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                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC 20549

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

                                   FORM 10-K

                 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
          SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
   ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                      OR

[_]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 0-20789

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

                                 ONEWAVE, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

               DELAWARE                              04-3249618
       (STATE OF INCORPORATION)         (I.R.S. EMPLOYER IDENTIFICATION NO.)

                           ONE ARSENAL MARKETPLACE,
                              WATERTOWN, MA 02172
                   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                           TELEPHONE: (617) 923-6500

       SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE.

          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

                    COMMON STOCK, PAR VALUE $.001 PER SHARE
                               (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
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 voting stock of the registrant held by
non-affiliates of the registrant on March 23, 1998 was $15,532,615.

  The number of shares of the registrant's Common Stock, par value $.001 per
share, outstanding on March 23, 1998 was 14,370,616.

                      DOCUMENTS INCORPORATED BY REFERENCE

  Portions of the Company's definitive proxy statement relating to the Annual
Meeting of Stockholders to be held on May 21, 1998 is incorporated by
reference into Part III of this Report on Form 10-K.

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  STATEMENTS MADE OR INCORPORATED INTO THIS FORM 10-K INCLUDE A NUMBER OF
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. FORWARD
LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONTAINING THE
WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," AND WORDS OF
SIMILAR IMPORT WHICH EXPRESS MANAGEMENT'S BELIEFS, EXPECTIONS OR INTENTIONS
REGARDING THE COMPANY'S FUTURE PERFORMANCE. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE SET FORTH IN THE FORWARD-LOOKING STATEMENTS.
CERTAIN FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE ARE DISCUSSED IN THE
SECTION ENTITLED "CERTAIN FACTORS THAT MIGHT AFFECT FUTURE RESULTS" ON PAGE 15
OF THIS ANNUAL REPORT.

                                    PART I

ITEM 1. BUSINESS

  OneWave, Inc. ("OneWave" or the "Company"), a Delaware corporation, was
incorporated in January 1994. Since its inception, OneWave has helped
organizations to build applications that integrate and extend disparate
information systems. In the past, OneWave focused on developing and marketing
its application development products, along with implementation services.

  At the end of the second quarter of 1997, there was a change in control of
the Company. Avix Ventures, L.P. ("Avix") purchased a majority interest in the
Company from a group of the Company's principal shareholders. Two senior
executives resigned, and Lennart Mengwall, a principal at Avix with 30 years
of experience in the information technology industry, was thereafter appointed
the new Chairman and, subsequently, Chief Executive Officer of the
Company. New management immediately undertook a comprehensive review of the
Company's strategy and operations. As a result of this review, the Company
took steps to reduce expenses, including reducing OneWave's workforce by
approximately 39%. At the same time, the Company was re-organized into two
distinct business units: the Consulting Services Group (CSG) and the Software
Products Group (SPG). The Company believed that a re-organization into two
separate business units would allow each business to focus on its core
competencies.

  Late in the first quarter of 1998, the Company made a decision to unify its
two business units into a single consulting services organization focused on
delivering business and information technology solutions on a fixed-
price/fixed-time basis. As a result, the Company does not anticipate the
future marketing of its current stand alone software products. The Company
intends to extend its current services business to emphasize building cross-
enterprise, e-Business solutions. E-Business encompasses a wide variety of
business processes in which Internet technologies are used to bring together
customers, vendors, suppliers and employees in ways that are generally
designed to enhance commerce among business partners.

  OneWave intends to utilize innovative methodologies combined with cutting-
edge technical capabilities to conceptualize, design, develop, and deploy e-
Business solutions facilitated by Internet technologies. The Company believes
that this focus will allow OneWave to more effectively leverage its core
competencies to deliver maximum value to its customers through consulting
services centric solutions.

BUSINESS BACKGROUND

 Evolution of Business Processes

  In response to increased competitive pressures, businesses in recent years
have engaged in the extensive re-engineering of critical business processes.
At first, these efforts focused primarily on realizing productivity and
efficiency gains within functional areas, such as finance, sales and
marketing, manufacturing, and resource planning. As gains in these areas began
to plateau, organizations shifted the focus of their process design efforts

                                       2
<PAGE>

from departmental to enterprise business processes. Enterprise business
processes span functional boundaries and require sharing of information across
departmental information systems. A number of software vendors have been
successful in selling enterprise client/server systems to support this type of
enterprise re-engineering. In addition, systems integration firms have
provided services to integrate disparate departmental systems to support
unified enterprise business processes.

  Most recently, organizations have begun to realize the potential of a new
generation of e-Business solutions to link business partners and customers
through a set of common business applications. For example, business partners
can automate complex business transactions, or streamline current business
processes, such as the cycle of order processing, fulfillment, payment,
inventory tracking and replenishment, and shipment confirmation. Creating and
managing these processes requires a new approach, which must include
innovative techniques and methodologies for all aspects of building and
designing solutions that address the needs of multiple organizations.

 Internet Technologies and the Demand for e-Business Solutions

  The recent emergence and rapid development of Internet technologies has
created the opportunity to implement business solutions that are truly
collaborative by leveraging the convenience, availability and world-wide reach
of the Internet. OneWave believes that businesses will be able to realize
substantial productivity and efficiency gains by using Internet technologies
to facilitate systems integration and support collaborative business
processes.

  However, as companies begin to take advantage of Internet technologies, they
find that the Internet provides an infrastructure for communication but does
not by itself enable organizations to build business processes characteristic
of e-Business. Developing e-Business solutions requires methodologies that can
resolve the competing demands of potential business partners, as well as solve
complex systems integration issues as they arise.

  For this reason, the Company believes that there is a strong demand for
consulting services to design and implement innovative e-Business solutions.
The Company further believes that few companies today have the combination of
expertise in consulting methodology and integration technologies required for
building such solutions.

STRATEGY

 Evolution of OneWave's Strategy

  Prior to the change in the Company's senior executive management in the
second quarter of 1997, OneWave built its services strategy around its
technology for the integration of disparate legacy systems. Following the
change of control and subsequent review of its operations, the Company
modified its strategy. Specifically, the Company established the Consulting
Services Group and Software Products Group as independent business units to
allow each to focus on its core competencies.

 Consulting Services Group

  The Consulting Services Group (CSG) was chartered to build strategic
applications for customers seeking to integrate and extend core business
systems using best-of-breed technologies. These strategic applications
delivered value to customers by supporting entirely new business processes
based on Internet infrastructures.

  In the second half of 1997, CSG formalized its OneSTEP(TM) methodology for
delivering complete, comprehensive, and effective business solutions.
OneWave's OneSTEP methodology utilizes a fixed-price/fixed-time approach that
allows clients to implement solutions rapidly, while giving them control over
each distinct phase of the process.


                                       3
<PAGE>

  Using this model, applications are split into several phases. Each phase is
carefully chosen to incorporate valuable business functionality, and also to
be deliverable within a short timeframe. The phases are then delivered in the
following Steps:

  Scope: The purpose of the Scope Step is to clearly define application
objectives and requirements, build a strong business case for the application,
and begin building a project team. At the end of the Scope Step, the client's
project team presents its findings to its management and reviews the actions
required to undertake the next Step. OneWave's presentation includes a fixed-
price/fixed-time frame proposal for the next Step, and an estimated price and
timeframe for the Development Step.

  SWAT Workshop (SWAT): The SWAT Workshop is an optional, intensive, three-
week program designed to build consensus within the client's organization for
the proposed application. As part of a SWAT, OneWave facilitates sessions with
the client that clarify the business case and calculate the projected return
on investment for the proposed application. In addition, the client's project
team and OneWave develop a live prototype that connects to the current in-
house applications. This prototype is presented to the customer's executive
management team on the last day of the program. A SWAT is most useful for
clients seeking to create additional momentum for proceeding with a project.
The workshop provides application stakeholders with justification for
beginning the development life cycle.

  Design: The purpose of the Design Step is to define all aspects of the
application and formulate a schedule for the Development Step. As part of the
Design Step, customers may opt to build a live prototype that is
representative of the final application. OneWave consultants facilitate
discussions with end-users and technical staff to define specifications for
graphical user interfaces, application functionality, system performance and
connectivity to existing systems.

  Development: The purpose of the Development Step is to build and test the
fully functional application. Frequent checkpoint meetings and user acceptance
testing ensure that the application adheres to the specifications set forth in
the Design Step.

  Rollout: The Rollout Step involves deploying the fully developed and tested
system to the client's production environment. Continuous involvement in the
Scope, Design, and Development Steps of the project builds a knowledge base
within the client's technical staff and increases client self-sufficiency.

  OneWave expects that the OneSTEP methodology will be its foundation for
delivering e-Business solutions. OneWave believes that the OneSTEP methodology
will evolve as the Company continues to refine its methods for scoping,
designing, and delivering such solutions based on a multi-organization
collaborative process. OneWave further believes that few service companies are
delivering this type of solution today, and that, consequently, there is no
commonly accepted business model for doing so. OneWave believes that to be
successful, it will need to create innovative business practices that assist
business partners to collaborate through all phases of the development cycle.

 Software Products Group

  The Software Products Group (SPG) was chartered to build production-quality
application development tools based on OneWave's existing technology base.
From its inception, the Company has specialized in tools for building multi-
tiered applications that connect complex enterprise systems to the Internet.
The Company's principal software product, OneWave Enterprise, provided an end-
to-end solution for building multi-tiered Internet-based applications.

  After an extensive review of the market for Internet-based application
development tools, the Company concluded, that the rapid emergence of full-
featured application development tools for building user interfaces and the
rapid maturation of Web servers from industry leaders limited the market
opportunity for an end-to-end application development product from OneWave.
Based on this assessment, the Company concluded its ability

                                       4
<PAGE>

to connect to complex, back-end enterprise systems from market leading Web
servers was the preferred utilization of its core technical competencies given
the then current status of market opportunities. This ability to connect to a
variety of disparate systems is a fundamental enabling technology for building
distributed Web-based applications that leverage information and business
functionality across inter-company systems. Consequently, SPG focused on
developing technologies and application development tools for connecting
legacy systems to market leading Web servers. While SPG continued to support
existing OneWave Enterprise customers, development resources in the second
half of 1997 were primarily allocated to enhancing OneWave's connectivity
technology.

  The Company intended to market its technology as a licensed software product
called OneWave Connector(TM). After evaluating the results of market tests and
competitive developments, the Company decided that marketing OneWave Connector
as a licensed product was not the most effective way to deliver the value of
the technology to customers. Instead, the Company intends to leverage the
expertise acquired through the development of the OneWave Connector
technology, where appropriate, in the development and deployment of solutions
that require integration of disparate enterprise systems.

 OneWave's Unified Strategy: Delivering Next-Generation Solutions for e-
Business

  Late in the first quarter of 1998, OneWave began to focus on building e-
Business solutions to meet the growing demand for a new generation of business
applications that enable collaboration between organizations, their business
partners, and their customers. OneWave intends to market a well-defined set of
service offerings based on its current OneSTEP methodology, with an emphasis
on ensuring process definition and business application implementation.

  To support this unified solutions strategy, the Consulting Services Group
and the Software Products Group will no longer operate as independent business
units. The Company believes that combining the core competencies of CSG and
SPG enhances OneWave's ability to differentiate itself in the market for
building business-to-business solutions. The Company further believes
OneWave's set of core competencies can be leveraged to provide customers with
rapid development of production-quality solutions.

  While the Company believes that in the long term its change of business
focus will improve Company performance, in the short term revenues will be
uncertain while the Company solidifies its service offerings and progresses
through its transition period. Among other things the Company must build its
sales organization and re-deploy employees previously focused on its software
product offering. It is premature for the Company to determine whether its new
strategy will be successful, and the Company's plans and strategies are likely
to continue to evolve.

STRATEGIC RELATIONSHIPS

  To reach a broad potential customer base, the Company believes that it must
develop partnerships in multiple sales channels. OneWave's partnerships with
complementary technology vendors and systems integrators have to date focused
on promoting the Company's products, augmenting the Company's product
capabilities, and providing consulting services to support application
development efforts using the Company's products. OneWave's new strategy of
providing consulting services to support the development of collaborative
business solutions changes the way in which the Company will approach its
partnerships. OneWave is in the process of re-evaluating and re-focusing
existing partnerships.

COMPETITION

  The market for custom software solutions and technologies is intensely
competitive and subject to rapid technological change. OneWave expects
competition to persist and intensify in the future. OneWave has experienced
and expects to continue to experience increased competition from current and
future competitors, many of whom have significantly greater financial,
technical, marketing resources, name recognition and

                                       5
<PAGE>

customer base. OneWave's current and potential competitors include, among
others: consulting divisions of leading software system providers and hardware
manufacturers; solution services companies; and software vendors whose
packaged applications can be used or customized to support e-Business
processes.

  OneWave's competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources
to the promotion and sale of their consulting services than the Company. Also,
the Company's current and potential competitors generally have greater
financial or management resources, name recognition, or more extensive
customer bases that could be leveraged, thereby potentially limiting OneWave's
market share. OneWave expects to face additional competition as other
established and emerging firms enter the market for customized e-Business
system integration services. Increased competition could result in price
reductions, fewer customer orders, reduced gross margins and loss of market
share, any of which could materially and adversely affect the Company's
business, operating results and financial condition. In addition, current and
potential competitors may make strategic acquisitions or establish cooperative
relationships among themselves or with third parties, thereby increasing the
ability to address the needs of OneWave's prospective customers. Such
competition could materially and adversely affect OneWave's ability to obtain
and retain support for its services. There can be no assurance that OneWave
will be able to compete successfully against current and future competitors,
and the failure to do so could have a material adverse effect upon the
Company's business, operating results and financial condition.

  The principal factors affecting the market for OneWave's services are
expertise in functional areas and system implementation, price, customer
support, and project management. The failure to compete successfully could
have a material adverse effect upon the Company's business, operating results
and financial condition.

RESEARCH AND DEVELOPMENT

  Historically, the Company has made substantial investments in product
development and technology integration. The OneWave product line has been
developed primarily by the Company's internal development staff. Certain
technologies also have been purchased and integrated into OneWave products.
The Company's expenditures for research and development during 1995, 1996 and
1997 were $3,182,000, $3,529,000 and $2,167,000 respectively.

