the fair value of the reduced conversion
price was $274,000. We amortized such amounts as additional interest expense
from the date that the note was amended and the warrant issued through the
earliest conversion date of April 1, 1999.


      License fee income for the year ended December 31, 1999 was $1,250,000, as
compared with $2,750,000 for 1998. The license fee for both 1999 and 1998 were
portions of a $5 million fee paid by ITG to the Company as part of a joint
venture agreement under which ITG receives the right to market the Wave
technology in European and Middle Eastern markets. Additional development work
is expected to support increased distribution efforts.

      On June 9, 1999 the company and PC Free Inc., a worldwide customer-based
computer system provider signed an agreement to embed the company's EMBASSY
E-commerce system in PC Free's computer systems. Part of the agreement required
the Company to advance PC Free Inc. $240,000. As consideration for the advance,
the company was to receive from PC Free Inc. warrants to purchase the stock of
PC Free. The company subsequently determined that the initial investment had no
value and it was written off during December, 1999.

      In April 1999, WaveXpress, a joint venture between Wave and Sarnoff
Corporation was established. For technology licensed to WaveXpress by Wave,
Sarnoff and affiliates received a 40% equity stake in WaveXpress. Wave and
its affiliates that purchased founders stock in April 1999 own the remaining
60% of the outstanding capital stock. The affiliates of Wave include Peter
Sprague and Steven Sprague, the Chief Executive Officer and President of
Wave, respectively, certain members of the Board of Directors of Wave and
certain employees of Wave. This affiliate group purchased for a nominal
amount, founders stock representing, in the aggregate, 7% of
the outstanding capital stock of WaveXpress. Wave is also funding WaveXpress
through a convertible note and expects to continue to provide funding until
an external round of funding can be attained This note can be converted into
equity by the Company. Through December 31, 1999 Wave has provided
approximately $3.2 million in funds. WaveXpress's financials are included in
Wave's consolidated financials.

      The financial statements of WaveXpress have been consolidated with those
of the Company for the period ended December 31, 1999. As the joint venture
minority partners, Sarnoff Corporation and the Wave affiliates, have not
contributed any cash and are not required to fund the operations of the joint
venture, the Company 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. For
the period April 1999, date of inception, to December 31, 1999, WaveXpress'
operating results were a net loss of approximately $1.9 million and license fees
paid of approximately $1.8 million. The $1.8 million license fee has been
capitalized and is included in other assets on the consolidated balance sheet at
December 31, 1999.


      Due to the reasons set forth above, our net loss for the twelve months
ended December 31, 1999 was $28,052,572 as compared to $16,586,027 for the
comparable period of 1998. The net loss for the twelve months ended December 31,
1999 to common stockholders was $28,065,811, as compared to $17,444,890 for the
comparable period of 1998.


19
<PAGE>

      Years Ended December 31, 1998 and 1997

      For the years ended December 31, 1998 and December 31, 1997 we had only
minimal operating revenues.

      Selling, general and administrative expenses for the year ended December
31, 1998 were $11,945,273, as compared with $9,557,198 for 1997. The increase in
selling, general and administrative expenses was primarily attributable to
increased headcount, as well as trade-show related expenses.

      In the third quarter of 1997 we wrote off approximately $770,000 of
Goodwill recorded for the Win acquisition because we were uncertain as to
whether the anticipated future operations of the business would be sufficient to
justify the carrying value.

      Research and development expenses for the year ended December 31, 1998
were $6,247,105, as compared with $4,715,334 for 1997. The increase in research
and development expenses is attributable to increased headcount and
consulting-related expenses.

      License fee income for the year ended December 31, 1998 was $2,750,000, as
compared with $1,000,000 for 1997. The $2,750,000 for the year ended December
31, 1998 is before a charge of $1.1 million related to our net cost of a warrant
were obligated to issue to ITG as part of the technology licensing agreement.
The $1.1 million charge is net of the estimated fair value of the ITG warrant
that we received as part of the warrant exchange. The license fee for both 1998
and 1997 were portions of a $5 million fee paid by ITG to us as part of a joint
venture agreement under which ITG receives the right to market the Wave
technology in European and Middle Eastern markets. Additional development work
is expected to support increased distribution efforts.

      Interest expense for the year ended December 31, 1998 was $285,662, as
compared with interest expense of $177,868 for 1997. An increase in interest
expense for the year ended December 31, 1998 was primarily attributable to the
restated and amended note for Southeast Interactive Technologies Fund I.
Interest income was $231,820 for the year ended December 31, 1998 as compared
with interest income for the year ended December 31, 1997 of $85,939. The
increase was attributable to the interest earned on cash and marketable
securities. We held no marketable securities at December 31, 1998

      Due to the reasons set forth above, our net loss was $16,586,027 for the
year ended December 31, 1998, as compared with $18,012,635 for 1997.

Liquidity and capital resources

      We have experienced net losses and negative cash flow from operations
since our inception, and, as of December 31, 1999, had a $93,267,173 deficit
accumulated during the development stage, and stockholders' equity of
$9,708,240.

      At December 31, 1999, we had $6,290,045 in cash and cash equivalents. At
December 31, 1998, we had $4,451,175 in cash and cash equivalents. We held
$4,480,500 in marketable securities at December 31, 1999 due to the ITG Warrant
exercise. No marketable securities were held at December 31, 1998. The increase
in cash and cash equivalents is primarily attributable to cash proceeds from
private placements during the first quarter of 1999. In January 1999, we issued
a $2 million convertible promissory note, which was subsequently


20
<PAGE>

converted into Class A common stock in March 1999. We also completed a $23
million private placement with institutional, strategic and accredited investors
in March 1999. On March 6, 1998, we sold 150,000 shares of newly created Series
G Convertible Preferred Stock to one accredited investor at a price of $20 per
share, for an aggregate purchase price of $3,000,000, which was converted into
2,771,596 shares of Class A common stock. We also issued warrants to purchase a
total of 225,000 shares of Class A Common stock at an exercise price of $1.38
per share, exercisable until October 9, 2002. Until August, 1999, we had issued
and outstanding 360 shares of preferred stock designated as Series A Cumulative
Redeemable Preferred Stock, par value $.01 per share, all of which was held by
one person. This stock was redeemable, in whole or in part, at any time at our
option, at a price of $1,000 per share and was subject to mandatory redemption
five years from the date of issuance. The holder of these shares made demand for
redemption as of April 28, 1999. We redeemed these shares on August 11, 1999.
The total redemption price was $506,440, including accrued but unpaid dividends.

      On November 5, 1999 the Company had exercised its warrant for 1,000,000
shares in ITG. Also during the year ITG exercised its 1,000,000 warrants in the
Company. As of December 31, 1999 the value of Wave's holdings in ITG were valued
at $4,480,500 with an unrealized investment gain of $2,860,500.

      WaveXpress, the joint development venture with Sarnoff Corporation and
other affiliates, has been funded entirely by the Company. Through December 31,
1999 the Company has provided approximately $3.2 million in funds. Wave expects
to continue funding WaveXpress until it can secure a round of external funding,
which is expected to occur during 2000.

      As of December 31, 1999, we had available net operating loss carryforwards
for Federal income tax purposes of approximately $80.1 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.

      At December 31, 1999, we had working capital of $4,870,444. We expect we
may incur substantial additional expenses resulting in significant losses at
least through the period ending December 31, 2000, due to minimal revenues and
increased sales and marketing expenses associated with initial market entry, and
continued research and development costs.

      We anticipate that our existing capital resources as well as the
additional funding raised during the first quarter of 2000, which raised
approximately $122.4 million through the sale of 3.6 million shares of Class A
common stock, will be adequate to satisfy our capital requirements through the
end of 2001

Recent accounting pronouncements

      In November 1999, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 100, "Restructuring and Impairment Charges."
In December 1999, the SEC issued SAB No.101, "Revenue Recognition in Financial
Statements." SAB No. 100 expresses the views of the SEC staff regarding the
accounting for and disclosure of certain expenses not commonly reported in
connection with exit activities and business combinations. This includes the
accrual of exit and employee termination costs and the recognition of


21
<PAGE>

impairment charges. SAB No. 101 expresses the views of the SEC staff in applying
generally accepted accounting principles to certain revenue recognition issues.

      There was no material impact on our financial position or our results of
operations from the adoption of these Staff Accounting Bulletins.

Item 7A. Quantitative and Qualitative Disclosure about Market Risk

      Not applicable.

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.

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

      Not Applicable.


22
<PAGE>

                                    PART III

Item 10. Directors and Executive Officers of the Registrant

Directors of the Registrant

<TABLE>
<CAPTION>
                                               Business Experience and Principal Occupation or
                                             Employment During Past 5 Years; Positions held with    Director
Name                           Age                      Company; Other Directorships                  Since
----                           ---         -------------------------------------------------------  --------
<S>                            <C>         <C>                                                        <C>
Peter J. Sprague(1)(4)         60          Chairman of the Company since 1988 and Chief Executive     1988
                                           Officer of the Company since July 1991; Chairman of
                                           National Semiconductor Corporation from 1965 until May
                                           1995; Director of EnLighten Software, Inc. and Imagek,
                                           Inc.; Trustee of the Strang Clinic; Member of Academy
                                           of Distinguished Entrepreneurs, Babson College.

John E. Bagalay, Jr.,          66          Senior Advisor to Chancellor, Boston University from       1993
Ph.D.(1)(2)(4)                             January 1998; Managing Director of Community Technology
                                           Fund, a venture capital affiliate of Boston University,
                                           from September 1989 until January 1, 1998; Chief
                                           Operating Officer, Chief Financial Officer and Director
                                           of Eurus Technologies, inc. since January 15, 1999;
                                           General Counsel of Lower Colorado River Authority from
                                           October 1984 to September 1988; former General Counsel
                                           of Texas Commerce Bancshares, Inc. and Houston First
                                           Financial Group; Director of Seragen, Inc., Cytogen,
                                           Inc., AES, Inc. and several privately-held
                                           corporations; President and CEO of Cytogen Corporation
                                           from January 1998, CFO since October 1997; Managing
                                           Director of Boston University Venture Capital Fund from
                                           1989-1997.

Philippe Bertin(3)             50          Manager of Financiere Wagram Poncelet (direct              1993
                                           marketing; media) since December 1991; Manager of
                                           Midial S.A. (consumer goods) from 1984 until 1991;
                                           Manager of FINOVELEC since October 1997.

George Gilder(4)               60          Chairman of the Executive Committee of the Company         1993
                                           since 1996; Senior Fellow at the Discovery Institute in
                                           Seattle, Washington; author of nine books, including
                                           Life After Television, Microcosm, The Spirit of
                                           Enterprise and Wealth and Poverty; contributing editor
                                           to Forbes Magazine; Director and President 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.

John E. McConnaughy,           70          Chairman and Chief Executive Officer of JEMC               1988
Jr. (1)(2)(3)(4)                           Corporation (private investments); Chairman and Chief
                                           Executive Officer of Peabody International Corporation
                                           (an environmental services company) from 1969 through
                                           1985; Chairman and Chief Executive Officer of GEO
</TABLE>


23
<PAGE>

<TABLE>
<CAPTION>
                                               Business Experience and Principal Occupation or
                                             Employment During Past 5 Years; Positions held with    Director
Name                           Age                      Company; Other Directorships                  Since
----                           ---         -------------------------------------------------------  --------
<S>                            <C>         <C>                                                        <C>
                                           International Corporation (a nondestructive testing,
                                           screen printing and oil field services company which
                                           was spun off from Peabody) from February 1981 to
                                           October 1992; Director of Riddell Sports Inc., Levcor
                                           International, Inc., Transact International, Inc.,
                                           De-Vlieg Bullard, Inc. and Mego Financial Corp. Mr.
                                           McConnaughy is also a member of the Board of Trustees
                                           of the Strang Clinic and the Chairman of the Board of
                                           the Harlem School of the Arts.

Nolan Bushnell                 56          Chairman and Chief Executive Officer of uWink.com, Inc.     1999
                                           since 1996; Chairman of Octus, Inc. from 1991 to 1995;
                                           consultant to IBM, Commodore International and Bally
                                           Manufacturing.

Steven Sprague                 35          President and Chief Operating Officer of the Company       1997
                                           since May 1996; President of Wave Interactive Network
                                           from June 1995 to December 30, 1996; Vice President of
                                           Operations of the Company from April 1994 to June 1995;
                                           employee of the Company in the areas of operations and
                                           strategic planning from November 1992 to April 1994;
                                           consultant to the Company from March 1992 to November
                                           1992; President of Tech Support, Incorporated (hardware
                                           technical support information on CD-ROM) from June 1992
                                           to November 1992; sole proprietor of SKS Environmental
                                           Sales (manufacturers' representative for water
                                           treatment companies) from June 1991 to November 1992.
</TABLE>

------
(1) Member of Nominating Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.
(4) Member of Executive Committee.

Involvement in Certain Legal Proceedings

Mr. McConnaughy is the Chairman of the Board of the Excellence Group, LLC, which
filed a petition for bankruptcy under Chapter 11 on January 13, 1999. The
Excellence Group's subsidiaries produced labels for a variety of customers.

Executive Officers of the Registrant

      The executive officers of the Company are Mr. Peter J. Sprague, Chairman
and Chief Executive Officer, Mr. Steven Sprague, President and Chief Operating
Officer and Mr. Gerard T. Feeney, Senior Vice President of Finance and
Administration, Chief Financial Officer and Secretary.

      All officers are elected annually at the first meeting of the Board of
Directors following the annual meeting of the stockholders, and are subject to
removal at any time by the Board of Directors.

Section 16(a) Beneficial Ownership Reporting Compliance

      Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's directors and executive officers, and
persons owning more than ten percent of a registered class of the Company's
equity securities, to file with the Securities and Exchange Commission reports
of ownership


24
<PAGE>

and changes in ownership of equity securities of the Company. Such persons are
also required to furnish the Company with copies of all such forms.

      Based solely upon a review of the copies of such forms furnished to the
Company and, in certain cases, written representations that no Form 5 filings
were required, the Company believes that, with respect to the 1999 fiscal year,
all required Section 16(a) filings were made.

