The information in this Prospectus Supplement and the accompanying Prospectus
is not complete and may be changed. This Prospectus Supplement and the
accompanying Prospectus is not an offer to sell these securities and it is not
soliciting an offer to buy these securities in any state where the offer or
sale is not permitted.
Filed Pursuant to Rule 497
Registration Statement No. 333-112862
SUBJECT TO COMPLETION, DATED JUNE 14, 2004
PRELIMINARY PROSPECTUS SUPPLEMENT
(To Prospectus dated June 2, 2004)
2,500,000 Shares
[GRAPHIC OMITTED]
HARRIS & HARRIS GROUP, INC.
Common Stock
We are offering for sale 2,500,000 shares of our Common Stock. Our
Common Stock is traded on the Nasdaq National Market under the symbol "TINY."
The last reported sale price for our Common Stock on June 10, 2004 was $12.85
per share.
You should review the information set forth under "Risk Factors" on
page 7 of the accompanying Prospectus and page S-3 of the Prospectus
Supplement before investing in our Common Stock.
Per Share Total
--------- -----
Public offering price............................................. $ $
Underwriting discounts and commissions............................ $ $
Proceeds, before expenses, to the Company......................... $ $
You should read this Prospectus Supplement and the accompanying
Prospectus before deciding whether to invest in our Common Stock and retain it
for future reference. The Prospectus Supplement and the accompanying
Prospectus contain important information about us. Material that has been
incorporated by reference and other information about us can be obtained from
the Securities and Exchange Commission's ("SEC") website (http://www.sec.gov).
Neither the SEC nor any state securities commission has approved or
disapproved these securities or determined if this Prospectus Supplement is
truthful or complete. Any representation to the contrary is a criminal
offense.
The underwriters may also purchase up to an additional 375,000 shares
of our Common Stock from us at the public offering price, less underwriting
discounts and commissions, to cover over-allotments, if any, within 30 days of
the date of this Prospectus Supplement. The shares of Common Stock will be
ready for delivery on or about , 2004.
ThinkEquity Partners LLC Punk, Ziegel & Company
You should rely only on the information contained or incorporated by
reference in this Prospectus Supplement and the accompanying Prospectus. We
have not authorized any other person to provide you with different
information. If anyone provides you with different or inconsistent
information, you should not rely on it. We are not making an offer to sell
these securities in any jurisdiction in which the offer or sale is not
permitted.
In this Prospectus Supplement and in the accompanying Prospectus,
unless otherwise indicated, "Harris & Harris," "Company," "us," "our" and "we"
refer to Harris & Harris Group, Inc. This Prospectus Supplement also includes
trademarks owned by other persons.
-------------------
TABLE OF CONTENTS
Prospectus Supplement
Page
TABLE OF FEES AND EXPENSES......................................................................................S-1
USE OF PROCEEDS.................................................................................................S-2
PRICE RANGE OF COMMON STOCK.....................................................................................S-3
RISK FACTOR.....................................................................................................S-3
UNDERWRITING....................................................................................................S-4
LEGAL MATTERS...................................................................................................S-5
RECENT DEVELOPMENTS.............................................................................................S-5
Prospectus
PROSPECTUS SUMMARY................................................................................................1
TABLE OF FEES AND EXPENSES........................................................................................5
INCORPORATION BY REFERENCE........................................................................................6
RISK FACTORS......................................................................................................7
FORWARD-LOOKING INFORMATION......................................................................................14
USE OF PROCEEDS..................................................................................................14
PRICE RANGE OF COMMON STOCK......................................................................................15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................16
SELECTED CONDENSED CONSOLIDATED FINANCIAL DATA BALANCE SHEET DATA...............................................18
BUSINESS.........................................................................................................29
GENERAL DESCRIPTION OF OUR PORTFOLIO COMPANIES...................................................................34
DETERMINATION OF NET ASSET VALUE.................................................................................39
INVESTMENT POLICIES..............................................................................................41
MANAGEMENT OF THE COMPANY........................................................................................48
DIVIDENDS AND DISTRIBUTIONS......................................................................................61
TAXATION.........................................................................................................62
CERTAIN GOVERNMENT REGULATIONS...................................................................................65
CAPITALIZATION...................................................................................................67
PLAN OF DISTRIBUTION.............................................................................................68
LEGAL MATTERS....................................................................................................69
EXPERTS..........................................................................................................69
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS.........................................................................69
FURTHER INFORMATION..............................................................................................70
PRIVACY PRINCIPLES OF THE COMPANY................................................................................70
APPENDIX A: Consolidated Financial Statements and Supplementary Data......................................A-1
[This Page Intentionally Left Blank]
S-5
TABLE OF FEES AND EXPENSES
The following tables are intended to assist you in understanding the
various costs and expenses directly or indirectly associated with investing in
our Common Stock. Amounts are for the current fiscal year after giving effect
to anticipated net proceeds of the offering, assuming that we incur the
estimated offering expenses.