  The Company believes that its investment in developing proprietary
technology has resulted in considerable expertise in software development
methodologies, back-end integration techniques, and Internet application
development tools, as well as the intrinsic value of the technology itself.
This expertise serves to differentiate OneWave from other companies offering
solution services.

PROPRIETARY RIGHTS

  OneWave relies on a combination of trademark, copyright and trade secret
laws, employee and third-party nondisclosure agreements and other means to
protect its proprietary rights in its technology. The Company has filed
applications for registration of its various trademarks. There can be no
assurance that any trademark or patent applications will result in issued
patents or trademarks or that, if issued, such patents or trademarks would be
upheld if challenged.

  There can be no assurance that the Company's competitors will not
independently develop technologies that are substantially equivalent or
superior to the Company's technology or methodologies, or that the measures
taken by the Company to protect its proprietary rights will be adequate to
prevent misappropriation of its technology or methodologies or independent
development by others of similar technology or methodologies. In addition, the
laws of various countries in which the Company's products may be sold may not
protect the Company's intellectual property rights to the same extent as the
laws of the United States.

  There can be no assurance that third parties will not assert intellectual
property infringement claims against the Company or that any such claims will
not require the Company to enter into royalty arrangements or result

                                       6
<PAGE>

in costly litigation. The Company is not the subject of any legal action
alleging the infringement of any copyright or trademark rights of any person
or of any violation of trade secrets or other proprietary rights claimed by
any third party relating to the Company or the Company's technology or
methodologies, nor is the Company aware of any threatened litigation with
regard thereto. However, the computer software market is characterized by
frequent and substantial intellectual property litigation. Intellectual
property litigation is complex and expensive, and the outcome of such
litigation is difficult to predict.

  The Company believes that, due to the rapid pace of technological
innovation, its ability to establish and maintain a position of technology
leadership in the industry is dependent more upon the skills of its consulting
and development personnel than upon the legal protections afforded to its
existing technology.

EMPLOYEES

  As of March 23, 1998, OneWave had a total of 62 employees. The Company's
future success depends in significant part upon the continued service of its
key technical, consulting, and senior management personnel, and its continuing
ability to attract and retain highly qualified technical, services, and
managerial personnel. Competition for highly qualified personnel is intense,
and there can be no assurance that the Company will be able to retain its
technical and managerial employees or that it will be able to attract and
retain such personnel in the future. None of the Company's employees is
represented by a labor union. The Company has not experienced any work
stoppages and considers its relations with its employees to be generally good.

  In order for OneWave to fully exploit the market opportunity for its
services, an effective planning and management process is required. The
industry's rapid rate of change has placed, and is expected to continue to
place, a significant strain on managerial, operational and financial
resources. The senior members of the Company's management team joined OneWave
during 1997 and early 1998. In addition, many of the Company's consulting
staff were only recently hired and in June 1997 the Company experienced a
significant reduction in its senior management staff and operational staff. To
manage potential future growth, OneWave must continue to implement and improve
its operational and financial systems and to expand, train and manage its
employee base. The Company's future operating results also will depend on its
ability to expand and train its sales and marketing organizations and
implement and manage new distribution channels to penetrate different and
broader markets. Currently the Company has only 3 sales personnel including
the vice president of sales and market, Joe Seebach, formerly the president of
the Software Products Group. If OneWave is unable to manage growth
effectively, the Company's business, operating results and financial condition
could be materially adversely affected.

ITEM 2. PROPERTIES

  The Company leases approximately 26,000 square feet of office space in
Watertown, Massachusetts under a five-year lease agreement which commenced in
March 1996. Depending on its future growth, if any, the Company may need to
expand its existing facilities or obtain additional space prior to the end of
1998. Management believes that adequate facilities for expansion will be
available, if necessary, at competitive rates.

ITEM 3. LEGAL PROCEEDINGS

  In the normal course of its operations, the Company is subject to
performance under contracts and has certain legal actions and contingencies
pending. However, in management's opinion, any such outstanding matters would
not have a material adverse effect on the Company's financial position,
results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

  There were no matters submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders through solicitation of
proxies or otherwise.

                                       7
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                                    PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS

 Market Information

  The Company's Common Stock, $.001 par value ("Common Stock"), has been
traded on the NASDAQ National Market ("Nasdaq") since the Company's initial
public offering on July 3, 1996 and currently trades under the symbol "OWAV."
The following table sets forth the high and low of the closing bid prices for
the Company's Common Stock as reported by Nasdaq for the periods indicated:

<TABLE>
<CAPTION>
                                                              MARKET PRICES (1)
                                                              ------------------
     1996 FISCAL QUARTERS                                       HIGH      LOW
     --------------------                                     --------- --------
     <S>                                                      <C>       <C>
     Third (from July 3)..................................... $   18.00 $  12.75
     Fourth.................................................. $   17.25 $   7.00
<CAPTION>
                                                              MARKET PRICES (1)
                                                              ------------------
     1997 FISCAL QUARTERS                                       HIGH      LOW
     --------------------                                     --------- --------
     <S>                                                      <C>       <C>
     First................................................... $    8.88 $   1.94
     Second.................................................. $    2.69 $   1.63
     Third................................................... $    3.06 $   2.44
     Fourth.................................................. $    2.88 $   1.56
</TABLE>
--------
(1) The prices listed reflect inter-dealer prices without retail mark-up,
    mark-down or commission and may not necessarily represent actual
    transactions.

 Holders

  The number of record holders of the Company's Common Stock as of March 23,
1997 was approximately 140.

 Dividends

  The Company did not pay cash dividends on its Common Stock during the years
ended December 31, 1997 and December 31, 1996. The Company does not intend to
pay cash dividends on its Common Stock in the foreseeable future.

                                       8
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ITEM 6. SELECTED FINANCIAL DATA

  The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements of the Company, including the Notes
thereto, included elsewhere in this Annual Report. The consolidated statements
of operations data set forth below for the fiscal years ended December 31,
1995, 1996 and 1997, and the consolidated balance sheet data as of December
31, 1996 and 1997, are derived from the Company's audited financial statements
which have been audited by Arthur Andersen LLP, independent public
accountants, and which are included elsewhere in this report. The consolidated
statements of operations data for the period from inception (January 19, 1994)
to December 31, 1994 and the Consolidated balance sheet data as of December
31, 1994 and 1995 are derived from audited consolidated financial statements
not included in this Annual Report on Form 10-K. The historical results are
not indicative of the results of operations to be expected in the future.

<TABLE>
<CAPTION>
                          JANUARY 19, 1994   YEAR ENDED   YEAR ENDED   YEAR ENDED
                           (INCEPTION) TO   DECEMBER 31, DECEMBER 31, DECEMBER 31,
                          DECEMBER 31, 1994     1995         1996         1997
                          ----------------- ------------ ------------ ------------
                                    (IN THOUSANDS EXCEPT PER SHARE DATA)
<S>                       <C>               <C>          <C>          <C>
STATEMENT OF OPERATIONS
 DATA:
Revenues:
  Software license and
   maintenance..........       $   --         $ 2,151      $  8,106     $ 1,248
  Consulting and
   education services...           --           3,919         5,098       4,399
                               -------        -------      --------     -------
    Total revenues......           --           6,070        13,204       5,647
Cost of Revenues:
  Software license and
   maintenance..........           --             717         1,517         638
  Consulting and
   education services...           --           2,684         4,001       4,494
                               -------        -------      --------     -------
    Total cost of
     revenues...........           --           3,401         5,518       5,132
    Gross profit........           --           2,669         7,686         515
Operating Expenses:
  Selling, general and
   administrative.......           286          2,108        10,565       5,845
  Research and
   development..........           894          3,182         3,529       2,167
  Restructuring charge..           --             --            --        1,782
  Compensation to former
   chief executive
   officer..............           --             --          6,794         227
                               -------        -------      --------     -------
    Total operating
     expenses...........         1,180          5,290        20,888      10,021
                               -------        -------      --------     -------
    Operating loss......        (1,180)        (2,621)      (13,202)     (9,506)
Interest (Expense)
 Income, net............           --             (77)          953       1,885
                               -------        -------      --------     -------
  Loss before income
   taxes................        (1,180)        (2,698)      (12,249)     (7,621)
Income Tax Expense......           --             --             95          15
                               -------        -------      --------     -------
  Net loss..............       $(1,180)       $(2,698)     $(12,344)    $(7,636)
                               =======        =======      ========     =======
Basic and Diluted Net
 Loss per Common Share..       $  (.15)       $  (.28)     $  (1.03)    $  (.52)
                               =======        =======      ========     =======
Shares Used in Computing
 Net Loss per Common
 Share..................         7,933          9,492        12,560      14,560
                               =======        =======      ========     =======
<CAPTION>
                                                DECEMBER 31,
                          --------------------------------------------------------
                                1994            1995         1996         1997
                          ----------------- ------------ ------------ ------------
<S>                       <C>               <C>          <C>          <C>
BALANCE SHEET DATA:
Cash, cash equivalents
 and marketable
 securities.............       $   --         $   105      $ 40,050     $33,713
Working capital
 (deficit)..............          (932)        (1,967)       36,471      31,836
Total assets............            63          2,626        46,151      36,266
Stockholders' equity
 (deficit)..............          (868)        (2,804)       39,737      33,405
</TABLE>

                                       9
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS

OVERVIEW:

  The Company was incorporated in January 1994. Since its inception, OneWave
has helped organizations build applications that integrate and extend
disparate information systems. In the past, OneWave focused on developing and
marketing its application development products, along with implementation
services.

  At the end of the second quarter of 1997, there was a change in control of
the Company. Avix Ventures, L.P. ("Avix") purchased a majority interest in the
Company from a group of the Company's principal shareholders. Two senior
executives resigned, and Lennart Mengwall, a principal at Avix with 30 years
of experience in the information technology industry, was thereafter appointed
the new Chairman and, subsequently, Chief Executive Officer of the Company.
New management immediately undertook a comprehensive review of the Company's
strategy and operations. As a result of this review, the company took steps to
reduce expenses, including reducing OneWave's workforce by approximately 39%.
At the same time, the Company was re-organized into two distinct business
units: the Consulting Services Group (CSG) and the Software Products Group
(SPG). The Company believed that a re-organization into two separate business
units would allow each business to focus on its core competencies.

  Late in the first quarter of 1998, the Company made a decision to unify its
two business units into a single organization focused on delivering e-Business
solutions. As a result, the Company's management does not anticipate the
future marketing of stand alone software product offerings. Accordingly,
management can not currently anticipate revenue levels. However, management
does anticipate incurring significant expenses as the Company attempts to grow
its sales and consulting staff. The Company intends to expand its current
services business to emphasize building, cross-enterprise, e-Business
solutions. E-Business encompasses a wide variety of business processes in
which Internet technologies are used to bring together customers, vendors,
suppliers and employees in ways that are generally designed to enhance
commerce among business partners.

  OneWave intends to utilize innovative methodologies combined with cutting-
edge technical capabilities to conceptualize, design, develop, and implement
e-Business solutions facilitated by Internet technologies. The Company
believes that this focus will allow OneWave to more effectively leverage its
core competencies to deliver maximum value to its customers through consulting
services centric solutions.

  In 1994, the Company focused on research and development and did not
generate revenues. In 1995, the Company generated revenues primarily through
the reselling of software licenses of a related party, offering the associated
maintenance, and providing consulting and education services. These revenues
contributed to the funding of increased research and development and the
creation of market awareness for the OneWave product line (the Company
previously sold its product under the OpenScape name). The Company began
shipping OpenScape products in late December 1995. In 1996, the Company
primarily sold its products through alliance partners and its direct sales
force. Alliance partners generated 47% of 1996 revenues, primarily through a
limited number of large software license sales. The direct sales channel
generated 51% of 1996 revenues. The direct sales model did not develop into a
predictable source of revenue during 1996. The remaining 2% of 1996 revenues
was primarily generated from value added resellers.

  Included in revenues generated from alliance partners during 1996 were
$2,920,000 of software license fees and $514,000 of consulting services
revenues associated with the development of vertical applications in
conjunction with Internet Business Solutions, Inc. (IBS). IBS provided up to
100% of the funding of the purchase of software licenses and consulting
services in return for certain rights in the developed applications. IBS was
then a related party of the Company. See Note 4 (d) of Notes to the
Consolidated Financial Statements.

  The Company has a limited operating history upon which to base an evaluation
of the Company and its prospects. The Company and its prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in early stages of development, particularly
companies in new and rapidly

                                      10
<PAGE>

evolving markets and technologies. To address these risks, the Company must,
among other things, grow the consulting business, respond to competitive
developments, successfully adjust the Company's strategy to changes in the
marketplace, identify channels for the Company's services, continue to
attract, retain and motivate qualified management and other employees, and
remain knowledgeable with new and emerging technologies. There can be no
assurance that the Company will be successful in addressing such risks. The
Company has achieved only limited revenues to date and its ability to generate
significant revenues is subject to substantial uncertainty. The limited
operating history of the Company makes the prediction of future results of
operations difficult and therefore, there can be no assurance that the Company
will sustain revenue growth or achieve profitability. The Company has incurred
net losses since inception and expects to continue to incur losses on a
quarterly and annual basis for the foreseeable future. Due to all of the
foregoing factors, it is possible that in some future quarter, the Company's
operating results may be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock may be
materially adversely affected.