Item 11. Executive Compensation

      Summary Compensation Table

      The following table sets forth information with respect to the
compensation paid or awarded by the Company to the Chief Executive Officer and
the other executive officers whose cash compensation exceeded $100,000.
(collectively, the "Named Executive Officers") for services rendered in all
capacities during 1997, 1998 and 1999.

<TABLE>
<CAPTION>
                                                                                                  Long-Term
                                                                                             Compensation Awards
                                                        Annual Compensation                 ---------------------
                                                    ----------------------------              Number of Shares
Name and Principal Position             Year         Salary($)         Bonus($)             Underlying Options(#)
--------------------------------        ----        ----------        ----------            ---------------------
<S>                                     <C>         <C>               <C>                          <C>
Peter J. Sprague(1)                     1999        $  185,000        $  150,000                   100,000
   Chairman and Chief                   1998        $  182,917        $  150,000                   895,505
   Executive Officer                    1997        $  160,000        $  100,000                       -0-

Steven Sprague(2)                       1999        $  180,000        $  150,000                   100,000
   President and                        1998        $  177,500        $  150,000                   954,505
   Chief Operating Officer              1997        $  150,000        $  117,500                       -0-

Gerard T. Feeney(3)
   Senior Vice President, Chief
   Financial Officer and                1999        $  160,000        $  120,000                   100,000
   Secretary                            1998        $   90,359        $   65,000                   450,000
</TABLE>


(1) Mr. Peter Sprague was awarded a bonus of $150,000 for 1999 to be paid in
2000 and will be fully applied to his outstanding loans with Wave. He also
received a bonus for 150,000 in 1998, $75,000 was received in cash and $75,000
was applied to reduce his loans from the Company (see Item 13).


(2) Mr. Steven Sprague was elected President and Chief Operating Officer on May
23, 1996 and was not previously an executive officer during 1996. Prior to that,
Mr. Steven Sprague was Vice President of Operations of the Company from April
1994 to June 1995 and employee of the Company in the areas of operations and
strategic planning from November 1992 to April 1994.

(3) Mr. Gerard T. Feeney was hired as Senior Vice President, Finance and
Administration and Chief Financial Officer on June 8, 1998 and was elected
Secretary on February 25, 1999.

      Option Grants Table

      The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 1999 by the Company to the
Named Executive Officers.

<TABLE>
<CAPTION>
                                                                                     Potential Realizable Value
                            Number of     % of Total                                 at Assumed Annual Rates of
                             Shares        Options                                  Stock Price Appreciation For
                           Underlying     Granted to     Exercise                          Option Term (1)
                             Options       Employees       Price      Expiration    ----------------------------
Name                       Granted (#)    Fiscal Year    ($/Share)       Date          5% ($)         10% ($)
----                       -----------    -----------    ---------    ----------       -------        -------
<S>                          <C>              <C>         <C>          <C>             <C>            <C>
Peter J. Sprague             100,000          5.2%        $ 4.00       1/15/09         251,560        637,500
Steven Sprague               100,000          5.2           4.00       1/15/09         251,560        637,500
Gerard T. Feeney             100,000          5.2           4.00       1/15/09         251,560        637,500
</TABLE>


25
<PAGE>

----------
(1)   The potential realizable value of the options reported above was
      calculated by assuming 5% and 10% compounded annual rates of appreciation
      of the common stock from the date of grant of the options until the
      expiration of the options, based upon the market price on the date of
      grant. These assumed annual rates of appreciation were used in compliance
      with the rules of the Securities and Exchange Commission and are not
      intended to forecast future price appreciation of the common stock.





      Fiscal Year End Option Value Table

      The following table sets forth information regarding the aggregate number
and value of options held by the Named Executive Officers as of December 31,
1999, and the aggregate number and value of options exercised by the Named
Executive Officers during 1999.

<TABLE>
<CAPTION>
                           Shares                                Number of Shares                  Value of Unexercised
                        Acquired on                       Underlying Unexercised Options           In-The-Money Options
                          Exercise      Value Received       at December 31, 1999(#)            at December 31, 1999($)(1)
                        -----------     --------------   --------------------------------      -----------------------------
Name                                                     Exercisable        Unexercisable      Exercisable     Unexercisable
----                                                     -----------        -------------      -----------     -------------
<S>                       <C>               <C>            <C>                 <C>             <C>              <C>
Peter J. Sprague             - 0 -              - 0 -      330,499             697,001         $3,094,208       $6,322,763
Steven Sprague            35,000            560,000        165,166             856,334          1,657,673        7,804,265
Gerard T. Feeney             - 0 -              - 0 -      150,000             400,000          1,265,625        3,325,000
</TABLE>

----------
(1) The last reported bid price for the Company's Class A Common Stock on
December 31, 1999 was $11.9375 per share. Value is calculated on the basis of
the difference between the respective option exercise prices and $11.9375,
multiplied by the number of shares of common stock underlying the respective
options.

      Compensation of Directors

      Directors presently receive no cash compensation for serving on the Board
of Directors. Under the Company's Non-Employee Directors Stock Option Plan, each
director who is not an employee of the Company receives an annual grant of
options to purchase 10,000 shares of Class A Common Stock at fair market value.
The options are granted upon re-election after the annual meeting of the
stockholders and vest the day following the grant. Options terminate upon the
earliest to occur of (i) subject to (ii) below, three months after the optionee
ceases to be a director of the Company, (ii) one year after the death or
disability of the optionee, and (iii) ten years after the date of grant.

Item 12. Security Ownership of Certain Beneficial Owners and Management

      The following table sets forth certain information concerning the
beneficial ownership of the Company's Class A and Class B Common Stock as of
March 5, 1999 (except as otherwise noted) by (i) each stockholder who is known
by the Company to own beneficially more than five percent of the outstanding
Class A or Class B Common Stock, (ii) each director of the Company, (iii) each
of the executive officers of the Company named in the Summary Compensation Table
above, and (iv) all directors and executive officers of the Company 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 the Company. 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 Common Stock will have
five votes per share in cases where one or more directors are nominated for
election by persons other than the Company's Board of Directors and where there
is a vote on any merger, consolidation or other similar transaction which is not
recommended by the Company'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 the
Company. 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.


26
<PAGE>

<TABLE>
<CAPTION>
                                                                                                   Percent
                                                                                                    of All
                                  Number of Shares                 Number of Shares    Percent    Outstanding
                                 of Class A Common    Percent of   of Class B Common     of         Common
Beneficial Owner(1)                Stock Owned(2)        Class        Stock Owned       Class      Stock(3)
-------------------              -----------------    ----------   -----------------   -------    -----------
<S>                                  <C>                  <C>          <C>                <C>          <C>
Peter J. Sprague(4)                    480,500            1.2          1,172,899          57.2         4.0
Steven Sprague(5)                      508,224            1.3            185,659           9.1         1.7
John E. Bagalay, Jr.(6)                 96,000             *                   0           *           *
Philippe Bertin(7)                      76,000             *                   0           *           *
George Gilder(8)                       172,000             *                   0           *           *
John E. McConnaughy, Jr.(9)             23,115             *             275,000          13.4         *
Nolan Bushnell (10)                     22,000                                 0
Gerard T. Feeney (11)                  183,333             *                   0           *           *
All executive officers and
directors as a group
(8 persons)(12)                      1,561,172            4.0          1,633,558          80.0         7.7

Aladdin Knowledge Sys. (13)          1,620,254            4.1                  0           *           3.9
</TABLE>

----------
*Less than one percent.

(1)   Each individual or entity has sole voting and investment power, except as
      otherwise indicated.
(2)   Does not include shares of Class A Common Stock issuable upon the
      conversion of Class B Common Stock.
(3)   In circumstances where the Class B Common Stock has five votes per share,
      the percentages of total voting power would be as follows: Peter J.
      Sprague, 12.8%; Steven Sprague, 2.9%; John E. Bagalay, Jr., less than 1%;
      Philippe Bertin, less than 1%; George Gilder, less than 1%; John E.
      McConnaughy, Jr., 2.8%; Aladdin Knowledge Systems, 3.3%; and all Executive
      Officers and Directors as a group, 21.3%.
(4)   Includes 480,500 shares which are subject to options presently exercisable
      or exercisable within 60 days. Also includes 320,000 shares held in trust
      for the benefit of Mr. Sprague's adult children, and for which Mr. Sprague
      is a trustee.
(5)   Includes 501,224 shares which are subject to options presently exercisable
      or exercisable within 60 days. Also includes 37,102 shares held in trust
      for the benefit of Mr. Sprague's family, and for which Mr. Sprague is a
      trustee.
(6)   Includes 92,000 shares which are subject to options presently exercisable.
(7)   Includes 72,000 shares which are subject to options presently exercisable.
(8)   Includes 172,000 shares which are subject to options presently
      exercisable.
(9)   Includes 10,000 shares which are subject to options presently exercisable.
(10)  Includes 22,000 shares which are subject to options presently exercisable.
(11)  Includes 183,333 shares which are subject to options presently exercisable
      or exercisable within 60 days.
(12)  Includes 1,533,057 shares which are subject to options presently
      exercisable or exercisable within 60 days.
(13)  Includes 1,285,454 shares which are subject to warrants presently
      exercisable or exercisable within 60 days.

Item 13. Certain Relationships and Related Transactions

Note Receivable from Director/Officer

      On November 16, 1992, the Company made a personal loan to Mr. Peter J.
Sprague, Chairman and Chief Executive Officer of the Company, as evidenced by a
note for $150,000, which sum was due and payable to the Company on January 16,
1993 and which bore interest at the rate of ten percent (10%) per annum. On the
due date, the note was canceled and the total amount owed was "rolled-over" into
a subsequent note, dated May 12, 1993 for $150,000, plus accrued interest. The
note is due on demand by the Company and accrues interest at the rate of 10% per
annum. On April 22, 1993, the Company made an additional loan to Mr. Peter
Sprague for $23,175 as evidenced by a subsequent note, which is due on demand by
the Company and which bears interest at a rate of 10% per annum. All of these
loans were made to Mr. Sprague for personal reasons. As part of Mr. Sprague's
$150,000 bonus for 1998, $75,000 was applied against his indebtedness to the
Company. As of December 31, 1999, Mr. Sprague's aggregate indebtedness
(including accrued interest) to the Company under the notes totaled $154,160.
During March 2000 the entire note was paid. No demand has


27
<PAGE>

been made as of the date hereof. The notes are secured by a pledge of 67,000
shares of Class B Common Stock.

Compensation to Steven Sprague

      Steven Sprague received aggregate compensation of $330,000, $327,500 and
$267,500 for services rendered to the Company in 1999, 1998 and 1997,
respectively. Steven Sprague is the son of Mr. Peter J. Sprague, the Chairman
and Chief Executive Officer of the Company.

Compensation to Michael Sprague

      Michael Sprague received aggregate compensation of $111,666, $110,000 and
$112,500 for services rendered to the Company in 1999, 1998 and 1997,
respectively. Michael Sprague is the son of Mr. Peter J. Sprague, the Chairman
and Chief Executive Officer of the Company. During 1999 Michael Sprague became
the Vice President of Services Development at the Company's subsidiary
WaveXpress.

WaveXpress


      In April 1999, we joined with Sarnoff Corporation to announce the
formation of a new joint venture, WaveXpress. On October 15, 1999 Wave and
Sarnoff signed a Joint Venture Agreement which formally established
WaveXpress. Under this agreement Sarnoff and affiliates received a 40% equity
stake in WaveXpress. Wave and its affiliates that purchased founders stock in
April 1999 own the remaining 60% of the outstanding capital stock. The
affiliates of Wave include Peter Sprague and Steven Sprague, the Chief
Executive Officer and President of Wave, respectively, certain members of the
Board of Directors of Wave and certain employees of Wave. This affiliate
group purchased for a nominal amount, founders stock representing, in the
aggregate, 7% of the outstanding capital stock of WaveXpress. Wave is
currently funding WaveXpress through a convertible note. Through December 31,
1999, Wave has loaned WaveXpress approximately $3.2 million. Neither Sarnoff
nor any of the other minority shareholders are obligated to provide and
funding to the venture.

Amended and Restated License Agreement and Assignment

      Pursuant to an Amended and Restated License Agreement, dated February 14,
1994, and related Patent Assignment and Security Agreement, Mr. Peter J. Sprague
assigned his interest in a patent for the metering and usage of serial data
information to the Company in exchange for a non-terminable royalty interest.
The Company has agreed to payment of royalties to Mr. Sprague of 2% of the gross
revenues (less actual amounts paid to information, database and content
providers, hardware manufacturers and suppliers, search and retrieval software
suppliers, consolidators of information and network providers) derived from the
Company's technology based on the patent. The royalty payments are allocated 75%
to Mr. Sprague and 25% to a former officer of the Company, and are secured by a
security interest in and to the patent.

License and Cross-License Agreement

      On May 1, 1992, the Company entered into a Joint Technology Development
Agreement and License and Cross-License Agreement with The Titan Corporation
whereby Titan granted to the Company license rights to the use of certain
patents which are co-owned by Titan. Dr. Gene W. Ray, a former director of the
Company, is a director, President and Chief Executive Officer of Titan. The
Company 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 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.
On February 28, 1997 the Company and Titan executed an addendum to the License
and Cross-License Agreement whereby the Company received a sole license to the
licensed patent to develop and distribute products to the in-home consumer
microcomputer market segment.


28
<PAGE>

Under this addendum to the License and Cross-License Agreement, Titan waived any
and all defaults by the Company under the License and Cross-License Agreement
occurring prior to February 28, 1997.