Shareholder Transaction Expenses
Sales Load (as a percentage of offering price) 6.00%
Offering Expenses (as a percentage of offering price) 1.92
Annual Expenses (as a percentage of net assets attributable to Common Stock)
Management Fees(1) N/A
Other Expenses(2)
Salaries and Benefits(3)(4)(5) 2.61%
Administration and Operations(6) 1.18
Professional Fees 0.36
Total Annual Expenses (7) 4.15%
- -------------------------------
(1) The Company has no external management fees because it is internally
managed.
(2) "Other Expenses" are based on estimated amounts for the current fiscal
year.
(3) We have an Employee Profit-Sharing Plan that provides for profit sharing
equal to 20% of the net after-tax income we realize as reflected on our
Consolidated Statement of Operations for each year, less non-qualifying
gains, if any. Under the Employee Profit-Sharing Plan, the net income we
realize includes investment income, gains and losses we realize and
operating expenses (including taxes paid or payable by us), but does not
include dividends paid or distributions made to shareholders, payments
under the plan, gains and losses we have not realized and loss carryovers
from other years. The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 is considered
non-qualifying gain. At December 31, 2003, we did not have realized net
income for that year and accordingly the expense accrual associated with
this liability for 2003 was $0 or 0% of net assets. Under no
circumstances may this expense exceed 20% of the net after-tax income we
realize.
(4) We established a Mandatory Retirement Plan on March 20, 2003. In
conjunction with this plan, we are required to provide to one employee,
our President, Chief Operating Officer and Chief Financial Officer, a
retirement benefit that has an estimated present value of $450,000. We
are amortizing the expense of this benefit through December 31, 2004 in
the amounts of $225,000 in 2003 and $225,000 in 2004.
(5) Our President, Chief Operating Officer and Chief Financial Officer is
scheduled to retire on December 31, 2004, pursuant to the Mandatory
Retirement Plan. His salary and non-continuing benefits in 2004,
including the amortization of his retirement benefit, will total
approximately $517,300, or 0.70 % of net assets attributable to Common
Stock.
(6) "Administration and Operations" include expenses incurred for
administration, operations, rent, directors' fees and expenses,
depreciation and custodian fees.
(7) Total annual expenses after December 31, 2004 will not include $517,300
for our President, Chief Operating Officer and Chief Financial Officer,
but will include a $100,000 increase in annual salary for Douglas W.
Jamison, a Vice President of the Company who has been designated by the
Board of Directors to replace our current President, Chief Operating
Officer and Chief Financial Officer as of January 1, 2005, and to receive
an increase in annual salary of $100,000 at that time.
Example
The following examples illustrate the dollar amount of cumulative
expenses that would be incurred over various periods with respect to a
hypothetical investment in our Common Stock. These amounts are based upon
payment by us of expenses at levels set forth in the above table, which
include $517,300 of remuneration and non-continuing benefits for our
President, Chief Operating Officer and Chief Financial Officer in the first
year.
You would pay the following expenses on a $10,000 investment,
assuming a 5% annual return:
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$1,175 $1,892 $2,626 $4,538
The foregoing table is to assist you in understanding the various
costs and expenses that an investor in our Common Stock will bear directly or
indirectly. The assumed 5% annual return is not a prediction of, and does not
represent, the projected or actual performance of our Common Stock. The above
example should not be considered a representation of future expenses, and
actual expenses and annual rates of return may be more or less than those
assumed for purposes of the example. The foregoing table does not include the
expenses of our Employee Profit Sharing plan, which would increase the amounts
shown in the table if we achieved returns in excess of our expenses.