RESULTS OF OPERATIONS:

  The following table sets forth certain operational data as a percentage of
total revenues for the years ended December 31, 1995, 1996, and 1997:

<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                               ------------------------------
                                                1995       1996       1997
                                               -------    -------    --------
   <S>                                         <C>        <C>        <C>
   Revenues:
     Software license and maintenance........       35 %       61 %        22 %
     Consulting and education services.......       65         39          78
                                               -------    -------    --------
       Total revenues........................      100        100         100
   Cost of Revenues:
     Software license and maintenance........       12         12          11
     Consulting and education services.......       44         30          80
                                               -------    -------    --------
       Total cost of revenues................       56         42          91
       Gross profit..........................       44         58           9
   Operating Expenses:
     Selling, general and administrative.....       35         80         104
     Research and development................       52         26          38
     Restructuring charge....................       --         --          32
     Compensation to former chief executive
      officer................................       --         51           4
                                               -------    -------    --------
       Total operating expenses..............       87        157         177
       Operating loss........................      (43)       (99)       (168)
   Interest (Expense)/Income, net............       (1)         7          33
                                               -------    -------    --------
     Loss before provision for income taxes..      (44)       (92)       (135)
   Provision for Income Taxes................       --          1          --
                                               -------    -------    --------
     Net loss................................      (44)%      (93)%      (135)%
                                               =======    =======    ========
</TABLE>
1997 COMPARED TO 1996

 Revenues:

  Total revenues decreased by $7,557,000 to $5,647,000 in 1997 from
$13,204,000 in 1996. The decrease was due primarily to decreases in the volume
of sales of the Company's software products. For the fiscal year ended
December 31, 1997, software license and maintenance revenues represented 22%
of total revenues with the remaining 78% derived from consulting and education
services, compared with 61% and 39%, respectively, for the comparable prior
year. In early 1997, the Company changed its direct sales strategy to a
solutions-based model due to the failure to obtain repeatable software product
sales. The Company's revenues were negatively impacted as the Company
transitioned to this new model. During the second quarter of 1997, a change in
the

                                      11
<PAGE>

Company's senior executive management combined with the departure of two
senior executives and a reduction in force caused the Company to again
evaluate its approach to selling its products and services. As a result, the
Company separated into two business units, the Software Products Group and the
Consulting Services Group. During the second half of 1997, the two business
units focused on developing their individual core competencies. The Company's
revenues remained relatively flat through each quarter of 1997. The resale of
third-party software license and maintenance revenues decreased by $1,639,000
to $121,000 in 1997 from $1,760,000 in 1996.

  Late in the first quarter of 1998, the Company made a decision to unify its
two business units into a single consulting services organization focused on
delivering business and information technology solutions on a fixed-
price/fixed-time basis. As a result, the Company does not anticipate the
future marketing of stand alone software product offerings. The Company
intends to extend its current services business to emphasize building cross-
enterprise, e-Business solutions. The Company believes that this focus will
allow OneWave to more effectively leverage its core competencies to deliver
maximum value to its customers, but as of yet has not generated new revenues
from its efforts. The Company's management can not currently anticipate
revenue levels for the business.

 Gross profit:

  Total gross profit decreased by $7,170,000 to $515,000 in 1997 from
$7,685,000 in 1996. The cost of software license and maintenance revenues
consists of the cost of software and maintenance purchased for resale from a
third-party vendor, distribution costs and product support costs. See Note
4(b) of the Notes to the Consolidated Financial Statements. The cost of
consulting and education services consists primarily of consulting and
education personnel salaries, related costs and fees to third-party service
providers. For the year ended December 31, 1997, total gross margin decreased
to 9% of total revenues from 58% of total revenues for the comparable prior
year period. The gross margin for software license and maintenance revenues in
1997 was 49% and the gross loss percentage for consulting and education
services revenues was 2%, compared with 81% and 22%, respectively, for the
comparable prior year. The decrease in total gross margin from the comparable
prior year is primarily attributable to a decrease in software revenues as a
percentage of total revenues, since software revenues have higher profit
margins. The decrease in gross margin for software license and maintenance
revenues compared to the prior year is attributable to the higher levels of
fixed cost of facilities and equipment as a percentage of software license and
maintenance revenues. The decrease in gross margin for consulting and
education services from the comparable prior year is attributable to an
increase in fixed costs of facilities and equipment allocated to the
consulting group and the cost associated with the continued use of third-party
service providers as a percentage of consulting and education services
revenues. Management can not currently anticipate gross profit levels for 1998
as the Company has recently modified its business strategy.

 Selling, General and Administrative Expenses:

  Selling, general and administrative expenses consist primarily of payroll
costs related to executive management, finance, administration, sales and
marketing personnel, and costs for advertising, marketing and related
administrative support. Selling, general and administrative expenses decreased
to $5,845,000 for the year ended December 31, 1997 from $10,565,000 for the
comparable prior year, representing 104% and 80% of total revenues of such
years, respectively. The decrease of $4,720,000 in 1997 from 1996 reflects the
Company's reduced headcount as a result of the Company's restructuring plan
implemented during 1997.

 Research and Development Expenses:

  Research and development expenses primarily consist of payroll-related
costs, fees to independent contractors and purchases of technology. To date,
the Company has expensed all internal software development costs as incurred.
Research and development expenses decreased to $2,167,000 for the year ended
December 31, 1997 from $3,529,000 for the comparable prior year, representing
38% and 26% of total revenues, respectively. The decrease in research and
development expenses is attributable to the decrease in headcount as a result
of the Company's execution of its restructuring plan during 1997. Under the
Company's new e-Business strategy, research and development efforts may
decline relative to the Company's total expenditures.


                                      12
<PAGE>

 Restructuring Charge:

  On June 9, 1997, the Company announced that it had implemented a plan (the
"Restructuring Plan") to restructure the Company's operations. The
Restructuring Plan included write-offs and write-downs of certain assets and
included accruing the costs related to a significant reduction in the
Company's work force. The implementation of the Restructuring Plan resulted in
a one time charge of $1,782,000. See Note 1(l) of Notes to the Consolidated
Financial Statements.

 Compensation to Former Chief Executive Officer:

  In connection with the 960,000 shares of Common Stock purchased by the
Company's former Chief Executive Officer (the "Former CEO") in 1996 (see Note
7 of Notes to the Consolidated Financial Statements), the Company agreed to
loan the Former CEO up to $2,560,000 for payment of his anticipated income tax
liability resulting from such purchase. The Company funded $2,507,000 under
the loan agreement in April 1997. The loan was secured by a first priority
pledge of the purchased shares. In June 1997, the Former CEO surrendered the
purchased shares in satisfaction of the loan. For the three months ended June
30, 1997, the Company has recorded an expense of $227,000 to reflect the
difference between the amount of the loan and the market value of the shares
surrendered to the Company. The Company has classified the shares acquired as
treasury stock and is carrying the stock at a cost of $2,280,000.

 Interest Income (Expense), Net:

  For the year ended December 31, 1997, the Company recorded net interest
income of $1,885,000. The interest income is derived from interest earned on
the unused net proceeds received by the Company from its initial public
offering in July 1996. For the year ended December 31, 1996, the Company
recorded net interest income of $953,000.

1996 COMPARED TO 1995

 Revenues:

  Total revenues increased by $7,134,000 to $13,204,000 in 1996 from
$6,070,000 in 1995. The increase was due primarily to the introduction and
expansion of the Company's product offerings, including the OneWave (formerly
OpenScape) product line, and increased revenues from consulting and education
services. For the fiscal year ended December 31, 1996, software license and
maintenance revenues represented 61% of total revenues with the remaining 39%
resulting from consulting and education services, compared with 35% and 65%,
respectively, for the comparable prior year. During 1996, the Company executed
its plan to develop relationships with strategic partners within the industry.
These relationships generated large non-recurring software license and
consulting service contracts during 1996. Additionally, the Company continued
to resell third-party software licenses to its customers. The revenues from
the resale of third-party software license and maintenance services increased
by $718,000 to $1,760,000 in 1996 from $1,042,000 in 1995. The Company has
achieved only limited revenues from direct sales of OneWave products to end-
users.

 Gross profit:

  Total gross profit increased by $5,017,000 to $7,686,000 in 1996 from
$2,669,000 in 1995. The cost of software license and maintenance revenues
consists of the cost of software and maintenance purchased for resale from a
third-party vendor, distribution costs and product support costs. See Note
4(b) of the Notes to the Consolidated Financial Statements. The cost of
consulting and education services consists primarily of consulting and
education personnel salaries, related costs and fees to third-party service
providers. For the year ended December 31, 1996, total gross margin increased
to 58% of total revenues from 44% of total revenues for the comparable prior
year period. The gross margin for software license and maintenance revenues in
1996 was 81% and the gross margin for consulting and education services
revenues was 22%, compared with 67% and 32%, respectively, for the comparable
prior year. The increase in total gross margin from the comparable prior year
is

                                      13
<PAGE>

primarily attributable to an increase in software revenue as a percentage of
total revenue, since software revenues have higher profit margins. The
increase in gross margin for software license and maintenance revenues
compared to the prior year is attributable to a higher gross profit achieved
on revenues from OneWave products compared to prior year license and
maintenance revenues which were primarily generated by reselling related-party
licenses and maintenance. The decrease in gross margin for consulting and
education services from the comparable prior year is attributable to the
continued use of third-party service providers, an increase in consulting and
education personnel and a decrease in the number of educational seminars
provided. Additionally, there were a number of new employees hired during the
second half of the 1996 whose costs were included in cost of revenue, but who
were substantially engaged in the Company's orientation and training process
for the first few months of their employment. Historically, consulting service
revenues have provided significantly lower gross margin than software license
and maintenance revenues.

 Selling, General and Administrative Expenses:

  Selling, general and administrative expenses consist primarily of payroll
costs related to executive management, finance, administration, sales and
marketing personnel, and costs for advertising, marketing and related
administrative support. Selling, general and administrative expenses increased
to $10,565,000 for the year ended December 31, 1996 from $2,108,000 for the
comparable prior year, representing 80% and 35% of total revenues,
respectively. The total dollar increase of $8,457,000 in 1996 versus 1995
reflects the Company's increased selling, general and administrative expenses
associated with the hiring of an experienced management team, creation of a
direct sales force, the building of an IS/IT infrastructure, the move to a new
leased facility and lead generation activities such as advertising and
tradeshows.

 Research and Development Expenses:

  Research and development expenses primarily consist of payroll-related
costs, fees to independent contractors and purchases of technology. To date,
the Company has expensed all internal software development costs as incurred.
During the year ended December 31,1996, the Company capitalized approximately
$321,000, or 8% of total annual research and development expenditures
pertaining to third-party costs for the development of certain of the
Company's products. Research and development expenses increased to $3,529,000
for the year ended December 31, 1996 from $3,182,000 for the comparable prior
year, representing 26% and 52% of total revenues, respectively. The decrease
in research and development expenses as a percentage of total revenues is
attributable to the decrease in purchases of third-party developed technology
and a significant increase in total revenue.

 Compensation to Former Chief Executive Officer:

  During the year ended December 31, 1996, certain of the Company's
controlling stockholders sold 960,000 shares of Common Stock to the Company's
Former CEO for an aggregate purchase price of $1,440,000, and agreed to make
certain payments to the Former CEO to secure his services as the Company's
Former CEO. In accordance with generally accepted accounting principles, the
Company recorded a non-cash expense of $6,794,000 related to these
transactions. This non-cash expense consisted of: (i) $5,760,000, which
represents the difference between the purchase price paid by the Former CEO
for the shares of common stock that he purchased and the fair market value of
those shares at such time; (ii) $1,000,000, relating to a payment received by
the Former CEO from one of the Company's controlling stockholders; and (iii)
$34,000, representing the value of a payment guaranty that such stockholder
agreed to make to the Former CEO due to the decline in the value of certain
stock appreciation rights held by the Former CEO on capital stock of his
former employer. No future non-cash credits or charges will be recorded
related to these stock appreciation rights. See Note 7 of Notes to the
Consolidated Financial Statements.

 Interest Income (Expense), Net:

  For the year ended December 31, 1996, the Company recorded net interest
income of $953,000. The interest income is primarily derived from interest
earned on the net proceeds received by the Company from its initial

                                      14
<PAGE>

public offering in July 1996. For the year ended December 31, 1995, the
Company recorded net interest expense of $77,000. The expense was related to
interest on notes payable to stockholders who have been repaid in full as of
December 31, 1996 by the Company.

LIQUIDITY AND CAPITAL RESOURCES:

  In July 1996, the Company completed its initial public offering of 3,750,000
shares of its Common Stock, of which 3,000,000 shares were sold by the Company
and 750,000 shares were sold by certain of the Company's stockholders. The
public offering price was $16.00 per share and the net proceeds to the Company
were approximately $43,256,000, net of underwriting discounts, commissions and
other offering costs. Upon the consummation of the IPO, all outstanding shares
of the Company's preferred stock were automatically converted into Common
Stock. The Company used a portion of the proceeds for the repayment of a
$2,000,000 note payable to a bank.

  The Company's operating activities utilized cash and cash equivalents of
approximately $4,601,000 for the year ended December 31, 1997.

  The Company's investing activities, which consisted of net maturity of
short-term marketable securities, funding of a loan to the Company's Former
CEO and purchases of property and equipment, provided cash and cash
equivalents of approximately $1,512,000 for the year ended December 31, 1997.

  The Company's financing activities provided cash and cash equivalents of
approximately $1,025,000 for the year ended December 31, 1997, from issuances
of Common Stock under the Company's stock option plans and employee stock
purchase plan.

  The Company currently anticipates that the existing cash, cash equivalents
and marketable securities balances will be sufficient to meet its anticipated
working capital and capital expenditure requirements for at least the next
twelve months. Thereafter, the Company may need to raise additional funds. The
Company may in the future seek to expand its business through possible
acquisitions. The Company, however, has no commitments or agreements with
respect to any future acquisition and no assurances can be given with respect
to the likelihood or financial or business effect, of any future acquisition.
Future acquisitions could be financed by internally generated funds, bank
borrowings, public offerings or private placements of equity or debt
securities, or a combination of the foregoing. There can be no assurance that
additional financing will be available when needed on terms favorable to the
Company or at all.