29
<PAGE>

                                     PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) (1) Financial Statements:

                                                                         Page(s)
                                                                         -------

Index to Consolidated Financial Statements                                   F-1
Independent Auditors' Report                                                 F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998                 F-3
Consolidated Statements of Operations for each of the years
   ended December 31, 1999, 1998 and 1997 and for the period
   from February 12, 1988 (inception) through December 31, 1999              F-4
Consolidated Statements of Stockholders' Equity (Deficiency) and Other
   Comprehensive Income for each of the years ended December 31, 1999,
   1998 and 1997 and for the period from February 12, 1988 (inception)
   through December 31, 1999                                                 F-5
Consolidated Statements of Cash Flows for each of the years ended
   December 31, 1999, 1998 and 1997 and for the period from
   February 12, 1988 (inception) through December 31, 1999                  F-10
Notes to Consolidated Financial Statements                                  F-12

(a) (2) Financial Statement Schedules:

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

(a) (3) Exhibits:

Exhibit No.                                  Description of Exhibit
--------------------------------------------------------------------------------

         3.1        --        Restated Certificate of Incorporation of
                              Registrant (incorporated by reference to Exhibit
                              3.1 of the Registrant's Registration Statement on
                              Form S-1, File No. 33-75286)
         3.2        --        Bylaws of Registrant (incorporated by reference to
                              Exhibit 3.2 of the Registrant'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 the
                              Registrant'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 the
                              Registrant's Registration Statement on Form S-1,
                              File No. 33-75286)
         4.3        --        Certificate of Designation of Series B Preferred
                              Stock of Wave Systems Corp. as filed with the
                              Delaware Secretary of State on May 24, 1996
                              (incorporated by reference to Exhibit 3.1 of the
                              Registrant'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 Wave Systems Corp. as filed
                              with the Delaware Secretary of State on December
                              27, 1996 (incorporated by reference to Exhibit 3.1
                              of the Registrant'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 Wave Systems Corp. as filed
                              with the Delaware Secretary of State on December
                              27, 1996 (incorporated by reference to Exhibit 3.1
                              of the Registrant's Current Report on Form 8-K
                              filed on June 3, 1997, File No. 0-24752)
         4.6        --        Certificate of Designation of Series F Convertible
                              Preferred Stock of Wave Systems Corp. as filed
                              with the Delaware Secretary of State on October 9,
                              1997 (incorporated by reference to Exhibit 3.1 of
                              the Registrant's Current Report on Form 8-K filed
                              on October 15, 1997, File No. 0-24752)


30
<PAGE>

          4.7       --        Certificate of Designation of Series G Convertible
                              Preferred Stock of Wave Systems Corp. as filed
                              with the Delaware Secretary of State on March 5,
                              1998 (incorporated by reference to Exhibit 3.1 of
                              the Registrant'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 the Registrant'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 the Registrant'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 Systems Corp. (incorporated
                              by reference to Exhibit 10.4 of the Registrant'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 Systems
                              Corp., Peter J. Sprague and John R. Michener
                              (incorporated by reference to Exhibit 10.5 of the
                              Registrant's Registration Statement on Form S-1,
                              File No. 33-75286)
       ++10.5       --        Wave Systems Corp. 1994 Stock Option Plan
                              (incorporated by reference to Exhibit 10.6 of the
                              Registrant's Registration Statement on Form S-1,
                              File No. 33-75286)
       ++10.6       --        Wave Systems Corp. Non-Employee Directors Stock
                              Option Plan (incorporated by reference to Exhibit
                              10.7 of the Registrant's Registration Statement on
                              Form S-1, File No. 33-75286)
         10.7       --        Regulation S Securities Subscription Agreement,
                              dated as of May 29, 1996 (incorporated by
                              reference to Exhibit 4.1 of the Registrant's
                              Current Report on Form 8-K filed on May 30, 1996,
                              File No. 0-24752)
         10.8       --        Purchase Agreement between Wave Systems Corp. and
                              JNC Opportunity Fund Ltd., dated as of December
                              27, 1996 (incorporated by reference to Exhibit 4.1
                              of the Registrant's Current Report on Form 8-K
                              filed on January 8, 1997, File No. 0-24752)
         10.9       --        Registration Rights Agreement between Wave Systems
                              Corp. and JNC Opportunity Fund Ltd., dated as of
                              December 27, 1996 (incorporated by reference to
                              Exhibit 4.2 of the Registrant's Current Report on
                              Form 8-K filed on January 8, 1997, File No.
                              0-24752)
         10.10      --        Purchase Agreement between Wave Systems Corp. and
                              JNC Opportunity Fund Ltd., dated as of May 30,
                              1997 (incorporated by reference to Exhibit 4.1 of
                              the Registrant's Current Report on Form 8-K filed
                              on June 3, 1997, File No. 0-24752)
         10.11      --        Registration Rights Agreement between Wave Systems
                              Corp. and JNC Opportunity Fund Ltd., dated as of
                              May 30, 1997 (incorporated by reference to Exhibit
                              4.2 of the Registrant's Current Report on Form 8-K
                              filed on June 30, 1997, File No. 0-24752)
         10.12      --        Purchase Agreement between Wave Systems Corp. and
                              Combination, Inc., dated as of October 9, 1997
                              (incorporated by reference to Exhibit 4.1 of the
                              Registrant's Current Report on Form 8-K filed on
                              October 15, 1997, File No. 0-24752)
         10.13      --        Registration Rights Agreement between Wave Systems
                              Corp. and Combination Inc., dated as of October 9,
                              1997 (incorporated by reference to Exhibit 4.2 of
                              the Registrant's Current Report on Form 8-K filed
                              on October 15, 1997, File No. 0-24752)
         10.14      --        Purchase Agreement between Wave Systems Corp. and
                              Combination Inc., dated as of March 6, 1998
                              (incorporated by reference to Exhibit 4.1 of the
                              Registrant's Current Report on Form 8-K filed on
                              March 19, 1998, File No. 0-24752)


31
<PAGE>

         10.15      --        Registration Rights Agreement between Wave Systems
                              Corp. and Combination Inc., dated as of March 6,
                              1998 (incorporated by reference to Exhibit 4.2 of
                              the Registrant's Current Report on Form 8-K filed
                              on March 19, 1998, File No. 0-24752)
         10.16      --        Addendum to License and Cross-License Agreement,
                              dated February 28, 1997, between The Titan
                              Corporation and Wave Systems Corp. (incorporated
                              by reference to Exhibit 10.10 of the Registrant's
                              Current Report on Form 10-K filed on March 24,
                              1997, file No. 0-24752).
         10.17      --        Convertible Promissory Note, dated January 26,
                              1999, between Carriage Partners, LLC and Wave
                              Systems Corp.
       ++10.18      --        Employment Contract, dated June 8, 1998, between
                              Gerard T. Feeney and Wave Systems Corp.
       ++10.19      --        Employment Contract, dated November 10, 1998,
                              between Steven Sprague and Wave Systems Corp.
         23.1       --        Consent of Independent Auditors - KPMG LLP

----------
+Confidential treatment has been granted as to portions of this exhibit.
++Management contract or compensatory plan.

      (b) The Company filed a Form 8-K on March 19, 1998 in connection with the
sale of its Series G Convertible Preferred Stock to Combination Inc.


32
<PAGE>

                                   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 21, 2000
                                       WAVE SYSTEMS CORP.

                                       By:     /s/ Peter J. Sprague
                                          -------------------------
                                       Name:   Peter J. Sprague
                                       Title:  Chairman, Chief Executive Officer

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

<TABLE>
<CAPTION>
         Signature                               Title                                 Date
         ---------                               -----                                 ----
<S>                                  <C>                                            <C>
  /s/ Peter J. Sprague
-------------------------------
Peter J. Sprague                     Chairman and Chief Executive Officer           March 21, 2000

  /s/ Steven Sprague
-------------------------------
Steven Sprague                       President, Chief Operating Officer and         March 21, 2000
                                                Director

   /s/ John E. Bagalay, Jr.
-------------------------------
John E. Bagalay, Jr.                            Director                            March 21, 2000

   /s/ Philippe Bertin
-------------------------------
Philippe Bertin                                 Director                            March 21, 2000

   /s/ Nolan Bushnell
-------------------------------
Nolan Bushnell                                  Director                            March 21, 2000

   /s/ George Gilder
-------------------------------
George Gilder                                   Director                            March 21, 2000

   /s/ John E. McConnaughy, Jr.
-------------------------------
John E. McConnaughy, Jr.                        Director                            March 21, 2000

   /s/ Gerard T. Feeney
-------------------------------
Gerard T. Feeney                     Senior Vice President, Finance                 March 21, 2000
                                       and Administration, Chief Financial
                                       Officer and Secretary (Principal
                                       Financial Officer and Duly Authorized
                                       Officer of the Registrant
</TABLE>


33
<PAGE>
                                       F-1


                   Index to Consolidated Financial Statements

                                                                         Page(s)
                                                                         -------

Independent Auditors' Report                                                 F-2

Consolidated Balance Sheets as of December 31, 1999 and 1998                 F-3

Consolidated Statements of Operations for each of the years ended
  December 31, 1999, 1998 and 1997 and for the period from February 12,
  1988 (inception) through December 31, 1999                                 F-4

Consolidated Statements of Stockholders' Equity (Deficiency) and Other
  Comprehensive Income for each of the years ended December 31, 1999,
  1998 and 1997 and for the period from February 12, 1988 (inception)
  through December 31, 1999                                                  F-5

Consolidated Statements of Cash Flows for each of the years ended
  December 31, 1999, 1998 and 1997 and for the period from February 12,
  1988 (inception) through December 31, 1999                                F-10

Notes to Consolidated Financial Statements                                  F-12

<PAGE>
                                       F-2


                          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 generally accepted auditing
standards. 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, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1999 and for the period from February 12, 1988 (date of
inception) to December 31, 1999 in conformity with generally accepted accounting
principles.


                                                          KPMG LLP


Boston, Massachusetts
March 10, 2000

<PAGE>
                                      F-3


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

                           Consolidated Balance Sheets
                           December 31, 1999 and 1998

<TABLE>
<CAPTION>
         Assets
                                                                                 1999            1998
                                                                                 ----            ----
<S>                                                                          <C>             <C>
Current assets:
   Cash and cash equivalents                                                 $  6,290,045    $  4,451,175
   Marketable Securities                                                        4,480,500              --
   Inventories                                                                    431,686              --
   Prepaid expenses and other receivables                                         491,857          67,500
                                                                             ------------    ------------

         Total current assets                                                  11,694,087       4,518,675

Property and equipment, net                                                     2,680,874       1,342,229
Other assets                                                                    2,156,923         163,087
                                                                             ------------    ------------

                                                                               16,531,883       6,023,991
                                                                             ============    ============

         Liabilities and Stockholders' equity

Current liabilities:
   Accounts payable and accrued expenses                                        6,823,643       3,477,803
   Deferred license fee                                                                --       1,250,000
   Note payable                                                                        --         561,831
                                                                             ------------    ------------

         Total current liabilities                                              6,823,643       5,289,634
                                                                             ------------    ------------

   Series A Cumulative Redeemable Preferred Stock, $.01 par value
   360 shares outstanding in 1998                                                      --         493,201
                                                                             ------------    ------------

Stockholders' Equity :
   Series G Convertible Preferred stock, $.01 par value. 150,000 shares
     authorized and 20,000 outstanding in 1998                                         --         347,812

   Common stock, $.01 par value.  Authorized 75,000,000 shares as Class A;
     issued and outstanding 39,475,683 in 1999 and 30,682,970 in 1998             394,757         306,830
   Common stock, $.01 par value.  Authorized 13,000,000 shares as Class B;
     issued and outstanding 2,050,507 in 1999 and 3,140,665 in 1998                20,505          31,407
   Capital in excess of par value                                              99,853,811      64,919,050
   Deficit accumulated during the development stage                           (93,267,173)    (65,214,601)

   Other Comprehensive Income - unrealized gain on marketable securities        2,860,500              --

   Less: Note receivable from stockholder, including accrued interest
     of $105,985 in 1999 and $101,167 in 1998                                    (154,160)       (149,342)
                                                                             ------------    ------------

         Total stockholders' equity                                             9,708,240         241,156
                                                                             ------------    ------------

Commitments and contingencies

                                                                             $ 16,531,883    $  6,023,991
                                                                             ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements.
<PAGE>
                                      F-4


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

                      Consolidated Statements of Operations

                  Years ended December 31, 1999, 1998, 1997 and
                period from February 12, 1988 (date of inception)
                            through December 31, 1999

<TABLE>
<CAPTION>
                                                                                                  Period from
                                                                                               February 12, 1988
                                                                                              (date of inception)
                                                                                                   through
                                                                                                 December 31,
                                                     1999            1998            1997            1999
                                                     ----            ----            ----            ----
<S>                                              <C>             <C>             <C>             <C>
Revenues, Net                                         187,515          47,681          23,659         262,075
  Cost of Sales                                        93,170          37,488          12,947         145,367
                                                 ------------    ------------    ------------    ------------
Gross Margin                                           94,345          10,193          10,712         116,708
                                                 ------------    ------------    ------------    ------------

Operating expenses:
   Selling, general and administrative             16,749,276      11,945,273       9,557,198      57,733,962
   Research and development                        10,697,971       6,247,105       4,715,334      33,395,870
   Acquisition Costs                                1,494,000              --              --       1,494,000
   Write-off of goodwill                                   --              --         769,886         769,886
   Aladdin license and in process
     research and development expense                      --              --       3,889,000       3,889,000
                                                 ------------    ------------    ------------    ------------

                                                   28,941,247      18,192,378      18,931,418      97,282,718
                                                 ------------    ------------    ------------    ------------
Other income (expense):
   License fee                                      1,250,000       2,750,000       1,000,000       5,000,000
   License warrant cost                                    --      (1,100,000)             --      (1,100,000)
   Interest income                                    617,306         231,820          85,939       1,921,578
   Interest expense                                  (832,976)       (285,662)       (177,868)     (1,695,461)
   Other (expense)                                   (240,000)             --              --        (227,280)
                                                 ------------    ------------    ------------    ------------
                                                      794,330       1,596,158         908,071       3,898,837
                                                 ------------    ------------    ------------    ------------
          Net loss                                (28,052,572)    (16,586,027)    (18,012,635)    (93,267,173)

Accrued dividends on preferred stock
   (including accretion of assured incremental
   yield on preferred stock of $750,000 in
   1998 and $1,673,000 in 1997)                        13,239         858,863       2,482,982       4,350,597
                                                 ------------    ------------    ------------    ------------