USE OF PROCEEDS
We estimate the total net proceeds of the offering to be $29,580,700
($34,017,805 if the over-allotment option is exercised), based on the assumed
public offering price of $12.85 per share and after deducting underwriting
discounts and commissions and estimated offering expenses payable by us.
We expect to invest or reserve for potential follow-on investment the
net proceeds of the offering within two years from the completion of the
offering. Reserves for follow-on investments referred to above in any
particular initial investment may be no more than the greater of twice the
investment to date or five times the initial investment in the case of
seed-stage investments. Although we intend to make our initial investments
exclusively in companies that we believe are involved significantly in tiny
technology, we may also make follow-on investments in existing portfolio
companies involved in other technologies. Pending investment in portfolio
companies, we intend to invest the net proceeds of any offering of our Common
Stock in time deposits and/or income-producing securities that are issued or
guaranteed by the federal government or an agency of the federal government or
a government owned corporation, which are likely to yield less than our
operating expense ratio. We may also use the proceeds of this offering for
operating expenses, including due diligence expenses on potential investments.
If we pay operating expenses from the proceeds, it will reduce the net
proceeds of the offering that we will have available for investment.
PRICE RANGE OF COMMON STOCK
The following table sets forth for the quarters indicated, the high
and low sale prices on the Nasdaq National Market per share of our Common
Stock and the net asset value and the premium or discount from net asset value
per share at which the shares of Common Stock were trading, expressed as a
percentage of net asset value, at each of the high and low sale prices
provided.
Premium or Discount as a
Market Price Net Asset Value % of NAV
------------------- ("NAV") Per Share at ------------------------
Quarter Ended High Low End of Period High Low
- ---------------------------------------------------------------------------------------------------------------
March 31, 2000 $35.75 $9.00 $5.08 603.7% 77.2%
June 30, 2000 18.50 5.13 3.88 376.8 32.2
September 30, 2000 10.75 5.50 4.64 131.7 18.5
December 31, 2000 7.13 2.25 3.51 103.1 (35.9)
March 31, 2001 4.25 2.06 3.09 37.5 (33.3)
June 30, 2001 3.29 2.01 3.29 0.0 (38.9)
September 30, 2001 2.86 1.60 2.92 (2.1) (45.2)
December 31, 2001 2.33 1.55 2.75 (15.3) (43.6)
March 31, 2002 5.50 1.80 2.63 109.1 (31.6)
June 30, 2002 5.10 2.74 2.68 90.3 2.2
September 30, 2002 2.99 2.00 2.61 14.6 (23.4)
December 31, 2002 2.50 1.85 2.37 5.5 (21.9)
March 31, 2003 3.99 2.36 2.26 76.5 4.4
June 30, 2003 7.95 2.71 2.22 258.1 22.1
September 30, 2003 9.49 4.47 2.11 349.8 111.8
December 31, 2003 12.29 6.18 2.95 316.6 109.5
March 31, 2004 20.70 11.47 3.01 587.7 281.1
Second Quarter
- -------------------------------
through June 10, 2004 13.26 12.74 - - -
The last reported price for our Common Stock on June 10, 2004 was
$12.85 per share.
RISK FACTOR
On March 31, 2004, our net asset value per share was $3.01. Assuming
that we sell 2,500,000 shares in the offering at prices above $3.01, the
shares you purchase will have a net asset value of less than the price you
paid in the offering. This difference will be greater as the offering price
increases. For example, if the shares are sold at $11.00, $13.00 or $15.00,
the net asset value per share as of March 31, 2004 after giving effect to the
offering would be approximately $4.09, $4.38, $4.67, resulting in a difference
to you of $6.91, $8.62 or $10.33 per share, respectively.
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement
dated , 2004, each of the underwriters named below have agreed to purchase
from us the number of shares of Common Stock set forth opposite its name
below:
Number of
Underwriters Shares
- ------------ ------
ThinkEquity Partners LLC.........................................