IMPACT OF YEAR 2000 ISSUE

  The Company has reviewed its internal computer systems and products and
their capability of recognizing the year 2000 and years thereafter. The
Company expects that any costs relating to ensuring such systems to be year
2000 compliant will not be material to the financial condition or the results
of operations of the Company.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

  Statements made or incorporated into this Form 10-K include a number of
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward
looking statements include, without limitation, statements containing the
words "anticipates," "believes," "expects," "intends," "future," and words of
similar import which express Management's beliefs, expectations or intentions
regarding the Company's future performance. The Company's actual results could
differ materially from its historical results and from those set forth in the
forward-looking statements and may fluctuate between operating periods.
Factors that might cause such differences and fluctuations include the
following: the success of the Company's new business strategy, rapid changes
in the marketplace, risks related to the management of growth, the Company's
ability to attract, train and retain qualified personnel, the Company's
ability to build its sales staff and re-deploy its employees previously
focused

                                      15
<PAGE>

on the Company's software product offerings, development and promotional
expenses related to the introduction of new service offerings, changes in
technology and industry standards, limited operating history, changes in the
market for the Company's services, the rate of acceptance of the Company's
services, dependence of the Company's business on the Internet, increased
competition, changing of pricing policies by the Company or its competitors,
the timing of receipt of orders from major customers, development of Internet
and Intranet products or enhancements by vendors of existing client/server or
legacy software systems that compete with the Company's consulting services,
dependence on key personnel, proprietary technology and the inherent
difficulties in protecting intellectual property, dependence on third-party
technology, and exposure for product and professional services liability. The
market price of the Company's Common Stock has been, and in the future will
likely be, subject to significant fluctuations in response to variations in
quarterly operating results and other factors, such as announcements of
technological innovations or new products by the Company or its competitors,
or other events.


                                      16
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                 ONEWAVE, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
Report of Independent Public Accountants..................................  18
Consolidated Balance Sheets as of December 31, 1996 and 1997..............  19
Consolidated Statements of Operations for the Years Ended December 31,
 1995, 1996 and 1997......................................................  20
Consolidated Statements of Redeemable Convertible Preferred Stock and
 Stockholders' Equity (Deficit) for the Years Ended December 31, 1995,
 1996 and 1997............................................................  21
Consolidated Statements of Cash Flows for the Years Ended December 31,
 1995, 1996 and 1997......................................................  22
Notes to Consolidated Financial Statements................................  23
</TABLE>

                                       17
<PAGE>

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To OneWave, Inc.:

  We have audited the accompanying consolidated balance sheets of OneWave,
Inc. (a Delaware corporation) as of December 31, 1996 and 1997, and the
related consolidated statements of operations, redeemable convertible
preferred stock and stockholders' equity (deficit) and cash flows for the
years ended December 31, 1995, 1996 and 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these 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 OneWave,
Inc. as of December 31, 1996 and 1997, and the results of its operations and
its cash flows for the years ended December 31, 1995, 1996 and 1997, in
conformity with generally accepted accounting principles.

                                          Arthur Andersen LLP

Boston, Massachusetts
January 28, 1998

                                      18
<PAGE>

                                 ONEWAVE, INC.

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                    --------------------------
                                                        1996          1997
                                                    ------------  ------------
<S>                                                 <C>           <C>
                      ASSETS
Current Assets:
  Cash and cash equivalents (Note 1)............... $ 12,868,496  $ 10,804,064
  Marketable securities (Note 1)...................   27,181,222    22,908,833
  Accounts receivable, less reserve of $283,000 and
   $50,000 at December 31, 1996 and 1997,
   respectively....................................    1,783,741       783,471
  Inventories (Note 1).............................      303,900           --
  Prepaid expenses and other current assets........      691,735       201,298
  Due from affiliates (Note 4).....................       55,402           --
                                                    ------------  ------------
    Total current assets...........................   42,884,496    34,697,666
                                                    ------------  ------------
Property and Equipment, at cost (Note 1):
  Computer and office equipment....................    3,155,384     2,309,907
  Furniture and fixtures...........................      462,944       480,599
  Leasehold improvements...........................       59,964        59,964
                                                    ------------  ------------
                                                       3,678,292     2,850,470
  Less--Accumulated depreciation and amortization..      669,118     1,281,924
                                                    ------------  ------------
    Net property and equipment.....................    3,009,174     1,568,546
                                                    ------------  ------------
Other Assets (Note 1)..............................      256,865           --
                                                    ------------  ------------
    Total assets................................... $ 46,150,535  $ 36,266,212
                                                    ============  ============
       LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Accounts payable................................. $  1,454,440  $    799,856
  Accrued expenses (Note 7)........................    4,410,615     1,570,275
  Deferred revenue (Note 1)........................      548,330       490,819
                                                    ------------  ------------
    Total current liabilities......................    6,413,385     2,860,950
                                                    ------------  ------------
Commitments (Note 6)
Stockholders' Equity (Note 2):
  Preferred stock, $1.00 par value--
    Authorized--5,000,000 shares
    Issued--no shares..............................          --            --
  Common stock, $.001 par value
    Authorized 50,000,000 shares
    Issued 14,907,696 and 15,068,164 at December
     31, 1996 and 1997, respectively...............       14,908        15,069
  Additional paid-in capital.......................   58,504,913    58,906,123
  Note receivable from former chief executive
   officer (Note 7)................................   (2,560,000)          --
  Treasury stock (Note 2)..........................          --     (1,656,676)
  Accumulated deficit..............................  (16,222,671)  (23,859,254)
                                                    ------------  ------------
    Total stockholders' equity.....................   39,737,150    33,405,262
                                                    ============  ============
    Total liabilities and stockholders' equity..... $ 46,150,535  $ 36,266,212
                                                    ============  ============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       19
<PAGE>

                                 ONEWAVE, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                              YEAR ENDED DECEMBER 31,
                                        --------------------------------------
                                           1995          1996         1997
                                        -----------  ------------  -----------
<S>                                     <C>          <C>           <C>
Revenues (Note 1):
  Software license and maintenance..... $ 2,150,735  $  8,106,049  $ 1,247,942
  Consulting and education services....   3,918,927     5,098,402    4,399,267
                                        -----------  ------------  -----------
    Total revenues.....................   6,069,662    13,204,451    5,647,209
                                        -----------  ------------  -----------
Cost of Revenues (Note 1):
  Software license and maintenance.....     716,392     1,517,532      637,882
  Consulting and education services....   2,684,216     4,001,376    4,494,000
                                        -----------  ------------  -----------
    Total cost of revenues.............   3,400,608     5,518,908    5,131,882
                                        -----------  ------------  -----------
    Gross profit.......................   2,669,054     7,685,543      515,327
                                        -----------  ------------  -----------
Operating Expenses:
  Selling, general and administrative..   2,107,956    10,564,948    5,844,454
  Research and development (Note 1)....   3,181,972     3,528,799    2,167,334
  Restructuring charge (Note 1)........         --            --     1,782,298
  Compensation to former chief
   executive officer (Note 7)..........         --      6,793,696      227,472
                                        -----------  ------------  -----------
    Total operating expenses...........   5,289,928    20,887,443   10,021,558
                                        -----------  ------------  -----------
    Operating loss.....................  (2,620,874)  (13,201,900)  (9,506,231)
Interest (Expense)/Income, net.........     (77,574)      953,284    1,884,584
                                        -----------  ------------  -----------
    Loss before provision for income
     taxes.............................  (2,698,448)  (12,248,616)  (7,621,647)
Provision for Income Taxes.............         --         95,331       14,936
                                        -----------  ------------  -----------
    Net loss........................... $(2,698,448) $(12,343,947) $(7,636,583)
                                        ===========  ============  ===========
Basic and Diluted Net Loss per Common
 Share (Note 1)........................ $      (.28) $      (1.03) $      (.52)
                                        ===========  ============  ===========
Shares Used in Computing Net Loss per
 Common Share..........................   9,491,957    12,560,185   14,560,222
                                        ===========  ============  ===========
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       20
<PAGE>

                                 ONEWAVE, INC.

             STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
                      AND STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                         REDEEMABLE
                         CONVERTIBLE
                       PREFERRED STOCK
                    ----------------------
                      NUMBER
                        OF       CARRYING
                      SHARES      VALUE
                    ----------  ----------
 <S>                <C>         <C>
 Balance,
 December 31,
 1994............          --          --
 Issuance of
 common stock at
 $.0015 per
 share...........          --          --
 Issuance of
 Series A
 preferred stock
 at $1.20 per
 share...........          --          --
 Conversion of
 Series A
 preferred stock
 into common
 stock...........          --          --
 Conversion of
 long-term debt
 to stockholders
 into common
 stock at $.66
 per share.......          --          --
 Deferred
 compensation
 related to grant
 of stock
 options.........          --          --
 Compensation
 expense related
 to stock
 options.........          --          --
 Net loss........          --          --
                    ----------  ----------
 Balance,
 December 31,
 1995............          --          --
 Issuance of
 Series B
 redeemable
 convertible
 preferred stock
 at $5.54 per
 share, net of
 issuance costs
 of $600,000.....    1,332,127   7,379,984
 Compensation
 expense to
 former chief
 executive
 officer.........          --          --
 Issuance of note
 receivable from
 former chief
 executive
 officer.........          --          --
 Issuance of
 Series C
 convertible
 preferred stock
 at $5.00 per
 share, net of
 issuance costs
 of $30,000......          --          --
 Repurchase and
 retirement of
 common stock
 $7.50 per
 share...........          --          --
 Issuance of
 common stock at
 $16.00 per share
 related to
 initial public
 offering, net of
 issuance costs
 of $4,744,000...          --          --
 Conversion of
 redeemable
 convertible
 preferred stock
 and convertible
 preferred stock
 into common
 stock...........   (1,332,127) (7,379,984)
 Compensation
 expense related
 to stock
 options.........          --          --
 Issuance of
 common stock
 from stock
 option
 exercises.......          --          --
 Deferred
 compensation
 adjustment
 related to
 termination of
 stock options...          --          --
 Net loss                  --          --
                    ----------  ----------
 Balance,
 December 31,
 1996............          --          --
 Adjustment to
 note receivable
 from former
 chief executive
 officer.........          --          --
 Surrender of
 shares in
 satisfaction of
 note receivable
 from former
 chief executive
 officer.........          --          --
 Issuance of
 common stock
 from stock
 option
 exercises.......          --          --
 Issuance of
 common stock for
 employee stock
 purchase plan...          --          --
 Net loss........          --          --
                    ----------  ----------
 Balance,
 December 31,
 1997............          --   $      --
                    ==========  ==========
<CAPTION>
                                                                     STOCKHOLDERS' EQUITY (DEFICIT)
                    -------------------------------------------------------------------------------------------------------------
                                                                                                            NOTE
                         CONVERTIBLE                                                                     RECEIVABLE
                       PREFERRED STOCK          COMMON STOCK         TREASURY STOCK                         FROM
                    ----------------------- --------------------- -----------------------                  FORMER
                      NUMBER                  NUMBER                                       ADDITIONAL      CHIEF
                        OF        $1.00         OF        $.001   NUMBER OF                 PAID-IN      EXECUTIVE     DEFERRED
                      SHARES    PAR VALUE     SHARES    PAR VALUE  SHARES      AMOUNT       CAPITAL       OFFICER    COMPENSATION
                    ----------- ----------- ----------- --------- ---------- ------------ -------------- ----------- ------------
 <S>                <C>         <C>         <C>         <C>       <C>        <C>          <C>            <C>         <C>
 Balance,
 December 31,
 1994............          --          --    7,933,333   $ 7,933       --            --   $    303,967   $      --     $    --
 Issuance of
 common stock at
 $.0015 per
 share...........          --          --       66,667        67       --            --             33          --          --
 Issuance of
 Series A
 preferred stock
 at $1.20 per
 share...........      250,000     250,000         --        --        --            --       (250,000)         --          --
 Conversion of
 Series A
 preferred stock
 into common
 stock...........     (250,000)   (250,000)  1,666,667     1,667       --            --        248,333          --          --
 Conversion of
 long-term debt
 to stockholders
 into common
 stock at $.66
 per share.......          --          --    1,136,363     1,136       --            --        748,864          --          --
 Deferred
 compensation
 related to grant
 of stock
 options.........          --          --          --        --        --            --        179,400          --     (179,400)
 Compensation
 expense related
 to stock
 options.........          --          --          --        --        --            --            --           --       12,806
 Net loss........          --          --          --        --        --            --            --           --          --
                    ----------- ----------- ----------- --------- ---------- ------------ -------------- ----------- ------------
 Balance,
 December 31,
 1995............          --          --   10,803,030    10,803       --            --      1,230,597          --     (166,594)
 Issuance of
 Series B
 redeemable
 convertible
 preferred stock
 at $5.54 per
 share, net of
 issuance costs
 of $600,000.....          --          --          --        --        --            --       (600,000)         --          --
 Compensation
 expense to
 former chief
 executive
 officer.........          --          --          --        --        --            --      6,793,696          --          --
 Issuance of note
 receivable from
 former chief
 executive
 officer.........          --          --          --        --        --            --            --    (2,560,000)        --
 Issuance of
 Series C
 convertible
 preferred stock
 at $5.00 per
 share, net of
 issuance costs
 of $30,000......    1,200,000   1,200,000         --        --        --            --      4,770,000          --          --
 Repurchase and
 retirement of
 common stock
 $7.50 per
 share...........          --          --     (800,000)     (800)      --            --     (5,999,200)         --          --
 Issuance of
 common stock at
 $16.00 per share
 related to
 initial public
 offering, net of
 issuance costs
 of $4,744,000...          --          --    3,000,000     3,000       --            --     43,253,000          --          --
 Conversion of
 redeemable
 convertible
 preferred stock
 and convertible
 preferred stock
 into common
 stock...........   (1,200,000) (1,200,000)  1,688,074     1,688       --            --      8,578,296          --          --
 Compensation
 expense related
 to stock
 options.........          --          --          --        --        --            --            --           --       41,169
 Issuance of
 common stock
 from stock
 option
 exercises.......          --          --      216,592       217       --            --        603,949          --          --
 Deferred
 compensation
 adjustment
 related to
 termination of
 stock options...          --          --          --        --        --            --       (125,425)         --      125,425
 Net loss                  --          --          --        --        --            --            --           --          --
                    ----------- ----------- ----------- --------- ---------- ------------ -------------- ----------- ------------
 Balance,
 December 31,
 1996............          --          --   14,907,696    14,908       --            --     58,504,913   (2,560,000)        --
 Adjustment to
 note receivable
 from former
 chief executive
 officer.........          --          --          --        --        --            --            --        52,528         --
 Surrender of
 shares in
 satisfaction of
 note receivable
 from former
 chief executive
 officer.........          --          --          --        --    960,000    (2,280,000)          --     2,507,472         --
 Issuance of
 common stock
 from stock
 option
 exercises.......          --          --      132,675       133  (261,448)      620,939       277,611          --          --
 Issuance of
 common stock for
 employee stock
 purchase plan...          --          --       27,793        28    (1,004)        2,385       123,599          --          --
 Net loss........          --          --          --        --        --            --            --           --          --
                    ----------- ----------- ----------- --------- ---------- ------------ -------------- ----------- ------------
 Balance,
 December 31,
 1997............          --   $      --   15,068,164   $15,069   697,548   $(1,656,676) $ 58,906,123   $      --     $    --
                    =========== =========== =========== ========= ========== ============ ============== =========== ============