          Net loss to common stockholders        $(28,065,811)   $(17,444,890)   $(20,495,617)   $(97,617,770)
                                                 ============    ============    ============    ============
Loss per common share - basic and diluted        $       (.73)   $       (.55)   $       (.88)   $      (6.90)
                                                 ============    ============    ============    ============
Weighted average number of common
   shares outstanding during the period            38,365,873      31,580,665      23,224,569      14,153,050
</TABLE>

          See accompanying notes to consolidated financial statements.
<PAGE>
                                      F-5


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

   Consolidated Statements of Stockholders' Equity (Deficiency) And
   Comprehensive Income

<TABLE>
<CAPTION>
                                                                                                                       Deficit
                                                                                                                     accumulated
                                                            Class A                 Class B             Capital      during the
                                                         common stock            common stock        in excess of    development
                                                        Shares   Amount      Shares        Amount      par value        stage
                                                        ------   ------      ------        ------      ---------        -----
<S>                                                         <C>  <C>        <C>         <C>           <C>            <C>
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                 --       --            --            --            --       (326,832)
                                                        ------   ------   -----------   -----------   -----------    -----------

Balance at December 31, 1988                                --       --     4,980,000        49,800       304,226       (326,832)

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                   --       --            --            --            --       (982,186)
                                                        ------   ------   -----------   -----------   -----------    -----------

Balance at December 31, 1989                                --       --     5,251,920        52,519       946,657     (1,309,018)

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                   --       --            --            --            --     (1,178,129)
                                                        ------   ------   -----------   -----------   -----------    -----------

Balance at December 31, 1990                                --       --     5,647,920        56,479     1,713,947     (2,487,147)

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                   --       --            --            --            --     (1,009,368)
                                                        ------   ------   -----------   -----------   -----------    -----------

Balance at December 31, 1991 (carried forward)              --       --     5,982,720        59,827     2,268,599     (3,496,515)

<CAPTION>

                                                                             Note
                                                                          receivable
                                                             Deferred        from
                                                           compensation   stockholder        Total
                                                           ------------   -----------        -----
<S>                                                           <C>           <C>           <C>
Shares issued to founders at $.003 per share                  $   --        $   --        $    15,600
Shares issued at $1.25 per share, net of expenses of
   $36,574 from September through November 1988                   --            --            338,426
Net loss for period ended December 31, 1988                       --            --           (326,832)
                                                              ------        ------        -----------

Balance at December 31, 1988                                      --            --             27,194

Shares issued at $1.25 per share, net of expenses of
   $68,750, from January through December 1989                    --            --            268,750
Shares issued at $1.25 per share in July 1989 as
   compensation for services rendered                             --            --              2,400
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                         --            --           (982,186)
                                                              ------        ------        -----------

Balance at December 31, 1989                                      --            --           (309,842)

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                             --            --             10,000
Shares issued at $1.67 per share, net of expenses of
   $5,000 in March, April, November and December 1990             --            --            645,000
Net loss for year ended December 31, 1990                         --            --         (1,178,129)
                                                              ------        ------        -----------

Balance at December 31, 1990                                      --            --           (716,721)

Shares issued at $1.67 per share from March
   through November 1991                                          --            --            525,000
Shares issued at $1.67 per share in November
   1991 as compensation for services rendered                     --            --             33,000
Net loss for year ended December 31, 1991                         --            --         (1,009,368)
                                                              ------        ------        -----------

Balance at December 31, 1991 (carried forward)                    --            --         (1,168,089)
</TABLE>

<PAGE>
                                      F-6


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

   Consolidated Statements of Stockholders' Equity (Deficiency) And
   Comprehensive Income - (Continued)

<TABLE>
<CAPTION>
                                                                                                                          Deficit
                                                                                                                        accumulated
                                                                Class A                Class B              Capital     during the
                                                              common stock           common stock        in excess of   development
                                                             Shares   Amount     Shares        Amount      par value       stage
                                                             ------   ------     ------        ------      ---------       -----
<S>                                                              <C>      <C>   <C>              <C>        <C>          <C>
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            --
Amortization of deferred compensation                            --       --           --            --            --            --
Accrued dividends on preferred stock                             --       --           --            --        (6,383)           --
Note received from stockholder and accrual of
   interest thereon                                              --       --           --            --            --            --
Net loss for year ended December 31, 1992                        --       --           --            --            --    (4,182,638)
                                                             ------   ------   ----------    ----------    ----------    ----------

Balance at December 31, 1992 (carried forward)                   --       --    8,402,697        84,027     8,173,879    (7,679,153)

<CAPTION>
                                                                               Note
                                                                            receivable
                                                                Deferred       from
                                                              compensation  stockholder       Total
                                                              ------------  -----------       -----
<S>                                                              <C>           <C>         <C>
Balance at December 31, 1991 (brought forward)                         --            --    (1,168,089)

Shares issued at $1.67 per share from January through
  October 1992                                                         --            --     1,180,000
Shares issued at $1.67 per share in May 1992 in connection
   with License and Cross-License Agreement                            --            --     1,124,960
Shares issued at $1.67 per share in May 1992 as
   compensation for services rendered                                  --            --        30,000
Shares issued at $2.50 per share in May and November
   1992 as compensation for services rendered                          --            --     1,927,500
Shares issued at $2.50 per share, net of expenses
   of $7,500, in November and December 1992                            --            --       800,003
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                           --            --            --
Issuance of stock options at $.003 exercise price
   per share in June 1992                                        (398,660)           --       399,740
Amortization of deferred compensation                             155,455            --       155,455
Accrued dividends on preferred stock                                   --            --        (6,383)
Note received from stockholder and accrual of
   interest thereon                                                    --      (152,974)     (152,974)
Net loss for year ended December 31, 1992                              --            --    (4,182,638)
                                                               ----------    ----------    ----------

Balance at December 31, 1992 (carried forward)                   (243,205)     (152,974)      182,574
</TABLE>

<PAGE>
                                      F-7


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

   Consolidated Statements of Stockholders' Equity (Deficiency) And
   Comprehensive Income - (Continued)

<TABLE>
<CAPTION>
                                                                        Class A                    Class B              Capital
                                                                     common stock                common stock        in excess of
                                                                 Shares        Amount        Shares        Amount      par value
                                                                 ------        ------        ------        ------      ---------
<S>                                                             <C>              <C>        <C>              <C>       <C>
Balance at December 31, 1992 (brought forward)                         --            --     8,402,697        84,027     8,173,879

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                                  --            --            --            --            --
Accrued dividends on preferred stock                                   --            --            --            --       (38,467)
Note received from stockholder and accrual of
   interest thereon                                                    --            --            --            --            --
Net loss for year ended December 31, 1993                              --            --            --            --            --
                                                              -----------   -----------   -----------   -----------   -----------

Balance at December 31, 1993                                           --            --     9,056,375        90,564    10,352,283

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                              --            --            --            --            --
                                                              -----------   -----------   -----------   -----------   -----------

Balance at December 31, 1994 (carried forward)                  3,728,200        37,282     9,757,297        97,573    28,534,990

<CAPTION>
                                                                 Deficit
                                                               accumulated                      Note
                                                               during the                    receivable
                                                               development      Deferred        from
                                                                  stage       compensation   stockholder      Total
                                                                  -----       ------------   -----------      -----
<S>                                                            <C>               <C>            <C>          <C>
Balance at December 31, 1992 (brought forward)                  (7,679,153)      (243,205)      (152,974)       182,574

Shares issued at $1.67 per share in February 1993                       --             --             --         50,100
Shares issued at $3.50 per share, net of expenses of
   $82,427, from April through December 1993                            --             --             --      1,843,798
Shares issued at $3.50 per share from May to December
   1993 as compensation for services rendered, for the
   acquisition of property and equipment and as additional
   interest on borrowings                                               --             --             --        256,617
Issuance of warrants to purchase Class B common stock
   from September to December 1993 in conjunction with
   the issuance of convertible debt                                     --             --             --         72,893
Amortization of deferred compensation                                   --        243,205             --        243,205
Accrued dividends on preferred stock                                    --             --             --        (38,467)
Note received from stockholder and accrual of
   interest thereon                                                     --             --        (39,783)       (39,783)
Net loss for year ended December 31, 1993                       (3,959,334)            --             --     (3,959,334)
                                                               -----------    -----------    -----------    -----------

Balance at December 31, 1993                                   (11,638,487)            --       (192,757)    (1,388,397)

Shares issued at $3.50 per share in January and
   February 1994                                                        --             --             --        335,003
Shares issued at $3.50 per share in February 1994
   as additional interest on borrowings                                 --             --             --         19,950
Issuance of warrants to purchase Class B common stock
   in January and February 1994 in conjunction with
   the issuance of convertible debt                                     --             --             --        115,234
Accrued dividends on preferred stock                                    --             --             --        (39,484)
Accrual of interest on note receivable from stockholder                 --             --        (17,315)       (17,315)
Sale of warrants to underwriter in September 1994                       --             --             --              4
   Conversion of notes payable                                          --             --             --      2,085,126
Shares issued at $5.00 per share in initial public offering
   in September 1994, net of expenses of $2,929,835                     --             --             --     15,711,165
Net loss for year ended December 31, 1994                       (4,271,501)            --             --     (4,271,501)
                                                               -----------    -----------    -----------    -----------

Balance at December 31, 1994 (carried forward)                 (15,909,988)            --       (210,072)    12,549,785
</TABLE>

<PAGE>
                                      F-8


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

   Consolidated Statements of Stockholders' Equity (Deficiency) And
   Comprehensive Income - (Continued)

<TABLE>
<CAPTION>
                                                                      Class A                        Class B
                                                                    common stock                   common stock
                                                                Shares         Amount         Shares          Amount
                                                                ------         ------         ------          ------
<S>                                                            <C>              <C>          <C>                <C>
Balance at December 31, 1994 (brought forward)                  3,728,200         37,282      9,757,297          97,573

Shares issued at prices ranging from $1.00 per share to
   $3.13 per share as compensation for services rendered           31,559            315             --              --
Exercise of options to purchase Class B stock                          --             --        681,700           6,817
Accrued dividends on preferred stock                                   --             --             --              --
Accrual of interest on note receivable from stockholder                --             --             --              --
Exchange of Class B stock for Class A stock                     2,855,859         28,559     (2,855,859)        (28,559)
Net loss for the year ended December 31, 1995                          --             --             --              --
                                                             ------------   ------------   ------------    ------------

Balance at December 31, 1995                                    6,615,618         66,156      7,583,138          75,831

Exercise of options to purchase Class A stock                     214,091          2,141             --              --
Shares issued at prices ranging from $2.06 per share to
   $3.44 per share as compensation for services rendered           42,077            421             --              --
Issuance of unregistered Class B common stock to acquire
   Wave Interactive Network valued at approximately
   $.98 per share                                                      --             --        375,000           3,750
Issuance of warrants to purchase unregistered shares of
   Class A common stock in conjunction with the issuance
   of convertible debt and preferred stock                             --             --             --              --
Conversion of Class B Preferred Stock                           2,960,303         29,603             --              --
Accrual of interest on note receivable                                 --             --             --              --
Accrued dividends on preferred stock                                   --             --             --              --
Exchange of Class B stock for Class A 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             --              --
Net loss for the year ended December 31, 1996                          --             --             --              --
                                                             ------------   ------------   ------------    ------------

Balance at December 31, 1996                                   12,455,403        124,554      6,208,141          62,081
                                                             ------------   ------------   ------------    ------------

Exercise of options to purchase Class A and B common stock         70,326            703         10,330             104
Shares issued at prices ranging from $1.00 per share
   to $3.00 per share as compensation for services
   rendered                                                       126,885          1,269             --              --
Conversion of preferred stock into common stock                 7,998,860         79,989             --              --
Issuance of Class A common stock and warrants to
   purchase Class A common stock to Aladdin                       500,000          5,000             --              --
Issuance of Class A common stock and warrants to
   purchase Class A common stock                                  799,964          8,000             --              --
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                 --             --             --              --
Accrued dividend on preferred stock including accretion
   of assured incremental yield                                        --             --             --              --
Assured incremental yield on issuance of Series F
   convertible preferred stock and debt                                --             --             --              --
N*ABLE  APIC in connection with the issuance of
     Class A common stock due to merger                         1,404,723         14,047             --              --
Net loss                                                               --             --             --              --
Exchange of Class B stock for Class A 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

<CAPTION>
                                                                               Deficit
                                                                             accumulated                    Note
                                                               Capital       during the                  receivable
                                                            in excess of     development     Deferred       from
                                                              par value         stage      compensation  stockholder       Total
                                                              ---------         -----      ------------  -----------       -----
<S>                                                           <C>           <C>                   <C>      <C>          <C>
Balance at December 31, 1994 (brought forward)                 28,534,990    (15,909,988)         --        (210,072)    12,549,785

Shares issued at prices ranging from $1.00 per share to
   $3.13 per share as compensation for services rendered           57,184             --          --              --         57,499
Exercise of options to purchase Class B stock                     429,413             --          --              --        436,230
Accrued dividends on preferred stock                              (40,600)            --          --              --        (40,600)
Accrual of interest on note receivable from stockholder                --             --          --         (17,318)       (17,318)
Exchange of Class B stock for Class A stock                            --             --          --              --             --
Net loss for the year ended December 31, 1995                          --     (6,832,866)         --              --     (6,832,866)
                                                             ------------   ------------      ------    ------------   ------------

Balance at December 31, 1995                                   28,980,987    (22,742,854)         --        (227,390)     6,152,730