Punk, Ziegel & Company, L.P...................................... _________
Total......................................................... 2,500,000
The underwriting agreement provides that the several obligations of
the underwriters are subject to certain conditions precedent, including the
absence of any significant negative change in our business and the receipt of
certain certificates, opinions and letters from us and our attorneys and
registered public accounting firm. The nature of the underwriters' Obligation
is such that they are committed to purchase all shares of Common Stock offered
hereby if any of the shares are purchased.
We have granted the underwriters the option, exercisable for 30 days
after the date of this Prospectus Supplement, to purchase up to an aggregate
of 375,000 shares of our Common Stock at the public offering price, less the
underwriting discounts and commissions set forth on the cover page of this
Prospectus Supplement. The underwriters may exercise this option solely to
cover unfilled customer orders, if any, in connection with the sale of our
Common Stock.
The following table summarizes the underwriting discounts and
commissions to be paid by us to the underwriters for each share of our Common
Stock. This information is presented assuming either no exercise or full
exercise of the underwriters' option to purchase additional shares of our
Common Stock.
Paid by Harris & Harris Group, Inc.
-----------------------------------
No Exercise Full Exercise
----------- -------------
Per Share............................ $ $
Total............................. $ $
We have been advised that the underwriters propose to offer the
shares of Common Stock to the public at the public offering price set forth on
the cover page of this Prospectus Supplement and to some dealers at that price
less a concession not in excess of $ per share. The underwriters may allow a
concession not in excess of $ per share to certain other dealers. The offering
of the shares of Common Stock is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of this offering without notice. The underwriters reserve the
right to reject an order for the purchase of shares in whole or in part.
We and our most senior executive officers have agreed that for a
period of 90 days after the date of this Prospectus Supplement, we and they
will not, without the prior written consent of ThinkEquity Partners LLC,
directly or indirectly: offer, sell, contract to sell or otherwise dispose of,
any shares of our Common Stock, or any securities convertible into or
exercisable or exchangeable for shares of our Common Stock, or grant any
rights, options or warrants to purchase shares of our Common Stock; provided,
that following the sale by each underwriter of its allotment of shares, we
may, without the prior written consent of the underwriters, sell shares of
Common Stock that are registered under the Registration Statement and the
accompanying Prospectus but are not being sold pursuant to this Prospectus
Supplement.
In connection with this offering, the underwriters may purchase and
sell shares of Common Stock in the open market. These transactions may include
short sales and stabilizing transactions. Short sales involve sales of Common
Stock in excess of the number of shares to be purchased by the underwriters in
this offering, which creates a short position. "Covered" short sales are sales
of shares made in an amount up to the number of shares represented by the
underwriters' over-allotment option. In determining the source of shares to
close out the covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
over-allotment option. Transactions to close out the covered short position
involve either purchases in the open market after the distribution has been
completed or the exercise of the over-allotment option. The underwriters may
also make "naked" short sales of shares in excess of the over-allotment
option. The underwriters must close out any naked short position by purchasing
shares of Common Stock in the open market. A naked short position is more
likely to be created if the underwriters are concerned that there may be
downward pressure on the price of the shares in the open market after pricing
that could adversely affect investors who purchase in the offering.
Stabilizing transactions consist of bids for, or purchases of, shares in the
open market while the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriter a portion of the underwriting
discount received by it because the underwriters have repurchased shares sold
by or for the account of that underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or
otherwise affect the market price of the Common Stock. As a result, the price
of the Common Stock may be higher than the price that otherwise might exist in
the open market. If these activities are commenced, they may be discontinued
by the underwriter without notice at any time. These transactions may be
effected on the Nasdaq National Market, or otherwise.
We have agreed to indemnify each of the underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, and to
contribute to payments which such underwriters may be required to make in
respect thereof.
LEGAL MATTERS
Certain legal matters will be passed on by Skadden, Arps, Slate,
Meagher & Flom LLP, New York, New York, our special counsel in connection with
the offering of Common Stock. Certain legal matters in connection with this
offering will be passed upon for the underwriters by Greenberg Traurig LLP,
Miami, Florida.