<CAPTION>
                    STOCKHOLDERS' EQUITY (DEFICIT)
                    ------------------------------
                                       TOTAL
                                   STOCKHOLDERS'
                     ACCUMULATED      EQUITY
                       DEFICIT       (DEFICIT)
                     ------------- --------------
 <S>                 <C>           <C>
 Balance,
 December 31,
 1994............    $ (1,180,276) $   (868,376)
 Issuance of
 common stock at
 $.0015 per
 share...........             --            100
 Issuance of
 Series A
 preferred stock
 at $1.20 per
 share...........             --            --
 Conversion of
 Series A
 preferred stock
 into common
 stock...........             --            --
 Conversion of
 long-term debt
 to stockholders
 into common
 stock at $.66
 per share.......             --        750,000
 Deferred
 compensation
 related to grant
 of stock
 options.........             --            --
 Compensation
 expense related
 to stock
 options.........             --         12,806
 Net loss........      (2,698,448)   (2,698,448)
                     ------------- --------------
 Balance,
 December 31,
 1995............      (3,878,724)   (2,803,918)
 Issuance of
 Series B
 redeemable
 convertible
 preferred stock
 at $5.54 per
 share, net of
 issuance costs
 of $600,000.....             --       (600,000)
 Compensation
 expense to
 former chief
 executive
 officer.........             --      6,793,696
 Issuance of note
 receivable from
 former chief
 executive
 officer.........             --     (2,560,000)
 Issuance of
 Series C
 convertible
 preferred stock
 at $5.00 per
 share, net of
 issuance costs
 of $30,000......             --      5,970,000
 Repurchase and
 retirement of
 common stock
 $7.50 per
 share...........             --     (6,000,000)
 Issuance of
 common stock at
 $16.00 per share
 related to
 initial public
 offering, net of
 issuance costs
 of $4,744,000...             --     43,256,000
 Conversion of
 redeemable
 convertible
 preferred stock
 and convertible
 preferred stock
 into common
 stock...........             --      7,379,984
 Compensation
 expense related
 to stock
 options.........             --         41,169
 Issuance of
 common stock
 from stock
 option
 exercises.......             --        604,166
 Deferred
 compensation
 adjustment
 related to
 termination of
 stock options...             --            --
 Net loss             (12,343,947)  (12,343,947)
                     ------------- --------------
 Balance,
 December 31,
 1996............     (16,222,671)   39,737,150
 Adjustment to
 note receivable
 from former
 chief executive
 officer.........             --         52,528
 Surrender of
 shares in
 satisfaction of
 note receivable
 from former
 chief executive
 officer.........             --        227,472
 Issuance of
 common stock
 from stock
 option
 exercises.......             --        898,683
 Issuance of
 common stock for
 employee stock
 purchase plan...             --        126,012
 Net loss........     (7,636,583)    (7,636,583)
                     ------------- --------------
 Balance,
 December 31,
 1997............    $(23,859,254) $ 33,405,262
                     ============= ==============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements

                                       21
<PAGE>

                                 ONEWAVE, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                       ---------------------------------------
                                          1995          1996          1997
                                       -----------  ------------  ------------
<S>                                    <C>          <C>           <C>
Cash Flows from Operating Activities:
 Net loss............................. $(2,698,448) $(12,343,947) $ (7,636,583)
 Adjustments to reconcile net loss to
  net cash used in operating
  activities --
 Depreciation and amortization........      50,438       670,200     1,104,225
 Compensation expense to former chief
  executive officer...................         --      6,793,696       227,472
 Compensation expense related to
  stock options.......................      12,806        41,169           --
 Non-cash restructuring charge........         --            --      1,304,235
 Changes in operating assets and
  liabilities --
  Accounts receivable.................  (1,908,541)      124,800     1,000,270
  Inventories.........................    (292,000)      (11,900)          --
  Prepaid expenses and other current
   assets.............................    (157,333)     (534,402)      523,071
  Due from affiliates.................         --        (55,402)       55,402
  Accounts payable....................     300,575       878,865      (654,584)
  Due to affiliates...................   2,281,242    (2,938,086)          --
  Accrued expenses....................     637,613     1,213,002      (467,452)
  Deferred revenues...................     278,572       269,758       (57,511)
                                       -----------  ------------  ------------
   Net cash used in operating
    activities........................  (1,495,076)   (5,892,247)   (4,601,455)
                                       -----------  ------------  ------------
Cash Flows from Investing Activities:
 (Purchases)/ sales of marketable
  securities, net.....................         --    (27,181,222)    4,272,389
 Purchases of property and equipment..    (150,472)   (3,451,742)     (252,589)
 Loan to former chief executive
  officer.............................         --            --     (2,507,472)
 Increase in other assets.............         --       (321,065)          --
                                       -----------  ------------  ------------
   Net cash (used in)/provided by
    investing activities..............    (150,472)  (30,954,029)    1,512,328
                                       -----------  ------------  ------------
Cash Flows from Financing Activities:
 Proceeds from (payments on) long-term
  debt to stock holders...............   1,750,000    (1,000,000)          --
 Proceeds from secured note payable to
  a bank..............................         --      2,000,000           --
 Payments on secured note payable to a
  bank................................         --     (2,000,000)          --
 Net proceeds from issuance of common
  stock...............................         100    43,256,000           --
 Payment for the repurchase of common
  stock...............................         --     (6,000,000)          --
 Net proceeds from issuance of
  preferred stock.....................         --     12,749,984           --
 Proceeds from the exercise of stock
  options.............................         --        604,166       898,683
 Proceeds from common stock purchased
  through employee stock purchase
  plan................................         --            --        126,012
                                       -----------  ------------  ------------
   Net cash provided by financing
    activities........................   1,750,100    49,610,150     1,024,695
                                       -----------  ------------  ------------
Net Increase/(Decrease) in Cash and
 Cash Equivalents.....................     104,552    12,763,874    (2,064,432)
Cash and Cash Equivalents, beginning
 of period............................          70       104,622    12,868,496
                                       -----------  ------------  ------------
Cash and Cash Equivalents, end of
 period............................... $   104,622  $ 12,868,496  $ 10,804,064
                                       ===========  ============  ============
Supplemental Disclosure of Cash Flow
 Information:
 Cash paid during the period for
  interest............................ $    25,843  $     79,191  $      8,071
                                       ===========  ============  ============
 Cash paid for income taxes........... $       --   $     70,125  $     21,984
                                       ===========  ============  ============
Supplemental Disclosure of Noncash
 Financing Activities:
 Conversion of long-term debt to
  stockholders into common stock...... $   750,000  $        --   $        --
                                       ===========  ============  ============
 Conversion of preferred stock into
  common stock........................ $   250,000  $  8,579,984  $        --
                                       ===========  ============  ============
 Issuance of note receivable from
  former chief executive officer...... $       --   $  2,560,000  $     52,528
                                       ===========  ============  ============
 Acquisition of shares for
  satisfaction of note receivable..... $       --   $        --   $  2,507,472
                                       ===========  ============  ============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                       22
<PAGE>

                                 ONEWAVE, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 (a) Organization

  OneWave, Inc. ("OneWave" or "the Company"), a Delaware corporation, was
incorporated in January 1994. Since its inception, OneWave has helped
organizations build applications that integrate and extend disparate
information systems. In the past, OneWave has focused on developing and
marketing its application development products, along with implementation
services. After year end, the Company made a decision to unify its two
business units into a single consulting services organization focused on
delivering business and information technology solutions on a fixed-
price/fixed-time basis. As a result, the Company does not anticipate the
future marketing of stand alone software products. The Company intends to
extend its current consulting services business to emphasize building cross-
enterprise e-Business solutions. E-Business encompasses a wide variety of
business processes in which Internet technologies are used to bring together
customers, vendors, suppliers and employees in ways that are generally
designed to enhance commerce among business partners. OneWave intends to
utilize innovative methodologies combined with cutting-edge technical
capabilities to conceptualize, design, develop, and implement e-Business
solutions facilitated by Internet technologies. For fiscal year 1997, the
Company's principal market for its products was North America.

 (b) Principles of Consolidation

  The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, OneWave Securities Corporation. Inter-company
accounts and transactions are eliminated in consolidation.

 (c) Revenue Recognition

  The Company recognizes revenue in accordance with the provisions of
Statement of Position No. 97-2 (SOP 97-2), Software Revenue Recognition. The
Company generates software and maintenance revenues from licensing the rights
to use its software products and the resale of software products licensed from
a related party (see Note 4b). The Company also generates service revenues
from the sale of consulting and education services.

  Revenues from software license fees are recognized upon delivery, net of
estimated returns, provided there are no significant post-delivery
obligations, and payment is due within one year and is probable of collection.
If acceptance is required, software license revenues are recognized upon
customer acceptance. Maintenance revenues are deferred at the time of billing
and are recognized ratably over the term of the support period, which is
typically one year.

  Revenues from consulting and education services are recognized upon customer
acceptance or over the period in which services are provided if customer
acceptance is not required and the revenues are fixed and determinable.
Revenues from fixed price consulting contracts are recognized primarily on the
percentage of completion method. The cumulative impact of any revision in
estimates of the percent complete is reflected in the period in which the
changes become known. Losses on projects in progress are recognized when
known.

  Deferred revenues primarily relate to prepaid maintenance and consulting
services fees.

  Cost of software license and maintenance revenues consists of the cost of
software and maintenance purchased for resale from a related party;
distribution costs; and support personnel costs. Cost of consulting and
education services consists primarily of consulting and support personnel
salaries and related costs and fees to third party service providers.

                                      23
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


 (d) Cash and Cash Equivalents

  The Company classifies all short-term, highly liquid investments with
original maturities of three months or less as cash equivalents. The Company
held the following cash and cash equivalents at December 31:

<TABLE>
<CAPTION>
                                                           1996        1997
                                                        ----------- -----------
      <S>                                               <C>         <C>
      Corporate debt instruments....................... $ 9,053,091 $ 4,987,460
      Cash and Money Market Accounts...................   3,815,405   5,816,604
                                                        ----------- -----------
                                                        $12,868,496 $10,804,064
                                                        =========== ===========
</TABLE>

 (e) Marketable Securities

  Marketable securities consist of marketable financial instruments with
original maturities greater than 90 days. The Company has established
guidelines relative to concentration, maturities, and credit ratings that
maintain safety and liquidity.

  In accordance with Statement of Financial Accounting Standard No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No.
115"), the Company has classified its investments in marketable securities as
"Held-to-Maturity" Securities. Accordingly, marketable securities as of
December 31, 1997 are recorded at amortized cost, which approximates market.

  The Company held the following marketable securities at December 31:

<TABLE>
<CAPTION>
                                                           1996        1997
                                                        ----------- -----------
      <S>                                               <C>         <C>
      U.S. Government and Government Agency Securities
       (average maturity of 252 and 116 days at
       December 31, 1996 and 1997, respectively)......  $20,545,759 $ 7,288,889
      Commercial Paper (average maturity of 73 and 62
       days at December 31, 1996 and 1997
       respectively)..................................    6,635,463  15,619,944
                                                        ----------- -----------
                                                        $27,181,222 $22,908,833
                                                        =========== ===========
</TABLE>

 (f) Property and Equipment

  Property and equipment are stated at cost. Depreciation and amortization
expense is computed using the straight-line method over the estimated useful
lives of the assets (three to five years).

 (g) Research and Development and Software Development Costs

  In accordance with SFAS No. 86, Accounting for the Costs of Software To Be
Sold, Leased or Otherwise Marketed, the Company has evaluated the
establishment of technological feasibility of its various products during the
development phase. Due to the dynamic changes in the market, the Company has
concluded that it cannot determine technological feasibility until a fully
functional working model is complete. The time period during which costs could
be capitalized from the point of reaching technological feasibility until the
time of general product release is very short, and consequently, the amounts
that could be capitalized are generally not material to the Company's
financial position or result of operations. Therefore, the Company has charged
all internally generated research and development expenses to operations in
the period incurred.

  Since inception, the Company has incurred various charges associated with
the purchase of third party developed technology. During 1996 the Company
contracted with a third party to develop applications to be integrated with
the Company's existing product. The Company capitalized $321,065 of cost
associated with the

                                      24
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

development of this product. The Company amortized the cost of this product
over its expected useful life of fifteen months. The Company recorded
amortization expense of $64,200 and $107,000 for the years ended December 31,
1996 and 1997, respectively (see Note 1(l )). The unamortized cost of
$149,865, was charged to expense in connection with the Company's
restructuring in 1997. Included in research and development expenses for the
years ended December 31, 1995, 1996 and 1997, is $2,550,000, $450,000, and $0
respectively, relating to purchase of technology, of which $2,200,000 was
purchased from a related party in 1995 (see Note 4(b)).

 (h) Inventories

  Inventories are stated at the lower of cost or market and consist of
purchased software products from third party vendors held for resale.

 (i) Post-retirement Benefits

  The Company has no obligations for post-retirement benefits.

 (j) Concentration of Credit Risk

  SFAS No. 105, Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. Financial instruments that potentially subject the Company to
concentrations of credit risk are accounts receivable, cash equivalents and
marketable securities. For the year ended December 31, 1996, concentration of
credit risk with respect to accounts receivable was limited to one customer
that accounted for 24% of total revenue. This customer represented 19% of the
December 31, 1996 accounts receivable balance. For the year ended December 31,
1997, this customer accounted for approximately 11% of total revenues. As of
December 31, 1997, there were no amounts due from this customer. During the
year ended December 31, 1997, three new customers represented concentrations
of credit risk with respect to accounts receivable and revenue. These
customers accounted for approximately 26%, 11% and 9% of total revenues and
58%, 8% and 24% of the December 31, 1997 accounts receivable balance.