Exercise of options to purchase Class A stock                     420,366             --          --              --        422,507
Shares issued at prices ranging from $2.06 per share to
   $3.44 per share as compensation for services rendered          123,029             --          --              --        123,450
Issuance of unregistered Class B common stock to acquire
   Wave Interactive Network valued at approximately
   $.98 per share                                                 364,688             --          --              --        368,438
Issuance of warrants to purchase unregistered shares of
   Class A common stock in conjunction with the issuance
   of convertible debt and preferred stock                        283,455             --          --              --        283,455
Conversion of Class B Preferred Stock                           3,078,921             --          --              --      3,108,524
Accrual of interest on note receivable                                 --             --          --         (17,315)       (17,315)
Accrued dividends on preferred stock                             (199,014)            --          --              --       (199,014)
Exchange of Class B stock for Class A stock                            --             --          --              --             --
N*ABLE  APIC in connection with the issuance of
     Class A common stock due to merger                         1,296,241             --          --              --      1,304,974
Net loss for the year ended December 31, 1996                          --    (10,126,546)         --              --    (10,126,546)
                                                             ------------   ------------      ------    ------------   ------------

Balance at December 31, 1996                                   34,348,673    (32,869,400)         --        (244,705)     1,421,203
                                                             ------------   ------------      ------    ------------   ------------

Exercise of options to purchase Class A and B common stock        139,081             --          --              --        139,888
Shares issued at prices ranging from $1.00 per share
   to $3.00 per share as compensation for services
   rendered                                                       304,227             --          --              --        305,496
Conversion of preferred stock into common stock                 6,703,028             --          --              --      6,783,017
Issuance of Class A common stock and warrants to
   purchase Class A common stock to Aladdin                     3,834,000             --          --              --      3,839,000
Issuance of Class A common stock and warrants to
   purchase Class A common stock                                  792,000             --          --              --        800,000
Reduction in note receivable                                           --             --          --          50,000         50,000
Accrual of interest on note receivable                                 --             --          --         (17,319)       (17,319)
Issuance of warrants to purchase Class A common stock
   in conjunction with the issuance of preferred stock            386,462             --          --              --        386,462
Accrued dividend on preferred stock including accretion
   of assured incremental yield                                (1,372,984)            --          --              --     (1,372,984)
Assured incremental yield on issuance of Series F
   convertible preferred stock and debt                           682,000             --          --              --        682,000
N*ABLE  APIC in connection with the issuance of
     Class A common stock due to merger                        10,128,492             --          --              --     10,142,539
Net loss                                                               --    (18,012,635)         --              --    (18,012,635)
Exchange of Class B stock for Class A stock                            --             --          --              --             --
                                                             ------------   ------------      ------    ------------   ------------

Balance at December 31, 1997                                 $ 55,944,979   $(50,882,035)     $   --    $   (212,024)  $  5,151,672
</TABLE>

<PAGE>
                                      F-9


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

        Consolidated Statements of Stockholders' Equity (Deficiency) And
                       Comprehensive Income - (Continued)


<TABLE>
<CAPTION>
                                                                       Class A                        Class B
                                                                     common stock                   common stock
                                                                 Shares         Amount         Shares          Amount
                                                                 ------         ------         ------          ------
<S>                                                             <C>          <C>              <C>           <C>
Balance at December 31, 1997                                    25,152,679   $    251,527      4,421,953    $     44,220
                                                              ------------   ------------   ------------    ------------

Exercise of options to purchase Class A common stock                77,558            775
Options issued to employees below fair market-value                     --             --             --              --
Exercise of warrants to purchase Class A common stock            1,652,770         16,528             --              --
Warrants to purchase Class A common stock
   to be issued as part of technology licensing
   agreement and issued to consultants for services-                    --             --             --              --
Shares issued at prices ranging from $1.00 per share
   to $5.00 per share as compensation for services
   rendered                                                        121,400          1,214             --              --
Reduction in note receivable                                            --             --             --              --
Issuance of Series G Convertible Preferred stock and
   Common stock warrants, net of issuance costs of $222,500             --             --             --              --
Assured incremental yield on issuance of Series G
   convertible preferred stock and debt                                 --             --             --              --
Accrual of interest on note receivable                                  --             --             --              --
Accrued dividend on preferred stock including accretion
   of assured incremental yield                                         --             --             --              --
Conversion of Series G Preferred Stock                           2,394,494         23,945             --              --
N*ABLE's APIC in connection with the issuance of
   Class A common stock due to the merger                            2,781             28             --              --
Net loss                                                                --             --             --              --
Adjustment for net loss of N*ABLE for the  1st six
   months ended June 30,of 1998                                         --             --             --              --
Exchange of Class B stock for Class A 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
                                                              ------------   ------------   ------------    ------------

Net loss                                                                --             --             --              --

Unrealized gain on Marketable Securities                                --             --             --              --

Comprehensive income (loss)

Exercise of options to purchase Class A common stock               964,000          9,640
Warrants exercised to purchase Class A common stock              3,370,238         33,684             --              --
Shares Issued at $11.00 per share, net of issuance costs         2,090,405         20,904
Conversion of  Bridge to Loan to purchase Class A common stock     787,349          7,874
Warrants to Purchase Class A common stock
    For services rendered
Shares issued as compensation for services rendered                 83,461            834             --              --
Accrual of interest on note receivable                                  --             --             --              --
Conversion of Series G Preferred Stock                             377,102          3,771             --              --
Accrued dividend on preferred stock                                     --             --             --              --
Exchange of Class B 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
                                                              ============   ============   ============    ============

<CAPTION>
                                                                                  Deficit
                                                                                accumulated      Series G      Accumulated
                                                                  Capital       during the     Convertible        Other
                                                               in excess of     development     Preferred     Comprehensive
                                                                 par value         stage          Stock           Income
                                                                 ---------         -----          -----           ------
<S>                                                            <C>             <C>             <C>             <C>
Balance at December 31, 1997                                   $ 55,949,984    $(50,882,035)             --              --
                                                               ------------    ------------    ------------    ------------

Exercise of options to purchase Class A common stock                151,180              --              --              --
Options issued to employees below fair market-value                 234,723              --              --              --
Exercise of warrants to purchase Class A common stock             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                                                         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              --       1,809,250              --
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)             --         837,263              --
Conversion of Series G Preferred Stock                            2,274,756              --      (2,298,701)             --
N*ABLE's APIC in connection with the issuance of
   Class A common stock due to the merger                            59,182              --              --              --
Net loss                                                                 --     (16,586,027)             --              --
Adjustment for net loss of N*ABLE for the  1st six
   months ended June 30,of 1998                                          --       2,253,461              --              --
Exchange of Class B stock for Class A stock                              --              --              --
                                                               ------------    ------------    ------------    ------------

Balance at December 31, 1998                                   $ 64,919,050    $(65,214,601)   $    347,812              --
                                                               ------------    ------------    ------------    ------------

Net loss                                                                 --     (28,052,572)             --

Unrealized gain on Marketable Securities                                 --              --              --    $  2,860,500

Comprehensive income (loss)

Exercise of options to purchase Class A common stock              1,622,431              --              --              --
Warrants exercised purchase Class A common stock                  6,707,894              --              --              --
Shares Issued at $11.00 per share, net of issuance costs         21,481,665              --              --              --
Conversion of  Bridge to Loan to purchase Class A                 2,567,380              --              --              --
Warrants to Purchase Class A common stock
    For services rendered                                         1,075,240
Shares issued as compensation for services rendered               1,149,486              --              --              --
Accrual of interest on note receivable                                   --              --              --
Conversion of Series G Preferred Stock                              344,041              --        (347,812)             --
Accrued dividend on preferred stock                                 (13,239)             --              --
Exchange of Class B stock for Class A stock                              --              --              --              --
                                                               ------------    ------------    ------------    ------------

Balance at December 31, 1999                                   $ 99,854,111    $(93,267,173)   $          0    $  2,860,500
                                                               ============    ============    ============    ============

<CAPTION>
                                                                 Note
                                                              receivable
                                                                 from
                                                              stockholder       Total
                                                              -----------       -----
<S>                                                          <C>             <C>
Balance at December 31, 1997                                 $   (212,024)   $  5,151,672
                                                             ------------    ------------

Exercise of options to purchase Class A common stock                   --         151,955
Options issued to employees below fair market-value                    --         234,723
Exercise of warrants to purchase Class A common stock                  --       3,962,268
Warrants to purchase Class A common stock
   to be issued as part of technology licensing
   agreement and issued to consultants for services-                   --       1,546,824
Shares issued at prices ranging from $1.00 per share
   to $5.00 per share as compensation for services
   rendered                                                            --         648,488
Reduction in note receivable                                       75,000          75,000
Issuance of Series G Convertible Preferred stock and
   Common stock warrants, net of issuance costs of $222,500            --       2,027,500
Assured incremental yield on issuance of Series G
   convertible preferred stock and debt                                --         750,000
Accrual of interest on note receivable                            (12,318)        (12,318)
Accrued dividend on preferred stock including accretion
   of assured incremental yield                                        --         (21,600)
Conversion of Series G Preferred Stock                                 --
N*ABLE's APIC in connection with the issuance of
   Class A common stock due to the merger                              --          59,210
Net loss                                                               --     (16,586,027)
Adjustment for net loss of N*ABLE for the  1st six
   months ended June 30,of 1998                                        --       2,253,461
Exchange of Class B stock for Class A stock                            --
                                                             ------------    ------------

Balance at December 31, 1998                                 $   (149,342)   $    241,156
                                                             ------------    ------------

Net loss                                                               --     (28,052,572)

Unrealized gain on Marketable Securities                               --       2,860,500

Comprehensive income (loss)                                            --     (25,192,072)

Exercise of options to purchase Class A common stock                   --       1,632,071
Warrants exercised purchase Class A common stock                       --       6,741,759
Shares Issued at $11.00 per share, net of issuance costs               --      21,502,569
Conversion of  Bridge to Loan to purchase Class A                      --       2,575,254
Warrants to Purchase Class A common stock
    For services rendered                                                       1,075,240
Shares issued as compensation for services rendered                    --       1,150,320
Accrual of interest on note receivable                             (4,818)         (4,818)
Conversion of Series G Preferred Stock                                 --              --
Accrued dividend on preferred stock                                    --         (13,239)
Exchange of Class B stock for Class A stock                            --              --
                                                             ------------    ------------

Balance at December 31, 1999                                 $   (154,160)   $  9,708,240
                                                             ============    ============
</TABLE>


          See accompanying notes to consolidated financial statements.

<PAGE>
                                      F-10


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

                      Consolidated Statements of Cash Flows

            Years ended December 31, 1999, 1998, 1997 and the Period
      From February 12, 1988 (Date of Inception) through December 31, 1999

<TABLE>
<CAPTION>
                                                                                                          Period from
                                                                                                       February 12, 1988
                                                                                                      (date of inception)
                                                                                                            through
                                                                                                         December 31,
                                                             1999            1998            1997            1999
                                                             ----            ----            ----            ----
<S>                                                      <C>             <C>             <C>             <C>
Cash flows from operating activities:
   Net loss                                              $(28,052,573)   $(16,586,027)   $(18,012,635)   $(93,267,173)
   Adjustments to reconcile net loss to net cash
    used in operating activities:
     Write-off of goodwill                                         --              --         769,886         769,886
     Depreciation and amortization                            767,994         487,155         609,661       2,506,508
       Reserve for note from affiliate                             --              --              --       1,672,934
     Accrued interest on marketable securities                     --              --              --        (106,962)
     Non-cash expenses:
       Accretion of assured incremental yield on
          convertible debt                                         --              --         119,000         119,000
       Common stock issued in connection with
          License and Cross-License Agreement                      --              --              --       1,124,960
       Common stock issued for services rendered
          and additional interest on borrowings               150,320         648,488         305,496       3,491,866
       Warrants issued as compensation for services         1,075,240       1,552,235           5,411       2,751,595
       Issuance of warrants to Aladdin                             --              --       2,939,000       2,939,000
       Accrued interest on note payable                        15,388          39,707          56,624         121,219
       Preferred stock issued for services rendered                --              --              --         265,600
       Compensation associated with issuance of
          stock options                                            --         234,723              --         634,463
       Amortization of deferred compensation                       --              --              --         398,660
       Amortization of discount on notes payable                   --              --              --         166,253
       Common stock issued by principal stockholder
          for services rendered                                    --              --              --         565,250
     Changes in assets and liabilities:
       Increase (Decrease) in Deferred  Revenue            (1,250,000)      1,250,000              --              --
       Increase in accrued interest on note receivable         (4,818)        (12,318)        (17,319)       (105,986)
       Increase in Inventories                               (431,686)             --              --        (431,686)
       (Increase) decrease in prepaid expenses and
          other receivables                                  (424,358)        (67,500)         70,358        (491,857)
       (Increase) decrease in other assets                 (1,993,833)        (37,241)        129,141      (2,171,836)
       Increase in accounts payable and
          accrued expenses                                  3,345,840       1,695,479         600,095       7,061,155
                                                         ------------    ------------    ------------    ------------

          Net cash used in operating activities           (26,802,483)    (10,795,299)    (12,425,282)    (71,987,153)
                                                         ------------    ------------    ------------    ------------
</TABLE>

                                                                     (Continued)

<PAGE>
                                      F-11


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

          Supplemental Consolidated Statements of Cash Flows, Continued

<TABLE>
<CAPTION>
                                                                                                       Period from
                                                                                                    February 12, 1988
                                                                                                   (date of inception)
                                                                                                         through
                                                                                                       December 31,
                                                           1999            1998            1997           1999
                                                           ----            ----            ----           ----
<S>                                                   <C>             <C>             <C>             <C>
Cash flows from investing activities:
   Acquisition of property and equipment                (2,106,639)       (590,619)       (644,671)     (4,957,856)
   Short-term loans to affiliate                                --              --              --      (1,672,934)
   Organizational costs                                         --              --              --         (14,966)
   Exercise of warrant to acquire marketable
     securities-available for sale                      (1,620,000)             --              --     (29,166,769)
   Maturity of marketable securities                            --              --              --      27,653,731
                                                      ------------    ------------    ------------    ------------

          Net cash used in investing
            activities                                  (3,726,639)       (590,619)       (644,671)     (8,158,794)
                                                      ------------    ------------    ------------    ------------

Cash flows from financing activities:
   Net proceeds from issuance of common stock           30,874,435      10,644,264      11,860,970      70,664,326
   Net proceeds from issuance of preferred stock
     and warrants                                               --       2,777,500       3,555,500      12,283,027
   Sale of warrants                                             --              --              --               4
   Note receivable from stockholder                             --          75,000          50,000         (48,175)
   Proceeds from notes payable and warrants to
     stockholders                                        2,000,000              --              --       4,083,972
   Repayments of notes payable to stockholders                  --              --              --      (1,069,972)
   Proceeds from notes payable and warrants                     --              --              --       1,284,250
   Repayments of note payable                                   --              --              --        (255,000)
   Advances from stockholder                                    --              --              --         227,598
   Repayments of advances from stockholder                      --              --              --        (227,598)
   Redemption of Preferred Stock                          (506,440)             --              --        (506,440)
                                                      ------------    ------------    ------------    ------------

          Net cash provided by financing activities     32,367,995      13,496,764      15,466,470      86,435,992
                                                      ------------    ------------    ------------    ------------

Net increase in cash and cash equivalents                1,838,870       2,110,846       2,396,517       6,290,045

Cash and cash equivalents at beginning of period         4,451,175       2,340,329       4,196,758              --
                                                      ------------    ------------    ------------    ------------

Cash and cash equivalents at end of period            $  6,290,045    $  4,451,175    $  6,593,275    $  6,290,045
                                                      ============    ============    ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements.