RECENT DEVELOPMENTS
On June 10, 2004, the board of directors changed the composition of
the Pricing Committee. The members of the Pricing Committee now are Mr. Harris
(Chairman), Dr. Bardin, Mr. Parsells and Mr. Fletcher.
[This Page is Intentionally Left Blank]
[GRAPHIC OMITTED]
HARRIS & HARRIS GROUP, INC.
7,000,000 Shares
Common Stock
Harris & Harris Group, Inc. is a venture capital business development
company that operates as a non-diversified business development company under
the Investment Company Act of 1940. We may offer, from time to time, up to
7,000,000 shares of our common stock, $0.01 par value per share ("Common
Stock"), in one or more offerings. The Common Stock may be offered at prices
and on terms to be set forth in one or more supplements to this Prospectus
(each a "Prospectus Supplement"). The offering price per share of our Common
Stock less any underwriting commissions or discounts will not be less than the
net asset value per share of our Common Stock at the time we make the
offering. You should read this Prospectus and the applicable Prospectus
Supplement carefully before you invest in our Common Stock.
Our Common Stock may be offered directly to one or more purchasers
through agents designated from time to time by us, or to or through
underwriters or dealers. The Prospectus Supplement relating to the offering
will identify any agents or underwriters involved in the sale of our Common
Stock, and will set forth any applicable purchase price, fee, commission or
discount arrangement between us and our agents or underwriters, or among our
underwriters or the basis upon which such amount may be calculated. We may not
sell any of our Common Stock through agents, underwriters or dealers without
delivery of a Prospectus Supplement describing the method and terms of the
particular offering of our Common Stock. Our Common Stock is listed on the
Nasdaq National Market under the symbol "TINY." On June 1, 2004, the last
reported sale price of our Common Stock was $14.65.
An Investment in the Securities Offered in this Prospectus Involves a
High Degree of Risk. You Should Consider Investing in Us Only if You Are
Capable of Sustaining the Loss of Your Entire Investment. See "Risk Factors"
Beginning on Page 7.
This Prospectus sets forth concisely the information about us that a
prospective investor ought to know before investing. You should read this
Prospectus before deciding whether to invest in our Common Stock and retain it
for future reference. Material that has been incorporated by reference and
other information about us can be obtained from the Securities and Exchange
Commission's ("SEC") website (http://www.sec.gov).
Neither the SEC nor any state securities commission has approved or
disapproved these securities or determined if this Prospectus is truthful or
complete. Any representation to the contrary is a crime.
This Prospectus may not be used to consummate sales of Common Stock
by us through agents, underwriters or dealers unless accompanied by a
Prospectus Supplement.
The date of the Prospectus is June 2, 2004.
[This Page Intentionally Left Blank]
You should rely only on the information contained or incorporated by
reference in this Prospectus. We have not authorized any other person to
provide you with different information. If anyone provides you with different
or inconsistent information, you should not rely on it. We are not making an
offer to sell these securities in any jurisdiction in which the offer or sale
is not permitted.
In this Prospectus, unless otherwise indicated, "Harris & Harris,"
"Company," "us," "our" and "we" refer to Harris & Harris Group, Inc. This
Prospectus also includes trademarks owned by other persons.
-------------------
TABLE OF CONTENTS
Page
PROSPECTUS SUMMARY................................................................................................1
TABLE OF FEES AND EXPENSES........................................................................................5
INCORPORATION BY REFERENCE........................................................................................6
RISK FACTORS......................................................................................................7
FORWARD-LOOKING INFORMATION......................................................................................14
USE OF PROCEEDS..................................................................................................14
PRICE RANGE OF COMMON STOCK......................................................................................15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................16
SELECTED CONDENSED CONSOLIDATED FINANCIAL DATA...................................................................18
BUSINESS.........................................................................................................29
GENERAL DESCRIPTION OF OUR PORTFOLIO COMPANIES...................................................................34
DETERMINATION OF NET ASSET VALUE.................................................................................39
INVESTMENT POLICIES..............................................................................................41
MANAGEMENT OF THE COMPANY........................................................................................48
DIVIDENDS AND DISTRIBUTIONS......................................................................................61
TAXATION.........................................................................................................62
CERTAIN GOVERNMENT REGULATIONS...................................................................................65
CAPITALIZATION...................................................................................................67
PLAN OF DISTRIBUTION.............................................................................................68
LEGAL MATTERS....................................................................................................69
EXPERTS..........................................................................................................69
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS.........................................................................69
FURTHER INFORMATION..............................................................................................70
PRIVACY PRINCIPLES OF THE COMPANY................................................................................70
[This Page Intentionally Left Blank]
- --------------------------------------------------------------------------------
PROSPECTUS SUMMARY
This summary highlights information that is described more fully
elsewhere in this Prospectus and in the documents to which we have referred.