  In the years ended December 31, 1995, 1996 and 1997, sales outside the
United States accounted for approximately 17%, 10%, and 3% of total revenues,
respectively. To reduce accounts receivable credit risk, the Company routinely
assesses the financial strength of its customers and, as a consequence,
believes that its accounts receivable credit risk exposure is limited. The
Company maintains an allowance for potential credit losses but has not
experienced any significant losses related to individual customers or groups
of customers in any particular industry or geographic area. To reduce cash
equivalent and marketable securities credit risk, the Company invests in
highly liquid U.S. Government and commercial paper obligations with maturities
of less than one year. The Company limits the amount of holdings with any one
particular financial institution or government agency.

 (k) Net Loss per Common Share

  In 1997, the Company adopted Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share,
effective December 15, 1997. Basic net loss per share is computed by dividing
reported earnings available to common stockholders by the weighted average
common shares outstanding, with no consideration given for any potentially
dilutive securities. Diluted net loss per share is the same as basic net loss
per share because the inclusion of common stock issuable pursuant to stock
options, warrants, and the conversion of redeemable and convertible preferred
stock would be antidilutive.

                                      25
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  The calculations of basic and diluted net loss per common share are as
follows:

<TABLE>
<CAPTION>
                                           1995          1996         1997
                                        -----------  ------------  -----------
   <S>                                  <C>          <C>           <C>
   Net loss............................ $(2,698,448) $(12,343,947) $(7,636,583)
   Discount on preferred stock.........         --       (630,000)         --
                                        -----------  ------------  -----------
   Net loss applicable to common
    stockholders....................... $(2,698,448) $(12,973,947) $(7,636,583)
                                        ===========  ============  ===========
   Weighted average common shares
    outstanding........................   9,491,957    12,560,185   14,560,222
                                        ===========  ============  ===========
   Basic and diluted net loss per
    share.............................. $      (.28) $      (1.03) $      (.52)
                                        ===========  ============  ===========
</TABLE>

 (l) Restructuring Charge

  On June 9, 1997, the Company announced that it had implemented a plan (the
"Plan") to restructure the Company's operations. The Plan included write-offs
and writedowns of certain assets and included accruing the costs related to a
significant reduction in the Company's work force. The implementation of the
Plan resulted in a one time charge of $1,782,298. Included in accrued expenses
as of December 31, 1997 is $187,112 of liabilities related to the
restructuring charge.

  The following are the significant components of the charge for
restructuring:

<TABLE>
   <S>                                                               <C>
   Write-off and writedown of assets to net realizable value........ $1,117,124
   Employee severance, benefits and related costs...................    650,035
   Other............................................................     15,139
                                                                     ----------
                                                                     $1,782,298
                                                                     ==========
</TABLE>

 (m) Use of Estimates in the Preparation of the Financial Statements

  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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.

 (n) Financial Instruments

  The estimated fair value of the Company's financial instruments, which
include cash equivalents, marketable securities and accounts receivable and
accounts payable, approximates their carrying value.

2. STOCKHOLDERS' EQUITY (DEFICIT)

 (a) Authorized Capital Stock

  As of December 31, 1997, the Company's authorized capital stock consisted of
50,000,000 shares of common stock, $.001 par value per share, and 5,000,000
shares of preferred stock, $1.00 par value per share.

 (b) Common Stock

  In May 1995, the Company issued a convertible note payable to a stockholder
for $750,000. In accordance with the provisions of the note payable agreement,
the outstanding principal of the note was converted into 1,136,362 shares of
common stock in November 1995.

                                      26
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  In April 1996, the Company repurchased and retired 800,000 shares of common
stock for $6,000,000.

  In July 1996, the Company completed an initial public offering of its common
stock. The Company issued 3,000,000 shares at $16.00 per share for net
proceeds of $43,256,000.

 (c) Conversion of Series A Convertible Preferred Stock

  In December 1994, certain stockholders contributed $300,000 to the Company
for the purchase of 250,000 shares of Series A convertible preferred stock.
The shares of Series A convertible preferred stock were issued to the
stockholders in February 1995 and were subsequently converted to 1,666,667
shares of common stock in November 1995.

 (d) Conversion of Series B Redeemable Convertible Preferred Stock

  In March 1996, the Company issued 1,332,127 shares of Series B redeemable
convertible preferred stock at $5.54 per share, less offering costs of
$600,000 for net proceeds of $6,779,984. Upon consummation of the Company's
initial public offering, all outstanding shares of redeemable convertible
preferred stock were converted into 888,080 shares of common stock.

 (e) Conversion of Series C Convertible Preferred Stock

  In April 1996, the Company issued 1,200,000 shares of Series C convertible
preferred stock at a price of $5.00 per share, less offering costs of $30,000,
for net proceeds of $5,970,000. Upon consummation of the Company's initial
public offering, all outstanding shares of Series C preferred stock were
converted into 799,994 shares of common stock.

 (f) Treasury Stock

  In April 1997, the Company funded $2,507,000 under a loan agreement with its
then Chief Executive Officer. The loan was secured by a first priority pledge
of 960,000 shares of the Company's common stock. In June 1997, the then Chief
Executive Officer resigned from the Company and surrendered these shares in
satisfaction of the loan agreement. The market price of $2.375 on the date the
shares were surrendered was used to determine the cost of the treasury stock.
The 960,000 shares have been classified as treasury stock with a total cost of
$2,280,000. The $227,000 difference between the amount of the loan and the
cost of the treasury stock was recorded as a charge to operations and is
classified as compensation to former chief executive officer. As of December
31, 1997, the Company has issued approximately 262,000 shares from treasury
for the Company's employee stock option and the employee stock purchase plans.

 (g) Stock Split

  In February 1995, the Company effected a 10-for-1 stock split of the common
stock in the form of a stock dividend. On May 20, 1996, the Company effected a
2-for-3 reverse stock split. The accompanying financial statements have been
affected for the stock splits.

 (h) Stock Options

  1995 STOCK PLAN

  The Company has a stock plan (the 1995 Plan) that provides for the issuance
of incentive stock options (ISOs), non-qualified stock options and shares of
common stock. Under the terms of the 1995 Plan, non-qualified options may be
granted at a price not less than the lesser of (i) the book value per share of
common stock as of

                                      27
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

the end of the fiscal year of the Company immediately preceding the date of
such grant, or (ii) 50% of the fair market value per share of common stock on
the date of such grant and, in the case of ISOs, not less than the fair market
value per share at the date of grant. Options generally vest over a four-year
period, commencing one year after the date of the grant. In 1995, the Company
granted an option to purchase 40,000 shares of common stock to an employee at
an exercise price of $.015 per share. The difference between the estimated
fair market value of the common stock and the aggregate exercise price of
$179,400 was recorded as deferred compensation at the date of grant. During
1995 and 1996, the Company recorded compensation expense related to these
options in the amount of $12,806 and $41,169, respectively. The remaining
balance of deferred compensation was reversed upon the cancellation of all
unvested stock options during 1996. All other options have been granted at
exercise prices that represent the fair market value of the common stock at
the time of the grant and accordingly the Company has not recorded any
compensation on these option grants.

  1996 STOCK PLAN

  On May 17, 1996, the Board of Directors and stockholders approved the
Company's 1996 Stock Plan (the 1996 Plan). Each non-employee director will
receive an initial option grant to purchase 7,000 shares of common stock, at
the then fair market value, when such director is first appointed to the Board
of Directors. In addition, each non-employee director will receive an option
grant to purchase 1,700 shares of common stock, at the then fair market value,
on each January 1 that such director is a member of the Board of Directors.

  The Company has reserved 4,150,000 shares of common stock for issuance under
the 1995 Plan and the 1996 Plan. As of December 31, 1997, there were
approximately 2,643,085 shares available for grant. Generally, the options
granted under both Plans vest equally over four years and expire after ten
years.

  The following table summarizes incentive and non-qualified stock option
activity under the 1995 and 1996 Stock Plans:

<TABLE>
<CAPTION>
                                                                       WEIGHTED
                                                                        AVERAGE
                                                NUMBER       PRICE       PRICE
                                              OF SHARES    PER SHARE   PER SHARE
                                              ----------  ------------ ---------
   <S>                                        <C>         <C>          <C>
   Outstanding, December 31, 1994............        --   $        --   $  --
   Options granted...........................  1,219,533     .015-4.50    3.90
                                              ----------  ------------  ------
   Outstanding, December 31, 1995............  1,219,533     .015-4.50    3.90
   Options granted...........................  2,457,648    7.50-16.00   10.53
   Options exercised.........................   (216,592)   .015-13.13    4.25
   Options canceled..........................   (850,245)   1.50-16.00    8.01
                                              ----------  ------------  ------
   Outstanding, December 31, 1996............  2,610,344    1.50-16.00   10.42
   Options granted...........................  2,356,250     1.94-2.88    2.36
   Options exercised.........................   (394,121)    1.50-7.50    2.28
   Options canceled.......................... (3,676,271)   1.50-16.00    6.44
                                              ----------  ------------  ------
   Outstanding, December 31, 1997............    896,202  $ 1.50-16.00  $ 2.97
                                              ==========  ============  ======
   Exercisable, December 31, 1997............    115,444  $1.50-$16.00  $ 3.40
                                              ==========  ============  ======
</TABLE>

                                      28
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  The following detail pertains to outstanding options of the Company at
December 31, 1997:

<TABLE>
<CAPTION>
    NUMBER OF    EXERCISE PRICE   WEIGHTED AVERAGE                      WEIGHTED AVERAGE
     SHARES      RANGE PER SHARE EXERCISE PRICE PER     NUMBER OF      EXERCISE PRICE PER
   OUTSTANDING     OUTSTANDING   SHARE OUTSTANDING  SHARES EXERCISABLE SHARE EXERCISABLE
   -----------   --------------- ------------------ ------------------ ------------------
   <S>           <C>             <C>                <C>                <C>
      45,572     $ 1.50 - $ 1.60       $ 1.50             25,905             $ 1.50
     794,299       1.60 -   3.20       $ 2.61             58,291             $ 2.53
      28,665       3.20 -   4.80       $ 4.50             24,332             $ 4.50
       6,666       6.40 -   8.00       $ 7.50              1,666             $ 7.50
      21,000      14.40 -  16.00       $16.00              5,250             $16.00
     -------     ---------------       ------            -------             ------
     896,202     $ 1.50 - $16.00       $ 2.97            115,444             $ 3.40
     =======     ===============       ======            =======             ======
</TABLE>

  In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires the
measurement of the fair value of stock options, including stock purchase
plans, or warrants granted to be included in the statement of operations or
disclosed in the notes to financial statements. The Company has determined
that it will continue to account for stock-based compensation for employees
under Accounting Principles Board Opinion No. 25 and elect the disclosure-only
alternative under SFAS No. 123. The Company has computed the pro forma
disclosures required under SFAS No. 123 for options granted in 1995, 1996, and
1997 using the Black-Scholes option pricing model prescribed by SFAS No. 123.
The weighted average assumptions used for 1995, 1996, and 1997 are as follows:

<TABLE>
<CAPTION>
                                           1995          1996          1997
                                       ------------- ------------- -------------
   <S>                                 <C>           <C>           <C>
   Risk-free interest rate............ 5.86% - 7.05% 5.97% - 6.69% 5.80% - 6.40%
   Expected dividend yield............      --            --            --
   Expected life......................    5 years       5 years       5 years
   Expected volatility................      70%           70%          100%
</TABLE>

  The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input of
highly subjective assumptions including expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.

  The total fair value of the options granted during 1995, 1996, and 1997 was
computed as approximately $2,463,000, $14,030,000, and $4,392,000,
respectively. Of these amounts approximately $865,000, $4,941,000, and
$1,355,000 would have been charged to operations for the years ended December
31, 1995, 1996, and 1997, respectively. The remaining amount would be
amortized over the remaining vesting periods. The resulting pro forma
compensation expense may not be representative of the amount to be expected in
future years as pro forma compensation expense may vary based upon the number
of options granted and cancelled.

  The pro forma net loss and pro forma basic and diluted net loss per common
share presented below have been computed assuming no tax benefit. The effect
of a tax benefit has not been considered since a substantial portion of the
stock options granted are incentive stock options and the Company does not
anticipate a future deduction associated with the exercise of these stock
options.

                                      29
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  The pro forma effect of SFAS No. 123 for the years ended December 31, 1995,
1996 and 1997 is as follows:

<TABLE>
<CAPTION>
                                      1995                       1996                       1997
                             ------------------------  --------------------------  ------------------------
                             AS REPORTED   PRO FORMA   AS REPORTED    PRO FORMA    AS REPORTED   PRO FORMA
                             -----------  -----------  ------------  ------------  -----------  -----------
   <S>                       <C>          <C>          <C>           <C>           <C>          <C>
   Net loss attributable to
    common stockholders....  $(2,698,448) $(3,563,504) $(12,973,947) $(17,914,947) $(7,636,583) $(8,991,583)
   Basic and diluted net
    loss per common
    share..................        $(.28)       $(.38)       $(1.03)       $(1.43)       $(.52)       $(.62)
</TABLE>

 (i) Warrants

  In February 1996, the Company issued a warrant to purchase 23,333 shares of
common stock at a price of $8.31 per share in connection with a financing
agreement which expired in 1997. The warrant is exercisable in whole or in
part, at any time on or before February 15, 2003.

 (j) Employee Stock Purchase Plan

  On May 17, 1996, the stockholders approved the Company's Employee Stock
Purchase Plan (ESPP). The Company has reserved 150,000 shares for issuance
under the ESPP. The ESPP permits eligible employees of the Company to purchase
common stock through payroll deductions of up to 10% of their total
compensation. The price of common stock purchased under the ESPP is 85% of the
lower of the fair market value of the common stock on the first or last day of
each six-month purchase period. During 1997, the Company issued 28,797 shares
of common stock under the ESPP.

 3. INCOME TAXES

  The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under SFAS No. 109, a deferred tax asset or
liability is measured by the enacted tax rates expected to be in effect when
the differences between the financial statement and tax bases of assets and
liabilities reverse.