<PAGE>
                                      F-12


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

                   Notes to Consolidated Financial Statements

       December 31, 1999, 1998, 1997 and The Period From February 12, 1988
                  (Date of Inception) Through December 31, 1999

(1) Business of the Company

      Wave Systems Corp. (the "Company" or "Wave") is engaged in the research
      and development of a proprietary system (the "Wave System") for use with a
      computer, that measures, controls, and records the use of electronic
      content. The Company is also engaged in various research, development and
      marketing efforts to commercialize the Wave System to provide more
      efficient and flexible pricing (e.g., pay per use or rent-to-own) and
      greater security on the usage of the electronic content. The Company is in
      the development stage and, accordingly, the accompanying consolidated
      financial statements are presented in a format prescribed for a
      development stage enterprise.

      The Company has incurred significant losses in current and prior periods.
      Management intends to continue to devote resources toward the research,
      development and marketing of its products in order to generate future
      revenues from licensing and product sales as well as develop the business
      of WaveXpress. In addition, the Company is actively pursuing additional
      short- and long-term financing sources, including debt and equity
      financing. On March 8, 2000 the Company completed an offering of common
      stock for net proceeds of approximately $122 million, as discussed in Note
      17. Management anticipates that the proceeds of this offering will be
      sufficient to fund operations through the end of 2001. However, while
      management believes that it can successfully research, develop and market
      its products and obtain additional financing to fund operations beyond
      2001, there can be no assurance that it will be able to do so.

(2) Significant Accounting Policies

   (a) Basis of Preparation

      The accompanying consolidated financial statements of Wave Systems Corp.
      and subsidiaries ("Wave" or the "Company") have been prepared to give
      retroactive effect to the acquisition of N*Able Technologies, Inc.
      ("N*Able"), which was acquired on July 27, 1999. The acquisition was
      effected through the issuance of 2,280,821 shares of Class A common stock
      in exchange for all the shares of N*Able and was accounted for pursuant to
      the pooling-of-interests method of accounting. N*Able was a Massachusetts
      based company that produces 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
      sensitive payment, personal information to and from desktop computers. The
      fiscal year end for N*Able is June 30. In preparing these consolidated
      financial statements, the calendar 1999 and 1998 financial statements of
      the Company were combined with the financial statements of N*Able for the
      same twelve month periods. For 1997, Wave's financial statements were
      combined with the June 30, 1998 fiscal year end statements for N*Able.
      Accordingly, an adjustment is reflected in the statements of Stockholder's
      Equity and cash flows to eliminate N*Able's net loss and net cash flows
      for the six months ended June 30, 1998.

                                                                     (Continued)
<PAGE>
                                      F-13


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

                   Notes to Consolidated Financial Statements

      N*Able has generated minimal revenues since inception. The results of
      operations previously reported by the separate companies and the combined
      amounts presented in the accompanying consolidated financial statements
      are summarized below:

                                  1999               1998               1997
Net Loss

Wave                         $(22,592,000)      $(11,895,944)      $(13,897,794)
N*Able                         (5,460,572)        (4,690,083)        (4,114,841)
Combined                     $(28,052,572)      $(16,586,027)      $(18,012,635)

   (b) Principles of Consolidation

      The consolidated financial statements include the financial statements of
      Wave; a wholly owned subsidiary, Harvard International Medical Library,
      Inc., doing business as MedWave; a majority owned inactive subsidiary,
      Network News Corp. ("NNC"); a wholly owned inactive subsidiary; N*Able as
      noted above and a majority owned subsidiary WaveXpress.All significant
      intercompany balances and transactions have been eliminated in
      consolidation.

   (c) Use of Estimates

      The preparation of financial statements in conformity with generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure of contingent assets and liabilities at the date of the
      financial statements and the reported amounts of expenses during the
      reporting period. Actual results could differ from those estimates.

   (d) Method of Accounting for Joint Ventures

      In April 1999, the Company established WaveXpress as the basis for a joint
      venture agreement with Sarnoff Corporation ("Sarnoff") to create
      technology that allows broadcasters to transmit enhanced television, rich
      media and Internet content to a variety of devices including digital
      televisions (DTV's) and PC's. The joint venture is owned 53% by the
      Company and certain of its affiliates, including Peter and Steven Sprague
      and certain Wave employees and members of the Board of Directors, and
      40% by Sarnoff and its affiliates. The Company has committed to provide
      technology and capital in the form of a convertible note for an amount up
      to $3.2 million and Sarnoff will provide technology, but will not provide
      any financing. For purposes of these consolidated financial statements,
      the Company has consolidated 100% of the financial statements of
      WaveXpress. No minority interest in the losses of WaveXpress has been
      recorded as the minority owners are not obligated to fund the losses of
      WaveXpress. See note 12.

   (e) Cash Equivalents

      For purposes of the consolidated statements of cash flows, the Company
      considers all highly liquid instruments with an original maturity of three
      months or less to be cash equivalents.

   (f) Marketable Securities

      Debt securities and publicly traded equity securities are classified as
      available for sale and are recorded at market using the specific
      identification method. Unrealized gains and losses are reflected in other
      comprehensive income. All other investments, excluding joint venture
      arrangements, are recorded at cost.

                                                                     (Continued)

<PAGE>
                                      F-14


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

            Notes to Consolidated Financial Statements - (Continued)

   (g) Property and Equipment

      Property and equipment, including computer software, are stated at cost.
      Depreciation is computed using the straight-line method over estimated
      useful lives of five years.

   (h) Goodwill

      Goodwill, which represents the excess of purchase price over the fair
      value of net assets acquired, is amortized on a straight-line basis over
      the period expected to be benefited of five years. The Company assesses
      the recoverability of this intangible asset by determining whether the
      amortization of the goodwill balance over its remaining life can be
      recovered through undiscounted future operating cash flows of the related
      acquired operation. The amount of goodwill impairment, if any, is measured
      based on projected discounted future operating cash flows using a discount
      rate reflecting the Company's average cost of funds. The assessment of the
      recoverability of goodwill is impacted if estimated future operating cash
      flows are not achieved. During the third quarter of 1997, the Company
      wrote-off goodwill related to the WIN acquisition as it was uncertain
      whether the current and expected future results of operations of WIN would
      be sufficient to support its carrying value.

   (i) Income Taxes

      The Company 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

      The Company accounts for its stock option plans in accordance with the
      provisions of Accounting Principles Board ("APB") Opinion No. 25,
      Accounting for Stock Issued to Employees, and related interpretations. As
      such, compensation expense is recorded on the date of grant only if the
      current market price of the underlying stock exceeds the exercise price.
      The Company adopted the disclosure provisions of Statement of Financial
      Accounting Standards ("SFAS") No. 123, Accounting for Stock Based
      Compensation and accordingly, provides pro forma net income and pro forma
      earnings per share footnote disclosures for employee stock options as if
      the fair value-based method defined in SFAS No. 123 had been applied.

   (k) Research and Development

      Research and development costs are expensed as incurred. Software
      development costs are required to be capitalized when a product's
      technological feasibility has been established either by completion of a
      detailed program design or a working model of the product and ending when
      a product is available for general release to consumers. Technological
      feasibility of the Company's product has not yet been established, and as
      a result, no software development costs have been capitalized.

                                                                     (Continued)

<PAGE>
                                      F-15


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

            Notes to Consolidated Financial Statements - (Continued)

   (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. No effect has been given to common stock equivalents or
      convertible preferred stock, warrants or convertible debt in the diluted
      loss per common share as they are all anti-dilutive. Included in net loss
      to common stockholders is the related to the ability of the Series B, C,
      D, F and G preferred stockholders to acquire common stock upon conversion
      at a discount

   (m) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of

      The Company reviews its long-lived assets and certain identifiable
      intangibles for impairment whenever events or changes in circumstances
      indicate that the carrying amount of an asset may not be recoverable.
      Recoverability of assets to be held and used is measured by a comparison
      of the carrying amount of an asset to future net cash flows expected to be
      generated by the asset. If such assets are considered to be impaired, the
      impairment to be recognized is measured by the amount by which the
      carrying amount of the assets exceed the fair value of the assets. Assets
      to be disposed of are reported at the lower of the carrying amount or fair
      value less costs to sell.

(3) Related Party Transactions

   (a) Notes Receivable from Stockholder

      A stockholder, the Chairman and Chief Executive Officer of the Company,
      was indebted to the Company at December 31, 1999 and 1998 under two
      promissory notes totaling $154,160 and 149,342 respectively, including
      accrued interest, due on demand. During 1998 and 1997, $75,000 and
      $50,000, respectively, of the Chairman and Chief Executive Officer's bonus
      was used to reduce the principal owed. As discussed in Note 17 the entire
      remaining loan balance was repaid in March, 2000.

      The notes are secured by a pledge of 67,000 shares of Class B common stock
      held by the stockholder and officer. The notes bear interest at 10% per
      annum. The notes and accrued interest thereon have been shown as a
      deduction from stockholders' equity in the accompanying consolidated
      financial statements.

   (b) Payments to Related Party

      In 1997, the Company 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. Michael Sprague is the son of
      the Chairman and Chief Executive Officer of the Company

      In 1998, the Company paid $25,000 to Studio 2, during which time Mr. Kevin
      Sprague was an employee of Studio 2. Kevin Sprague is the son of the
      Chairman and CEO of the Company.

                                                                     (Continued)

<PAGE>
                                      F-16


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

             Notes to Consolidated Financial Statements, (Continued)

   (c) Acquisition and Dispositions

      In November 1995, the Company 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 the Company 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. The Company 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, Chairman and CEO of Wave. The note was fully reserved as its
      collectibility was dependent upon WIN's ability to raise additional
      capital. In addition, the Company 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, the Company 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, the
      Company entered into a merger agreement with WIN whereby the Company
      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 the Company's Class B common stock. During
      1999, the time to attain the milestone had expired as did the entitlement
      to additional shares and no additional shares were issued. The Company
      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 noteholders
      and was allocated to goodwill as WIN had no net tangible assets.
      Subsequently, in 1997, the Company 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) WaveXpress

      In April 1999, the Company established WaveXpress as the basis for a
      joint venture agreement with Sarnoff Corporation ("Sarnoff"). The
      joint venture is owned 53% by the Company and 7% by certain of its
      affiliates, including Peter and Steven Sprague and certain Wave
      employees and members of the Board of Directors, and 40% by Sarnoff
      and its affiliates. The Company has committed to provide technology and
      capital in the form of a convertible note for an amount up to $3.2 million
      and Sarnoff will provide technology, but will not provide any financing.

                                                                     (Continued)

<PAGE>
                                      F-17


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

             Notes to Consolidated Financial Statements, (Continued)

(4) Property and Equipment

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

                                                        1999             1998
                                                        ----             ----

Equipment                                            $2,856,730       $1,687,032
Furniture, fixtures and improvements                    534,987          635,913
Computer software                                     1,528,990          534,614
                                                     ----------       ----------
                                                      4,920,707        2,857,559
Less: Accumulated depreciation                        2,239,834        1,515,330
                                                     ----------       ----------
   Total                                             $2,680,874       $1,342,229
                                                     ==========       ==========

      Depreciation expense on property and equipment amounted to approximately
      $768,000, $487,000, $408,000 and $2,506,000 for the years ended December
      31, 1999, 1998, and 1997 and for the period from inception through
      December 31, 1999, respectively.

(5) Notes Payable

      In connection with the acquisition of WIN, the Company issued a 10%
      convertible note amounting to $456,000 and a warrant to refinance WIN's
      obligation to a WIN noteholder. The note was convertible any time after
      April 1, 1997 and became due, including accrued interest of $66,125, on
      April 18, 1998. The note was convertible into a number of the Company's
      unregistered Class A common stock for a period beginning on April 1, 1997
      and ending April 18, 1998 calculated as the greater of (a) the number of
      shares that would be acquired at 80% of the fair market value of the Class
      A common stock or (b) 250,000 shares plus 2,000 shares for each month the
      note is outstanding.

      On October 18, 1998 the Company restated and amended the note. The note is
      now convertible any time after April 1, 1999 and up to April 18, 1999. The
      conversion price was reduced to $0.95 per share of common stock. An
      additional 75,000 warrants were issued as part of this amended note and
      the fair value of these warrants was $106,000. Additionally, the fair
      value of the reduced conversion price was $274,000. Such amounts were
      amortized as additional interest expense from the date the note was
      amended and warrant issued through the earliest conversion date of April
      1, 1999. During 1998, approximately $123,000 of the value of the reduced
      conversion rate and warrant was recorded as interest expense and the
      remainder was recorded as interest expense in 1999. During April 1999 the
      note was converted in full.