It may not contain all of the information that is important to you. To
understand the offering fully, you should read the entire document carefully,
including the risk factors beginning on page 7.
Our Business
Harris & Harris Group, Inc. is a venture capital company specializing
in tiny technology that operates as a non-diversified business development
company under the Investment Company Act of 1940, which we refer to as the
1940 Act. For tax purposes, we operate as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, which we refer to as the
Code. Our investment objective is to achieve long-term capital appreciation,
rather than current income, by making venture capital investments in
early-stage companies. Our approach is comprised of a patient examination of
available early stage opportunities, through due diligence and close
involvement with management.
We make initial venture capital investments exclusively in "tiny
technology," which we define as microsystems, microelectromechanical systems
(which we refer to as MEMS) and nanotechnology. We consider a company to be a
tiny technology company if the company employs intellectual property which we
consider to be at the microscale or smaller and which is material to its
business plan. Our portfolio includes non-tiny technology investments made
prior to 2001, and we may make follow-on investments in either tiny or
non-tiny technology companies. By making these investments, we seek to provide
our shareholders with an increasingly specific focus on tiny technology
through a portfolio of venture capital investments that address a variety of
markets and products. We believe that we are the only publicly traded U.S.
venture capital company specializing in tiny technology.
Tiny technology is multidisciplinary and widely applicable, and it
incorporates technology that is significantly smaller than is currently in
general use. Microsystems are measured in micrometers, which are units of
measurement in millionths of a meter. Nanotechnology is measured in
nanometers, which are units of measurement in billionths of a meter. Because
it is a new field, tiny technology has significant scientific, engineering and
commercialization risks. See "Business" and "Risk Factors."
As a venture capital company, we make it possible for our investors
to participate at an early stage in this emerging field while our portfolio
companies are still private. By making investments in companies that control
intellectual property relevant to tiny technology, we are building a portfolio
that we believe will be difficult to replicate in the future, as we believe it
will likely become increasingly difficult to create new intellectual property
in tiny technology. To the investor, we offer:
o a portfolio consisting of investments that are generally
available only to a small, highly specialized group of
investors;
o a team of professionals including four full time members of
management, each of whom are designated as Managing Directors
and vote on all purchases and sales of private equity
investments, Charles E. Harris, Mel P. Melsheimer, Daniel V.
Leff and Douglas W. Jamison, and two directors who are also
consultants, Dr. Kelly S. Kirkpatrick and Lori D. Pressman, who
collectively have expertise in venture capital investing,
intellectual property and nanotechnology to evaluate and
monitor investments;
o the opportunity to benefit from our experience in a new field
expected to permeate a variety of industries; and
o through the ownership of our publicly traded shares, a measure
of liquidity not available in typical underlying venture
capital portfolio investments.
The number of tiny technology investment opportunities available to
us has increased over the past two years, through both new opportunities and
opportunities for follow-on investments in our existing portfolio companies.
We believe that our expertise and record of prior investments in tiny
technology are likely to lead us to additional tiny technology investment
opportunities in the future. We intend to use the net proceeds of this
offering to:
o increase our capital in order to take advantage of these
investment opportunities;
o increase the types of tiny technology companies in our
portfolio;
o increase the percentage of our total assets invested in tiny
technology;
o lower our expenses as a percentage of assets and otherwise
achieve certain economies and advantages of scale in our
operations since our costs are primarily fixed. Therefore, as
our assets increase by the net proceeds of this offering, those
fixed costs will represent a smaller percentage of our assets;
and
o pay operating expenses, including due diligence expenses on
potential investments.