  As of December 31, 1997, the Company had available net operating loss
carryforwards of approximately $21,600,000 to reduce future federal and state
income taxes, if any. These carryforwards expire through 2011 and are subject
to review and possible adjustment by the Internal Revenue Service. The Tax
Reform Act of 1986 contains provisions that may limit the amount of net
operating loss carryforwards that the Company may utilize in any one year in
the event of certain cumulative changes in ownership over a three year period
in excess of 50%, as defined. The Company has completed several financings
since it's inception and believes that an ownership change as defined by The
Tax Reform Act of 1986 has occurred. The Company has not yet determined the
extent of any net operating loss carryforward limitations.

  The approximate income tax effect of each type of temporary difference and
carryforward is as follows:

<TABLE>
<CAPTION>
                                                            1996        1997
                                                         ----------  ----------
      <S>                                                <C>         <C>
      Net operating loss carryforwards.................. $5,248,000  $8,640,000
      Other temporary differences.......................  1,202,000   1,010,000
      Credit carryforwards..............................     85,000     247,000
                                                         ----------  ----------
                                                          6,535,000   9,897,000
      Valuation allowance............................... (6,535,000) (9,897,000)
                                                         ----------  ----------
      Net deferred tax asset............................ $      --   $      --
                                                         ==========  ==========
</TABLE>

                                      30
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  It is the Company's objective to become a profitable enterprise and to
realize the benefits of its deferred tax assets. However, in evaluating the
realizability of these deferred tax assets, management has considered the
Company's short operating history, the volatility of the market in which it
competes, and the operating losses incurred to date, and believes that, given
the significance of this evidence, a full valuation reserve against its
deferred tax asset is required as of December 31, 1996 and 1997, respectively.

4. RELATED-PARTY TRANSACTIONS

 (a) Cambridge Technology Group, Inc.

  During 1995 and the first two months of 1996, the Company shared office
space with Cambridge Technology Group, Inc. (CTGroup), a company under the
control of a then significant stockholder of the Company. CTGroup charged the
Company for a portion of certain common costs incurred in addition to any
specific items paid by CTGroup on the Company's behalf. These costs were
allocated based on head count or actual cost incurred. For the years ended
December 31, 1995 and 1996, CTGroup charged the Company $1,013,142 and
$117,442, respectively, for these costs.

  During 1995 and 1996, the Company sold software and services to CTGroup
amounting to $104,993 and $100,000, respectively. In addition, during 1995 and
1996, the CTGroup assigned its rights under certain contracts, to the Company.
The Company recorded revenue of $2,403,235 and $100,000, respectively for the
performance of education and consulting services and the delivery of software
licenses and maintenance services under these contracts.

  In March 1996, the Company purchased computer equipment from CTGroup for
$125,000.

  In September 1996, the Company obtained third party software licenses from
CTGroup in exchange for certain source code rights previously purchased from
Open Environment Corporation (Note 4(b)). The source code rights were
originally purchased with the intent of embedding the technology into certain
of the Company's future products. The software licenses received and the
source code rights given were deemed to be of equal value. In 1996, the
Company recorded software license revenue of approximately $412,000 from the
subsequent resale of software licenses acquired in this exchange.

  Amounts due from CTGroup for these transactions were $55,402 at December 31,
1996.


  The Company believes that the transactions described above were at terms no
less favorable than the Company would have obtained from unaffiliated third
parties.

  In June 1997, Avix Ventures, L.P. (Avix) purchased all outstanding shares
then held by the significant stockholders affiliated with CTGroup.
Accordingly, effective June 1997, CTGroup is not considered a related party.

 (b) Open Environment Corporation

  In 1995, the Company entered into a reseller agreement with Open Environment
Corporation (OEC) to license software developed by OEC, an entity that was
founded by individuals that were formerly significant stockholders of the
Company. During the years ended December 31, 1995, 1996, and 1997 the Company
generated software license and maintenance revenues of $1,111,992, $1,759,639,
and $121,013, respectively, from the resale of OEC products and services.
Total expenses relating to purchases of OEC software and OEC software bundled
with the Company's product and related maintenance contracts totaled $716,392,
$837,675 and $57,288 in the years ended December 31, 1995, 1996, and 1997,
respectively. In addition, the Company subcontracted consulting services from
OEC totaling $398,271, $153,622, and $0 in 1995, 1996, and 1997, respectively.

                                      31
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  On December 29, 1995, the Company and OEC entered into a $2,200,000 OEM
source code license agreement that provided the Company with a certain source
code developed by OEC. At the time of the purchase, the Company intended to
embed this source code into certain of the Company's future software products
which were then under development. In accordance with SFAS No. 86, the Company
charged the cost of this source code to research and development expenses in
the year ended December 31, 1995.

  On October 31, 1995, the Company sold to OEC the source code for certain
software technology relating to the customization and enhancement of SAP
software products. OEC paid the Company an initial software license fee of
$500,000 under the agreement by which the source code was transferred, and
agreed to pay the Company a royalty in an amount equal to 20% of the first
$1,000,000 of sales revenue recognized by OEC related to products
incorporating components of the transferred source code and 10% of such sales
revenues in excess of $1,000,000. OEC's royalty obligations expired on October
1, 1997. The initial software license fee was included in 1995 software
license revenues. To date the Company has not received any royalties under
this arrangement.

  The Company believes that the transactions described above were at terms no
less favorable than the Company would have obtained from unaffiliated third
parties.

  In November 1996, OEC was acquired by Borland International, Inc. To the
best of the Company's knowledge, as a result of the acquisition, no
stockholder of the Company holds a significant ownership interest in the
combined entity. Accordingly, effective November 1996, OEC is not considered a
related party.

 (c) International Integration, Incorporated

  The Company subcontracted consulting services from International
Integration, Incorporated, a company controlled by a then significant
stockholder of the Company. During 1995 and 1996, these consulting services
totaled $662,000 and $32,000, respectively, and were included in cost of
revenues.

  The Company believes that the transactions described above were at terms no
less favorable than the Company would have obtained from unaffiliated third
parties.

  In June 1997, Avix purchased all outstanding shares then held by the
significant stockholders which controlled International Integration,
Incorporated. Accordingly, effective June 1997, International Integration,
Incorporated is not considered a related party.

 (d) Internet Business Solutions, Incorporated

  During 1996, the Company generated revenues from unrelated entities of
$2,920,000 of software licenses and $514,450 of consulting services to develop
vertical applications in conjunction with Internet Business Solutions, Inc.
(IBS). IBS provided up to 100% of the funding of the purchase of software
licenses and consulting services in return for certain rights in the developed
applications. IBS was wholly-owned by certain of the Company's then
significant stockholders at the time these transactions were initiated.
Subsequently, IBS has received additional equity funding from Samsung
Corporation. As of December 31, 1996 the balance included in accounts
receivable related to these transactions was $184,500.

  In June 1997, Avix purchased all outstanding shares then held by the
significant stockholders which controlled Internet Business Solutions,
Incorporated. Accordingly, effective June 1997, Internet Business Solutions,
Incorporated is not considered a related party.


                                      32
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. EMPLOYEE BENEFIT PLAN

  The Company's employees participate in an employee benefit plan under
Section 401(k) of the Internal Revenue Code. The plan is available to
substantially all employees. The plan allows for employees to make
contributions up to a specified percentage of their compensation. For all
participants with greater than one year of continuous service, the Company
contributes 25% of the first 6% of employees' pay contributed to the plan.
Previously, the Company's employees were eligible to participate in a plan
sponsored by CTGroup. The Company contributed approximately $2,000, $53,500,
and $58,200 under these plans during the years ended December 31, 1995, 1996,
and 1997, respectively.

6. LEASE COMMITMENTS

  The Company leases its office facilities and certain office equipment under
operating leases expiring at various dates through 2001. Rental expense
amounted to approximately $83,000, $389,000 and $590,044 for the years ended
December 31, 1995, 1996, and 1997 respectively. At December 31, 1997, future
rental commitments are approximately as follows:

<TABLE>
      <S>                                                             <C>
      1998........................................................... $  508,000
      1999...........................................................    479,000
      2000...........................................................    464,000
      2001...........................................................     77,000
                                                                      ----------
        Total........................................................ $1,528,000
                                                                      ==========
</TABLE>

7. COMPENSATION TO FORMER CHIEF EXECUTIVE OFFICER

  In January 1996, a then significant stockholder of the Company entered into
an agreement with the Company's former Chief Executive Officer (CEO) under
which the former CEO purchased 960,000 shares of the Company's common stock
held by the stockholder at a price of $1.50 per share. To fund the purchase,
the former CEO entered into a $1,440,000 note payable agreement with the
stockholder. The note payable accrued interest at 6.56% per annum and provides
for full recourse against the former CEO. At the time of this sale
transaction, the fair market value of the Company's common stock was $7.50 per
share. The Company has recorded the aggregate difference between the fair
market value of the common stock and the price paid by the former CEO,
$5,760,000, in compensation to former chief executive officer in the
accompanying statement of operations for the year ended December 31, 1996. In
connection with this purchase, the Company agreed to loan the former CEO up to
$2,560,000 which represents the former CEO's estimated tax liability resulting
from the compensation on the purchase of shares at less than fair market
value. The Company recorded this commitment as an accrued expense and a
corresponding note receivable from executive officer in the accompanying
balance sheet as of December 31, 1996.

  The Company funded $2,507,000 under the loan agreement in April 1997. The
loan was secured by a first priority pledge of the purchased shares. In June
1997, the former CEO surrendered the purchased shares in satisfaction of the
loan. For the year ended December 31, 1997, the Company has recorded an
expense of $227,000 to reflect the difference between the amount of the loan
and the market value of the shares surrendered to the Company. The Company has
classified the shares acquired as treasury stock (see Note 2).

  In connection with the employment of the former CEO in January 1996, the
former CEO received a nonrefundable $1,000,000 cash payment from a significant
stockholder. The Company believes the nature of this payment to be a sign-on
bonus. Accordingly, the Company has recorded a $1,000,000 charge to
compensation to former chief executive officer in the accompanying statement
of operations for the year ended December 31, 1996 with a corresponding
contribution to additional paid-in capital.

                                      33
<PAGE>

                                 ONEWAVE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  Also in connection with the employment of the former CEO, the same
significant stockholder agreed to reimburse the former CEO for any potential
decline in value (from January 1996 to the date of exercise) for certain stock
appreciation rights held by the former CEO in an unrelated company. At the
time this agreement was entered into, the unrealized appreciation on the stock
appreciation rights was approximately $4,400,000. The stock appreciation
rights were exercised by the former CEO in September 1996. The value of the
stock of the unrelated company had declined to the extent that the stockholder
is required to reimburse the former CEO approximately $34,000. The Company has
recorded this charge to compensation to former chief executive officer in the
accompanying statement of operations for the year ended December 31, 1996,
with a corresponding contribution to additional paid-in capital.

                                      34
<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

  None.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The information appearing under the captions "Information Regarding
Directors", "Executive Officers" and "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" in the registrant's definitive proxy
statement relating to the Annual Meeting of Stockholders to be held on May 21,
1998 is incorporated herein by reference.

  The Company's directors and executive officers and their principal
occupations are set forth below:

<TABLE>
<CAPTION>
NAME                     PRINCIPAL OCCUPATION
----                     --------------------
<S>                      <C>
Kevin Azzouz............ Partner, Avix Associates, L.P.
Stephen R. Levy......... Private Investor and Consultant
Ofer Nemirovsky......... Managing Director, HVP Partners, LLC
Lennart Mengwall........ Chairman and Chief Executive Officer, OneWave, Inc. and
                         Partner, Avix Associates, L.P.
Peter Marton............ President of Consulting Services Group, OneWave, Inc.
Joseph Seebach.......... Vice President of Sales and Marketing, OneWave, Inc.
David Chapman........... Chief Financial Officer, Treasurer and Secretary,
                         OneWave, Inc.
</TABLE>

ITEM 11. EXECUTIVE COMPENSATION

  The information appearing under the caption "Executive Compensation" in the
registrant's definitive proxy statement relating to the Annual Meeting of
Stockholders to be held on May 21, 1998 is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information appearing under the caption "Principal and Management
Stockholders" in the registrant's definitive proxy statement relating to the
Annual Meeting of Stockholders to be held on May 21, 1998 is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information appearing under the caption "Certain Relationships and
Related Transactions" in the registrant's definitive proxy statement relating
to the Annual Meeting of Stockholders to be held on May 21, 1998 is
incorporated herein by reference.

                                      35
<PAGE>

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

  (a)(1) Financial Statements:

Reference is made to the Index set forth on page 17 of this Annual Report on
Form 10-K.

  (a)(2) Financial Statements Schedules:

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
      <S>                                                                   <C>
      Schedule II--Valuation and Qualifying Accounts....................... S-2
</TABLE>

  All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under
the related instructions or are not applicable and therefore have been
omitted.

  (a)(3) Exhibits. Exhibits 10.1 through 10.3 constitute all of the management
contracts and compensation plans and arrangements of the Company required to
be filed as exhibits to this Annual Report. The following is a complete list
of Exhibits filed or incorporated by reference as part of this Annual Report.