                                                                     (Continued)

<PAGE>
                                      F-18


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

             Notes to Consolidated Financial Statements, (Continued)

(6) Accounts Payable and Accrued Expenses

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

                                                          1999           1998
                                                          ----           ----

Accrual of costs related to the ITG agreement          $  490,000     $  490,000
Accounts payable                                        4,058,043        947,486
Accrued consulting and professional fees                  743,000        155,000
Legal Settlement                                               --        602,000
Accrued payroll and related costs                       1,110,000        934,545
Lease payable                                              20,472         60,169
Annual Report and Shareholders Meeting                    150,000             --
Other accrued liabilities                                 252,128        288,603
                                                       ----------     ----------

   Total                                               $6,823,643     $3,477,803
                                                       ==========     ==========

(7) Capital Stock

   (a) Redeemable Preferred Stock

      The Company 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 the Company 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 the Company for services provided to the Company.
      The holder of the Series A Preferred Stock is entitled to receive a
      dividend at the rate of $60 per share per annum, when and as declared by
      the Board of Directors of the Company. Dividends are cumulative from the
      date of original issue, and payable upon redemption.

      On August 11, 1999, the Company redeemed these shares for a total payment
      of $506,440, including accrued and unpaid dividends.

      In May of 1996, the Company 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 has a stated value
      of $10,000 per share, which accrues dividends for liquidation and
      conversion purposes at 6% per annum, and ranks senior to the Company's
      common stock 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 the Company'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.

                                                                     (Continued)

<PAGE>
                                      F-19


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

             Notes to Consolidated Financial Statements, (Continued)

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

      In December of 1996, the Company 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
      has a stated value of $20 per share, which accrues dividends payable
      quarterly in cash at 6% per annum.

      The Series C Preferred Stock ranks senior to the Company'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 the Company's Class A
      common stock based on the market price of the Company'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
      the Company's Class A common stock.

      In May of 1997 the Company 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 the Company 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 the Company'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 the Company's Class A Common Stock.

   (b) Convertible Preferred Stock

      In October 1997 the Company raised approximately $1,850,000, net of
      issuance costs of $397,000 ($224,000 of which related to the value
      ascribed to warrants issued), though the private placement 112,500 shares
      of newly created Series F Convertible Preferred Stock. The Series F
      Convertible Preferred Stock has 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 the Company's Class A Common
      Stock.

                                                                     (Continued)

<PAGE>
                                      F-20


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

             Notes to Consolidated Financial Statements, (Continued)

      During March of 1998, the Company 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 is senior to the
      Company's classes of common stock, and is junior to the Company' Series A
      Redeemable Preferred in liquidation rights. The Series G Convertible
      Preferred Stock accrues dividends at the rate of 6% per annum. The Series
      G Convertible Preferred stock is convertible into the Company'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, the Company issued warrants to the purchaser and
      placement agent for 225,000 shares of the Company's Class A common stock
      at an exercise price of $1.38. Series G preferred stock was converted into
      377,102 shares for $347,812.

   (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 opportunity. 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 the Company, 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,
      1999.

      In May and November, 1992, the Company issued 770,000 shares of Class B
      restricted common stock to certain employees, officers and stockholders of
      the Company for a purchase price of $.003 per share, payable in the form
      of services to the Company.

      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, the Company 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, the Company 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.

                                                                     (Continued)

<PAGE>
                                      F-21


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

             Notes to Consolidated Financial Statements, (Continued)

      In July and August 1996, the Company 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 the Company issued 126,885 shares of the Company'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 the Company sold approximately 800,000 shares of the Company's
      Class A common stock and warrants to purchase 160,000 shares of the
      Company's Class A common stock, which may be exercised at an exercise
      price of $1.00, for an aggregate purchase price of $800,000. As of
      December 31, 1999, 600,000 of the shares had been exercised.

      During 1997 the Company issued 500,000 shares of the Company'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.

      During March of 1999, the Company raised approximately $23,000,000 through
      the private placement to institutional, strategic and accredited
      individual investors of approximately 2.1 million shares of Class A common
      stock at $11.00 per share, excluding issuance costs.

   (d) Recapitalization

      In January 1994, the Board of Directors authorized the Company to amend
      and restate the Company's Certificate of Incorporation to reflect the
      authorization of 25,000,000 shares of a newly created Class A common
      stock, which stock has voting rights of one vote per share, and the
      reclassification of the then current outstanding shares of common stock
      into Class B common stock. In June 1994, the Board of Directors authorized
      that the Class B common stock will have one vote per share, except that
      Class B common stock will have five votes per share in cases where one or
      more directors are nominated for election by persons other than the
      Company's Board of Directors and where there is a vote on any merger,
      consolidation or other similar transaction, which is not recommended by
      the Company'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 the Company. 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.

                                                                     (Continued)

<PAGE>
                                      F-22


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

             Notes to Consolidated Financial Statements, (Continued)

(8) 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 is 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 the Company or a
      subsidiary and the optionee for any reason other than death, disability or
      retirement.

      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 may,
      in the discretion of the Compensation Committee, include 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.

      Subsequent to January 1994 no further options, other than reload 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.

   Other Options

      In 1993, in connection with an investment banking agreement, the Company
      granted options to purchase 30,000 shares of Class B common stock at an
      exercise price of $1.67 per share, and options to purchase 14,286 shares
      of Class B common stock at an exercise price of $3.50 per share. The
      options vested immediately and are exercisable for a period of seven years
      from the date of issuance.

   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, and November 1998 the Board of
      Directors approved an amendment to the Company's 1994 Plan to increase the
      number of shares of Class A common stock reserved for issuance thereunder
      by 1,000,000, 1,000,000 and 5,000,000, respectively. Therefore, the 1994
      Plan number of shares of Class A common stock reserved for issuance is
      8,000,000 shares.

      In January 1994, the Board of Directors authorized the establishment of
      the Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The
      total number of shares of Class A common stock subject to the Directors'
      Plan was 200,000. Pursuant to the Directors' Plan, each director who was
      not an employee of the Company received an initial grant of options to
      purchase 12,000 shares of Class A common stock at an exercise price of
      $3.50 per share.

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

                                                                     (Continued)
<PAGE>
                                      F-23


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

             Notes to Consolidated Financial Statements, (Continued)

      In February 1995, the Board of Directors authorized certain changes to the
      Directors' Plan. 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 stockholders of the Company authorized
      an increase to the total number of shares subject to the Directors' Plan
      from 200,000 shares to 500,000 shares. Options to purchase a total of
      110,000 and 100,000 shares of Class A common stock at $1.94 to $3.09 and
      $3.09 per share, were issued in 1997 and 1996, respectively, to
      nonemployee directors. In November 1998, the stockholders of the Company
      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 vest one-third upon grant,
      and one-third on each of the first and second anniversaries. Annual option
      grants vest 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 the Company, 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.

      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.

      At December 31, 1999, there were approximately 1,400,000 additional shares
      available for grant under the 1994 Plan. The per share weighted-average
      fair value of stock options granted during 1999, 1998 and 1997 was $9.56,
      $2.48 and $1.58 on the dates of grant using the Black Scholes
      option-pricing model with the following weighted-average assumptions:

<TABLE>
<CAPTION>

                                                1999         1998         1997
                                                ----         ----         ----
<S>                                          <C>          <C>          <C>
Expected Life (Years)                            10           10           10
Interest Rate                                   6.0%         6.0%         6.5%
Volatility                                      113%         105%         111%
Dividend Yield                                    0%           0%           0%

</TABLE>

      The Company applies APB Opinion No. 25 in accounting for its Plans and,
      accordingly, no compensation cost has been recognized for stock options
      granted to employees at fair market value in the financial statements,
      except for $234,723 of expense recorded in 1998 for options issued at
      exercise prices below the fair market value of the Company's stock.

                                                                     (Continued)

<PAGE>
                                      F-24


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

             Notes to Consolidated Financial Statements, (Continued)

      Had the Company determined compensation cost based on the fair value at
      the grant dates for its stock options under SFAS No. 123, the Company's
      net loss would have been increased to the pro forma amounts indicated
      below:

<TABLE>
<CAPTION>
                                                    1999            1998            1997
                                                    ----            ----            ----
<S>                                             <C>             <C>             <C>
Net loss - as reported                          $(28,052,572)   $(16,586,027)   $(18,012,635)
Net loss - pro forma                             (39,811,659)    (22,305,606)    (19,425,653)
Net loss to common stockholders - as reported    (28,065,811)    (17,444,890)    (20,495,617)
Net loss to common shareholders - pro forma      (39,824,898)    (23,164,469)    (21,908,635)
Loss per common share - as reported                     (.73)           (.55)           (.88)
Loss per common share - pro forma                      (1.04)           (.73)           (.94)
</TABLE>

      Pro forma net loss reflects only options granted since 1995. Therefore,
      the full impact of calculating compensation cost for stock options under
      SFAS No. 123 is not reflected in the pro forma net loss amounts presented
      above because compensation cost is reflected over the options' vesting
      periods and compensation cost for options granted prior to January 1, 1995
      are not considered.

Summary of Option Activity
A summary of option activity through December 31, 1999 follows:

<TABLE>
<CAPTION>

                                  Class A and B shares        Weighted average
                                    subject to option          exercise price
                                    -----------------          --------------
<S>                                  <C>                        <C>
Balance at January 1, 1991                     --                   $  --
Options granted                            30,000                    1.67
                                      -----------

Balance at December 31, 1991               30,000                    1.67
Options granted                           816,750                    1.18
                                       ----------

Balance at December 31, 1992              846,750                    1.20
Options granted                           949,186                    3.10
                                       ----------

Balance at December 31, 1993            1,795,936                    2.20
Options granted                           310,200                    3.05
Options canceled                         (108,500)                   3.38
                                       ----------

Balance at December 31, 1994            1,997,636                    2.27
Options granted                           777,850                    2.22
Options canceled                         (349,205)                   2.11
Options exercised                        (681,700)                    .64
                                       ----------
</TABLE>
                                                                     (Continued)

<PAGE>
                                      F-25


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

             Notes to Consolidated Financial Statements, (Continued)

<TABLE>

<S>                                          <C>                   <C>
Balance at December 31, 1995                      1,744,581            2.92
Options granted                                   1,342,075            2.65
Options canceled                                   (503,879)           3.20
Options exercised                                  (214,091)           1.97
                                                  ---------

Balance at December 31, 1996                      2,368,686            2.79
Options granted                                     707,914            1.02
Options canceled                                   (676,741)           1.57
Options exercised                                   (70,326)           1.90
                                                  ---------

Balance at December 31, 1997                      2,329,532            2.38
Options granted                                   5,756,893            2.47
Options canceled                                   (707,384)           2.48
Options exercised                                   (78,653)           1.94
                                                  ---------

Balance at December 31, 1998                      7,300,388          $ 2.40
Options granted                                   1,925,447           10.15
Options canceled                                   (450,378)           3.51
Options exercised                                  (964,000)           1.69
                                                  ---------

Balance at December 31, 1999                      7,811,456          $ 4.33

</TABLE>

      At December 31, 1999, there were approximately 2,429,509 options
      exercisable at prices ranging from $.49 to $15.75.

The following table summarizes information about stock options outstanding at
December 31, 1999:

<TABLE>
<CAPTION>
                                                                                          Weighted
                                                                     Weighted              average
                                                                      average             remaining
Range of                        Number           Number              exercise            contractual
exercise prices               outstanding      exercisable             price                life
---------------               -----------      -----------             -----                ----
<S>                           <C>              <C>                    <C>                 <C>
   $.49 - 1.06                  201,842          141,954               $.85               7.6 years

   1.07 - 1.69                2,515,893        1,000,323               1.16               7.5 years

   1.70 - 2.31                  161,820           62,392               1.94               8.1 years

   2.32 - 2.97                   40,380           31,203               2.56               4.9 years

   2.98 - 3.50                  603,732          297,666               3.43               7.7 years

   3.51 - 3.81                2,202,253          742,835               3.67               8.4 years

   3.82 - 7.06                  792,467           91,136               4.66               8.9 years

   7.06 - 15.75               1,293,069           62,000              12.89               8.7 years
</TABLE>

<PAGE>
                                      F-26


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

             Notes to Consolidated Financial Statements, (Continued)

   Warrants

      In 1993 and 1994, the Company 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 are exercisable for a period of five years from the date of
      issuance and were subsequently canceled or exercised in 1998 or 1999.

      In 1993 and 1994, the Company 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, the Company 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 are 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 the Company's initial public offering, the underwriter
      acquired warrants to purchase 360,000 Class A common shares at a price of
      $6.50 per share for nominal consideration. These warrants are 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 the Company 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.

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

      In connection with the acquisition of WIN, the Company issued a warrant
      that allows the holder the ability to purchase unregistered shares of the
      Company'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
      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 the Company's
      Series D Preferred Stock, JNC Opportunity Fund, the acquirer of the
      placement, received 80,000 warrants to purchase the Company'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.

                                                                     (Continued)

<PAGE>
                                      F-27


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

      Notes to Supplemental Consolidated Financial Statements, (Continued)

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

      In connection with the private placement of approximately 800,000 shares
      of the Company's Class A Common Stock, the Company issued 160,000 warrants
      to purchase shares of the Company's unregistered Class A Common Stock at
      an exercise price of $1.00. The warrants expire on September 16, 2000.

      In connection with a technology license agreement with Aladdin Knowledge
      Systems, Ltd., the Company issued two warrants on July 18, 1997 to
      purchase the Company's Class A Common Stock. The first warrant is
      exercisable in 100,000 share lots, and provides the holder with the right
      to acquire 1,216,136 shares of the Company's unregistered Class A Common
      Stock at an exercise price of $1.70 per share. The first warrant has a
      life of two years. The second warrant provides the holder with the right
      to acquire 7% of the Company's Class A Common Stock on a fully diluted
      basis for the average closing price for the 15 trading days prior to
      exercise has 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 has the right to acquire shares approximating 3.45% of the
      Company's Class A common stock. This second warrant expires July 17,2000..

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

                                                                     (Continued)

<PAGE>
                                      F-28


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

      Notes to Supplemental Consolidated Financial Statements, (Continued)

      A summary of warrants outstanding at December 31, 1999, follows:

<TABLE>
<CAPTION>
                            Range of
Class A and B shares        exercise           Expiration
subject to warrants          prices               Term
-------------------          ------               ----
 <S>                   <C>                 <C>
       32,500              3.09 - 3.13         5-10 years
      480,000                 1.00                5 years
       38,220                 1.83               10 years
      317,100             1.83 - 14.73         5-10 years
    ---------
      846,780
    =========

</TABLE>

      At December 31, 1999, warrants to acquire approximately 1.8 million shares
      of Class A and Class B common stock were exercisable.