<TABLE>
<CAPTION>
 EXHIBIT
   NO.   DESCRIPTION
 ------- -----------
 <C>     <S>
   3.1   Third Amended and Restated Certificate of Incorporation(2)
   3.2   Amended and Restated By-laws(2)
   4.1   Specimen Common Stock Certificate(3)
  10.1   1995 Stock Plan, as amended(1)
  10.1A  Form of Incentive Stock Option Agreement under the 1995 Stock Plan(4)
  10.1B  Form of Non-Qualified Stock Option Agreement under the 1995 Stock
         Plan(4)
  10.2   1996 Stock Plan, as amended(2)
  10.2A  Form of Incentive Stock Option Agreement under the 1996 Stock Plan(4)
  10.2B  Form of Non-Qualified Stock Option Agreement under the 1996 Stock
         Plan(4)
  10.3   Employee Stock Purchase Plan(2)
  10.4   Lease for One Arsenal Marketplace, Watertown, Massachusetts(1)
  10.5   Source Code License Agreement dated as of August 8, 1995 between the
         Company and InterGroup Technologies, Inc.(2)
  10.6   Software License Agreement dated as of August 8, 1995 between the
         Company and InterGroup Technologies, Inc.(2)
  10.6A  Agreements dated as of May 21, 1996 and May 22, 1996 amending the
         Source Code License Agreement and Software License Agreement between
         the Company and InterGroup Technologies, Inc.(2)
  10.7   Source Code License Agreement dated as of February 8, 1996 between the
         Company and Mentor Communications Limited(2)
  10.8   Software License Agreement dated as of August 10, 1995 between the
         Company and Mystic River Software, Inc.(2)
  10.9   Joint Marketing Agreement effective as of February 27, 1996 between
         the Company and Hewlett-Packard Company(2)
  10.10  Loan Agreement dated February 16, 1996 between the Company and State
         Street Bank and Trust Company, together with Guaranty (unlimited) of
         J&S Limited Partnership(1)
  10.11  Warrant Purchase Agreement dated as of February 16, 1996 between the
         Company and SSB Investments, Inc.(2)
  10.12  Common Stock Purchase Warrant dated as of February 16, 1996 issued to
         SSB Investments, Inc.(2)
</TABLE>


                                      36
<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
   NO.   DESCRIPTION
 ------- -----------
 <C>     <S>
  10.13  Series B Convertible Preferred Stock Purchase Agreement dated February
         27, 1996 between the Company and Hewlett-Packard Company(1)
  10.14  Amendment to Series B Convertible Preferred Stock Purchase Agreement
         dated as of March 6, 1996 between the Company and Hewlett-Packard
         Company(1)
  10.14A Amendment No. 1 to Series B Convertible Preferred Stock Purchase
         Agreement dated as of June 7, 1996 between the Company and Hewlett-
         Packard Company(3)
  10.15  Series B Convertible Preferred Stock Purchase Agreement dated March 6,
         1996 among the Company and the purchasers named therein(1)
  10.16  Registration Rights Agreement dated March 6, 1996 among the Company
         and the investors named therein(1)
  10.17  Co-Sale Rights Agreement dated as of March 6, 1996 among the investors
         and holders of shares of the Company's Common Stock named therein(1)
  10.18  Voting Agreement dated March 6, 1996 among the investors and holders
         of shares of the Company's Common Stock named therein(2)
  10.19  Series C Convertible Preferred Stock Purchase Agreement dated as of
         March 29, 1996 among the Company and the purchasers named therein(1)
  10.20  Registration Rights Agreement dated as of March 29, 1996 among the
         Company and the investors named therein(1)
  10.21  Stock Repurchase Agreement dated as of April 4, 1996 between the
         Company and James Nondorf(1)
  10.22  Stock Repurchase Agreement dated as of April 15, 1996 between the
         Company and J&S Limited Partnership(1)
  10.23  Stock Repurchase Agreement dated as of April 15, 1996 between the
         Company and Harrington Trust Limited as Trustee of The Appleby Trust(1)
  10.24  Loan Agreement dated as of March 31, 1996 between Klaus P. Besier and
         the Company(2)
  10.25  Stock Purchase Agreement dated as of April 22, 1997 by and among Avix
         Ventures, L.P. and the named Sellers therein(5)
  21     List of Subsidiaries(4)
 *23     Consent of Arthur Andersen LLP
 *27.1   Financial Data Schedule for (current) fiscal YEAR ended DEC-31-1997
 *27.2   Restated FDS for fiscal YEAR ended DEC-31-1996
 *27.3   Restated FDS for QUARTER ended SEP-30-1996
 *27.4   Restated FDS for QUARTER ended JUN-30-1996
</TABLE>
--------
(1) Filed as an exhibit to the Company's Registration Statement on Form S-1
    filed with the Securities and Exchange Commission on May 22, 1996 (File
    No. 333-04235) and incorporated herein by reference thereto.
(2) Filed as an exhibit to Amendment No. 1 to the Company's Registration
    Statement on Form S-1 filed with the Securities and Exchange Commission on
    June 13, 1996 (File No. 333-04235) and incorporated herein by reference
    thereto.
(3) Filed as an exhibit to Amendment No. 2 to the Company's Registration
    Statement on Form S-1 filed with the Securities and Exchange Commission on
    June 25, 1996 (File No. 333-04235) and incorporated herein by reference
    thereto.

                                      37
<PAGE>

(4) Filed as an exhibit to the Company's Annual Report on Form 10-K filed with
    the Securities and Exchange Commission on March 28, 1997 (File No. 000-
    20789) and incorporated herein by reference thereto.
(5) Filed as an exhibit to Schedule 13D filed with the Securities and Exchange
    Commission on May 2, 1997 (File No. 005-47827) and incorporated herein by
    reference thereto.
 * Filed herewith.

  A COPY OF ANY EXHIBIT TO THIS ANNUAL REPORT MAY BE OBTAINED WITHOUT CHARGE
BY WRITTEN REQUEST TO THE COMPANY'S SECRETARY, DAVID W. CHAPMAN, ONEWAVE INC.,
ONE ARSENAL MARKETPLACE, WATERTOWN, MA 02172.

  (b) Reports on Form 8-K. The Registrant did not file any reports on Form 8-K
during the last quarter of the period covered by this Annual Report.

  (c) Exhibits. The response to this portion of Item 14 is submitted as a
separate section of this Annual Report beginning on page 36.

  (d) Financial Statement Schedules. The response to this portion of Item 14
is submitted as a separate section of this Annual Report beginning on page S-
1.

                                      38
<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.

                                          OneWave, Inc.

                                                   /s/ Lennart Mengwall
                                          By: _________________________________
                                                    LENNART MENGWALL
                                           CHAIRMAN OF THE BOARD,PRESIDENT AND
                                                 CHIEF EXECUTIVE OFFICER

Dated: March 26, 1998

  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

              SIGNATURE                        TITLE                 DATE

        /s/ Lennart Mengwall           Chairman, President      March 26, 1998
-------------------------------------   and Chief Executive
          LENNART MENGWALL              Officer (Principal
                                        Executive Officer &
                                        Director)

        /s/ David W. Chapman           Chief Financial          March 26, 1998
-------------------------------------   Officer (Principal
          DAVID W. CHAPMAN              Financial and
                                        Accounting Officer)

          /s/ Kevin Azzouz             Director                 March 26, 1998
-------------------------------------
            KEVIN AZZOUZ

         /s/ Stephen R. Levy           Director                 March 26, 1998
-------------------------------------
           STEPHEN R. LEVY

         /s/ Ofer Nemirovsky           Director                 March 26, 1998
-------------------------------------
           OFER NEMIROVSKY

                                      39
<PAGE>

             REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE

To OneWave, Inc.:

  We have audited, in accordance with generally accepted auditing standards,
the consolidated balance sheets of OneWave, Inc. as of December 1996 and 1997
and the related consolidated statements of operations, redeemable convertible
preferred stock and stockholders' equity (deficit) and cash flows for the
years ended December 31, 1995, 1996, and 1997, included in this Form 10-K, and
have issued our report thereon dated January 28, 1998. Our audits were made
for the purpose of forming an opinion on the basic financial statements taken
as a whole. The attached schedule is the responsibility of the Company's
management and is presented for the purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures
applied in our audits of the basic financial statements and, in our opinion,
fairly states in all material respects, the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.

                                          Arthur Andersen LLP

Boston, Massachusetts
January 28, 1998

                                      S-1
<PAGE>

                                                                     SCHEDULE II

                                 ONEWAVE, INC.

                        VALUATION OF QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                    BALANCE AT    BAD DEBT              WRITE-    BALANCE AT
ALLOWANCE FOR DOUBTFUL ACCOUNTS  BEGINNING PERIOD EXPENSE  RECOVERIES    OFFS    END OF PERIOD
-------------------------------  ---------------- -------- ----------  --------  -------------
<S>                              <C>              <C>      <C>         <C>       <C>
Year ended December 31,
 1995...................             $    --      $143,000 $     --    $(43,000)   $100,000
Year ended December 31,
 1996...................              100,000      260,000       --     (77,000)    283,000
Year ended December 31,
 1997...................              283,000          --   (233,000)       --       50,000
</TABLE>

                                      S-2
<PAGE>

                                 ONEWAVE, INC.

                                 EXHIBIT INDEX

  Listed and indexed below are all Exhibits filed as part of this Report.
Certain Exhibits are incorporated by reference to documents previously filed
by the Company with the Securities and Exchange Commission pursuant to Rule
12b-32 under the Securities Exchange Act of 1934, as amended.

<TABLE>
<CAPTION>
 EXHIBIT NO. DESCRIPTION
 ----------- -----------
 <C>         <S>
     3.1     Third Amended and Restated Certificate of Incorporation(2)
     3.2     Amended and Restated By-laws(2)
     4.1     Specimen Common Stock Certificate(3)
    10.1     1995 Stock Plan, as amended(1)
    10.1A    Form of Incentive Stock Option Agreement under the 1995 Stock
             Plan(4)
    10.1B    Form of Non-Qualified Stock Option Agreement under the 1995 Stock
             Plan(4)
    10.2     1996 Stock Plan, as amended(2)
    10.2A    Form of Incentive Stock Option Agreement under the 1996 Stock
             Plan(4)
    10.2B    Form of Non-Qualified Stock Option Agreement under the 1996 Stock
             Plan(4)
    10.3     Employee Stock Purchase Plan(2)
    10.4     Lease for One Arsenal Marketplace, Watertown, Massachusetts(1)
    10.5     Source Code License Agreement dated as of August 8, 1995 between
             the Company and InterGroup Technologies, Inc.(2)
    10.6     Software License Agreement dated as of August 8, 1995 between the
             Company and InterGroup Technologies, Inc.(2)
    10.6A    Agreements dated as of May 21, 1996 and May 22, 1996 amending the
             Source Code License Agreement and Software License Agreement
             between the Company and InterGroup Technologies, Inc.(2)
    10.7     Source Code License Agreement dated as of February 8, 1996 between
             the Company and Mentor Communications Limited(2)
    10.8     Software License Agreement dated as of August 10, 1995 between the
             Company and Mystic River Software, Inc.(2)
    10.9     Joint Marketing Agreement effective as of February 27, 1996
             between the Company and Hewlett-Packard Company(2)
    10.10    Loan Agreement dated February 16, 1996 between the Company and
             State Street Bank and Trust Company, together with Guaranty
             (unlimited) of J&S Limited Partnership(1)
    10.11    Warrant Purchase Agreement dated as of February 16, 1996 between
             the Company and SSB Investments, Inc.(2)
    10.12    Common Stock Purchase Warrant dated as of February 16, 1996 issued
             to SSB Investments, Inc.(2)
    10.13    Series B Convertible Preferred Stock Purchase Agreement dated
             February 27, 1996 between the Company and Hewlett-Packard
             Company(1)
    10.14    Amendment to Series B Convertible Preferred Stock Purchase
             Agreement dated as of March 6, 1996 between the Company and
             Hewlett-Packard Company(1)
    10.14A   Amendment No. 1 to Series B Convertible Preferred Stock Purchase
             Agreement dated as of June 7, 1996 between the Company and
             Hewlett-Packard Company(3)
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT NO. DESCRIPTION
 ----------- -----------
 <C>         <S>
    10.15    Series B Convertible Preferred Stock Purchase Agreement dated
             March 6, 1996 among the Company and the purchasers named therein(1)
    10.16    Registration Rights Agreement dated March 6, 1996 among the
             Company and the investors named therein(1)
    10.17    Co-Sale Rights Agreement dated as of March 6, 1996 among the
             investors and holders of shares of the Company's Common Stock
             named therein(1)
    10.18    Voting Agreement dated March 6, 1996 among the investors and
             holders of shares of the Company's Common Stock named therein(2)
    10.19    Series C Convertible Preferred Stock Purchase Agreement dated as
             of March 29, 1996 among the Company and the purchasers named
             therein(1)
    10.20    Registration Rights Agreement dated as of March 29, 1996 among the
             Company and the investors named therein(1)
    10.21    Stock Repurchase Agreement dated as of April 4, 1996 between the
             Company and James Nondorf(1)
    10.22    Stock Repurchase Agreement dated as of April 15, 1996 between the
             Company and J&S Limited Partnership(1)
    10.23    Stock Repurchase Agreement dated as of April 15, 1996 between the
             Company and Harrington Trust Limited as Trustee of The Appleby
             Trust(1)
    10.24    Loan Agreement dated as of March 31, 1996 between Klaus P. Besier
             and the Company(2)
    10.25    Stock Purchase Agreement dated as of April 22, 1997 by and among
             Avix Ventures, L.P. and the named Sellers therein(5)
    21       List of Subsidiaries(4)
   *23       Consent of Arthur Andersen LLP
 *27.1       Financial Data Schedule for (current) fiscal YEAR ended DEC-31-
             1997
 *27.2       Restated FDS for fiscal YEAR ended DEC-31-1996
 *27.3       Restated FDS for QUARTER ended SEP-30-1996
 *27.4       Restated FDS for QUARTER ended JUN-30-1996
</TABLE>
--------
(1) Filed as an exhibit to the Company's Registration Statement on Form S-1
    filed with the Securities and Exchange Commission on May 22, 1996 (File
    No. 333-04235) and incorporated herein by reference thereto.
(2) Filed as an exhibit to Amendment No. 1 to the Company's Registration
    Statement on Form S-1 filed with the Securities and Exchange Commission on
    June 13, 1996 (File No. 333-04235) and incorporated herein by reference
    thereto.
(3) Filed as an exhibit to Amendment No. 2 to the Company's Registration
    Statement on Form S-1 filed with the Securities and Exchange Commission on
    June 25, 1996 (File No. 333-04235) and incorporated herein by reference
    thereto.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K filed with
    the Securities and Exchange Commission on March 28, 1997 (File No. 000-
    20789) and incorporated herein by reference thereto.
(5) Filed as an exhibit to Schedule 13D filed with the Securities and Exchange
    Commission on May 2, 1997 (File No. 005-47827) and incorporated herein by
    reference thereto.
*   Filed herewith.