      The above information table does not include the Aladdin warrant to
      purchase 3.45% of the Company due to its variable nature.

(9) Licensing Agreements

   (a) Licensed Patents

      In February 1994, the Company entered into an Amended and Restated License
      Agreement (the "Agreement") with Mr. Peter J. Sprague, the Chairman and
      Chief Executive Officer of the Company, and Mr. John Michener, then a
      shareholder and officer of the Company, whereby the Company was granted an
      exclusive license to make, have made, use, lease, sell or otherwise
      perform services covered by certain licensed patents (the "Licensed
      Patents") which are a fundamental part of the Company's product. The
      Agreement amends and restates certain license agreements entered into by
      the Company 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
      the Company and any sublicensee of the Company from the exploitation of
      the Licensed Patents, less any amounts paid, if any to (i) information and
      database providers for information distributed to or through the Company
      or its sublicensees, and to (ii) the Company's sublicensees for
      manufacturing the product or performing the services covered by the
      Licensed Patents. Royalty payments are payable quarterly and are to be
      apportioned 75% to Mr. Sprague and 25% to Mr. Michener.

                                                                     (Continued)

<PAGE>
                                      F-29


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

      Notes to Supplemental Consolidated Financial Statements, (Continued)

      Payment of royalties is secured by a security interest in and to the
      Licensed Patents. Mr. Sprague assigned all of his right, title, and
      interest in the Licensed Patents to the Company.

      The Company believes that the agreements as a whole provide it with
      exclusive rights under the Wave Patents. There can be no assurance that
      the Company 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 the Company entered into a license
      agreement with Aladdin Knowledge Systems, Ltd. ("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, the Company 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.

      The Company acquired the license for this technology in exchange for
      $950,000 plus two warrants to purchase the Company's Class A common stock
      valued at approximately $2.9 million (see note 8). The cost of this
      license was expensed as research and development costs. Aladdin also is
      provided a royalty payment of 5% to 9% of the Company's net content
      revenues.

      In connection with this agreement, Aladdin acquired an equity position in
      the Company by purchasing 500,000 shares of the Company's Class A common
      stock for $900,000, which approximated the fair market value of the shares
      on the date of purchase (see note 7).

(10) License and Cross-License Agreements

      On May 1, 1992, the Company 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 the Company license rights to the use of certain patents
      which are co-owned or licensed by Titan. The Company 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
      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. The Company 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, 1996.

      The License and Cross-License Agreement provides for royalties to be paid
      by the Company to Titan based upon the Company'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 the Company for use in its products
      and services. Royalties are payable on a quarterly basis.

                                                                     (Continued)

<PAGE>
                                      F-30


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

      Notes to Supplemental Consolidated Financial Statements, (Continued)

      The License and Cross-License Agreement also provides for royalties to be
      paid to the Company 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 the Company, 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 the Company'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, 1999, no royalties have been earned by
      Titan. On February 28, 1997, the Company and Titan executed an addendum to
      the License Agreement whereby the Company 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.

(11) Revenue Sharing Agreements With Partners

      The Company has, and intends to continue to, enter into revenue sharing
      arrangements with information providers, software developers, and hardware
      and systems manufacturers such as IBM discussed below. These revenue
      sharing arrangements will be negotiated between each of the partners and
      the Company. 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 the Company will be paid directly to the information provider
      or software developer. Once these payments are made the remainder of
      revenues will be shared between the Company and other partners. There can
      be no assurance that the Company will be successful in entering into
      definitive agreements with these parties, or that the terms of such
      agreements will be favorable to the Company.

      In December 1997, the Company entered into a series of agreements ("the
      agreements") with IBM pursuant to which the Company and IBM agreed to
      explore ways to incorporate the Company's WaveMeter chip into PC products
      and to support each other in achieving industry-wide adoption of the
      WaveMeter technology. Pursuant to the agreements, the Company must
      subsidize the incremental cost of using the Wave technology in IBM
      products. The total subsidy is capped at $30 million. The Company must
      also share varying percentages of its usage and advertising fee income
      that results from usage of any Wave technology distributed by IBM. In
      addition, the Company must provide user and technical service and support
      to IBM customers for the end-user application of Wave technology. Finally,
      the agreements provide for cash payments upon the attainment of certain
      milestones. The amount of such cash payments is based upon the
      appreciation of the Company's stock. To date, none of these milestones
      have been achieved; therefore, no costs have been recognized in the
      financial statements.

                                                                     (Continued)

<PAGE>
                                      F-31


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

             Notes to Consolidated Financial Statements, (Continued)

(12) Joint Ventures

   (a) ITG

      In July of 1997, the Company entered into a joint venture with Internet
      Technology Group, PLC ("ITG"), a United Kingdom Internet service provider.
      The joint venture is owned 25% by the Company and 75% by ITG. The Company
      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, Global
      Wave, Ltd., is to promote and commercialize the Wave technology in certain
      European and Middle Eastern markets. Pursuant to the joint venture
      agreement, the Company received a license fee of $5 million in exchange
      for the joint venture's right to market the Wave technology in European
      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,
      the Company received $1.0 million from the joint venture representing
      partial payment of the license fee, with the remaining payments to be made
      upon the Company'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 the Company had met the contractual requirements required in order
      to have earned the first payment. During the fourth quarter of 1997, the
      Company 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 the Company accrued $490,000 in the fourth
      quarter of 1997 for expenses related to the Company'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 the Company. The payment of $750,000 was
      received in January 1998. The Company also received the final payment of
      $3.25 million in June 1998. This payment and the $750,000 received in
      January 1998 total $4 million received in 1998. As part of the Agreement,
      after the final license fee was paid, the Company issued a warrant to each
      other to purchase approximately one million shares of each others' common
      stock. The exercise price of the Wave warrants is $1.75 per share. The
      exercise price of the ITG warrant is approximately .995 British pound per
      share. On June 5, 1998, the final milestone for the last payment on the
      license fee was attained and the Company 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 the Company of
      approximately $1.1 million. The Company, upon determining this cost,
      recorded the total amount as ITG net warrant cost in the Consolidated
      Statement of Operations. During November 1999 the Company exercised the
      ITG warrant.

      The joint venture is entirely funded through advances from ITG and the
      Company has no commitment to fund the operations of the joint venture.

      The Company accounts for its 25% interest in the joint venture pursuant to
      the equity method of accounting. At December 31, 1999 and 1998, the
      Company's investment in the joint venture was $0 for financial reporting
      purposes.

      On November 5, 1999 the Company had exercised its warrant for 1,000,000
      shares in ITG at a total cost of $1,620,000. Also during the year ITG
      exercised its 1,000,000 warrants in the Company yielding total proceeds of
      $1,750,000. As of December 31, 1999 Wave's equity investment in ITG was
      valued at $4,480,500 with an unrealized investment gain of $2,860,500.

                                                                     (Continued)

<PAGE>
                                      F-32


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

             Notes to Consolidated Financial Statements, (Continued)

   (b) WaveXpress

      In April 1999, WaveXpress, a joint venture between Wave and Sarnoff
      Corporation was established. The joint venture is owned 53% by the
      Company and 7% by certain of its affiliates, including Peter and Steven
      Sprague and certain Wave employees and members of the Board of Directors,
      and 40% by Sarnoff and its affiliates. Wave is also funding WaveXpress
      through a convertible note. This note can be converted into equity by the
      Company. Through December 31, 1999, Wave had provided approximately $3.2
      million in funds.

      The financial statements of WaveXpress have been consolidated with those
      of the Company as of, and for the period ended, December 31, 1999. As the
      joint venture partner, Sarnoff Corporation, has not contributed any cash
      and is not required to fund the operations of the joint venture, the
      Company 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 these consolidated
      financial statements. For the period April 1999, date of inception, to
      December 31, 1999, WaveXpress' operating results included a net loss of
      approximately $1.9 million and license fees paid of approximately $1.8
      million.

(13) Commitments and Contingencies

   Litigation

      The Company is 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 or
      results of operations of the Company.

      On June 27, 1997 a complaint alleging breach of contract, among other
      related claims, was filed against the Company by Carl A. Artopeous and
      Artopeous Capital Management (collectively, "Artopeous") with the
      Sacramento Superior Court in Sacramento, California in connection with the
      engagement of Artopeous by the Company to arrange financing. The action
      has been removed to the Federal Court, Eastern District of California.
      Wave filed its answer in December 1997 and agreed to a settlement on
      January 25, 1999. The settlement cost of approximately, $602,000 and has
      been accrued in the December 31, 1998 financial statements.

                                                                     (Continued)

<PAGE>
                                      F-33


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

             Notes to Consolidated Financial Statements, (Continued)

   Leases

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

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------
               Location      Annual Lease Cost          Lease Expires

<S>                              <C>                    <C>
                Lee, MA              $ 137,186              Jul. 2002

            Danvers, MA                 57,915              Sep. 2002

           New York, NY                144,000              May  2001

          Princeton, NJ                411,787              Dec. 2002

          Cupertino, CA                469,146              Oct. 2002

           San Jose, CA                 76,930              Dec. 2001

       New York, NY (1)                406,634              Apr. 2010
                                   --------------
                                    $1,703,598
                                   ==============

</TABLE>

(1) WaveXpress facility leased beginning Feb. 2000

      The Company is obligated under a capital lease for a phone system in the
      Lee, Massachusetts office. At December 31, 1999 the gross amount of the
      equipment and related accumulated amortization recorded under capital
      lease was as follows:

<TABLE>
<CAPTION>
                                                         1999             1998
                                                         ----             ----
<S>                                                <C>              <C>
Phone Equipment                                        $111,291         $111,291
Less: Accumulated Amortization                           90,819           33,387
                                                       --------         --------
Ending Balance                                         $ 20,472         $ 77,904
                                                       ========         ========
</TABLE>

      Amortization of assets held under capital lease is included with
      depreciation expense.

      Future minimum lease payments under noncancelable operating leases (with
      initial or remaining lease terms in excess of one year) and future minimum
      capital lease payments as of December 31, 1999 are as follows:

Year ending December 31,          Capital Lease        Operating Lease
------------------------          -------------        ---------------

         2000                         20,761               1,738,598
         2001                             --               1,783,909
         2002                             --                1,543378

Total minimum lease payments          20,761             $ 5,065,885
                                                         ===========

                                                                     (Continued)
<PAGE>
                                      F-34


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

             Notes to Consolidated Financial Statements, (Continued)

      Rent expense for the years ended December 31, 1999, 1998, 1997 and for the
      period from inception through December 31, 1999 amounted to approximately
      $957,000, $561,000, $484,000 and $3,119,000, respectively.

      WaveXpress, in January 2000, executed a ten year lease for 12,200 square
      feet in New York City, NY. The initial monthly lease payment is $35,000
      per month.

(14) Income Taxes

      The Company has net operating loss carryforwards for tax return purposes
      of approximately $80.1 million which expire beginning in 2003 through
      2020.

      Pursuant to the Internal Revenue Code, Section 382 of 1986, annual
      utilization of the Company's net operating loss carryforwards may be
      limited if a cumulative change in ownership of more than 50% occurs within
      a three year period. The Company 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.

      The tax effects of temporary differences that give rise to the deferred
      tax asset at December 31, 1999 and 1998 are as follows:

<TABLE>
<CAPTION>

                                                       1999            1998
                                                       ----            ----
<S>                                            <C>              <C>
     Deferred tax assets:
       Net operating loss carryforwards            $ 32,239,000    $ 21,706,000
       Start-up costs                                 1,114,000       1,383,000
       Accrued expenses                                 145,000          32,000
       License rights                                   626,000         980,000
                                                   ------------    ------------

          Total gross deferred tax assets            34,124,000      24,101,000

Deferred tax liability
       Unrealized Gain                               (1,152,000)
       Depreciation                                     (44,000)
                                                   ------------
          Total gross deferred tax liability         (1,196,000)
       Less valuation allowance                     (32,928,000)    (24,101,000)
                                                   ------------

          Net deferred tax asset                   $         --    $         --
                                                   ============    ============

</TABLE>

      The valuation allowance increased by approximately $8.8 million and $6.0
million, during the years ended December 31, 1999 and 1998, respectively.

      Management has concluded that it is more likely than not that the Company
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 $32,928,000 and $24,101,000 has
been established to reduce the deferred tax assets at December 31, 1999 and 1998
respectively.

                                                                     (Continued)

<PAGE>
                                      F-35


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

             Notes to Consolidated Financial Statements, (Continued)

(15) Defined Contribution Plan

      The Company 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 the Company become
      eligible immediately on employment. The Company has the option to make
      discretionary matching contributions; no contributions were made in 1999,
      1998 or 1997.

(16) Disclosures about the Fair Value of Financial Instruments

      Cash and Cash Equivalents, Marketable Securities, Prepaid Expenses and
      Other Receivables , 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 United Kingdom 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.

(17) Subsequent Events

      In January of 2000, a warrant holder exercised all of their 275,000
      warrants, which were issued as part of a loan provided to the Company in
      January 1999. The warrants were converted at the predetermined exercise
      price of $4.00 per share resulting in total proceeds to the Company of
      $1.1 million.

      During January of 2000, Concentric Network Corporation completed their
      acquisition of ITG. In consideration for its 1,000,000 shares in ITG, the
      Company received approximately $2,150,000 in cash and 83,910 shares of
      Concentric. As of March 3, 2000 the 83,910 shares of Concentric common
      stock had a market value of $3,608,130 based on that day's closing price
      of $43.00 per share.

      During March of 2000, Peter Sprague applied his $150,000 bonus to the
      repayment of his loan. At December 31, 1999, the outstanding balance on
      the loan was $154,160.

      During March of 2000, the Company raised $122,427,200 through the private
      placement to institutional and accredited investors of 3,600,800 shares of
      Class A common stock at $34.00 per share.