We identify investment opportunities primarily through four channels:
o our involvement in the field of tiny technology;
o research universities that seek to transfer their scientific
discoveries to the private sector;
o other venture capital companies seeking co-investors; and
o direct calls and business plan submissions by companies,
business incubators and individuals seeking venture capital.
Since registering as an investment company in 1992, we have invested
in a variety of industries. In 1994, we invested in our first tiny technology
company, Nanophase Technologies Corporation. In 1995, we elected to be
regulated as a business development company. Recognizing the potential of tiny
technology, we continued to monitor developments in the field, and since 2001,
we have made tiny technology our exclusive focus for initial investments.
Since August 2001, all 15 of our initial investments have been in companies
involved in the development of products and technologies based on tiny
technology.
Our portfolio now includes a total of 19 companies, 14 of which we
consider to be involved in tiny technology. We are an internally managed
investment company; that is, our officers and employees, rather than an
investment adviser, manage our operations under the general supervision of our
board of directors.
As is usual in the venture capital industry, our venture capital
investments are generally in convertible preferred stock, which is usually the
most senior security in a portfolio company's equity capital structure until
the company has substantial revenues, and which gives us seniority over the
holders of Common Stock (usually the founders) while preserving fully our
participation in the upside potential of the portfolio company through the
conversion feature and, in many cases, a dividend right payable in kind (which
increases our participation in the portfolio company) or potentially in cash.
In-kind distributions are primarily made in additional shares of convertible
preferred stock, and we would expect to continue to invest in convertible
preferred shares even if a portfolio company were to issue debt securities.
Tiny Technology
Tiny technology is neither an industry nor a single technology, but a
variety of enabling technologies with critical dimensions below 100
micrometers. Tiny technology manifests itself in tools, materials and devices
that address broad markets, including instrumentation, electronics, photonics,
computing, medical devices, pharmaceutical manufacturing, drug delivery and
drug discovery. The development and commercialization of tiny technology often
require the integration of multiple disciplines, including biology, physics,
chemistry, material sciences, computer science and the engineering sciences.
Examples of tiny technology-enabled products currently on the market
are quite diverse. They include accelerometers used in automobiles to sense
impact and deploy airbags, cosmetics with ingredients that block ultraviolet
light but that are invisible to the human eye, nanoclays used for strength in
the running boards of minivans, textiles with liquid-stain repellant surfaces
and fast acting painkillers.
Within tiny technology, microsystems and MEMS both refer to
materials, devices and processes that are on a micrometer size scale. A
micrometer, which is also referred to as a micron, is 0.000001 meter, or one
millionth of a meter. In practice, any device from 100 microns down to 0.1
micron in size may be considered "micro." Nanotechnology refers to materials,
devices and processes with critical dimensions below 0.1 micron, equal to 100
nanometers. A nanometer is 0.000000001 meter, or one billionth of a meter. It
is at the scale below 100 nanometers, the nanoscale, that quantum effects
begin to dominate classical macroscale physics. At the nanoscale, size- and
shape-dependent properties of materials allow previously unattainable material
and device performance.
Although the practical application of tiny technology requires great
expertise to implement in manufacturing processes, we believe that tiny
technology's broad applicability presents significant and diverse market
opportunities.
Risk Factors
Set forth below is a summary of certain risks that you should
carefully consider before investing in us through the offering. See "Risk
Factors" below for a more detailed discussion of the risks in investing in our
Common Stock.
o Investing in small, private companies involves a high degree of
risk and is highly speculative.
o We may invest in companies working with technologies or
intellectual property which currently has few or no proven
commercial applications.
o We invest in illiquid securities and may not be able to dispose
of them when it is advantageous to do so, or ever.
o Unfavorable economic conditions could impair our ability to
engage in liquidity events.
o Because there is generally no established market in which to
value our investments, our valuation committee's value
determinations may differ materially from the values that a
ready market or third party would attribute to these
investments.
o Because we are a non-diversified company with a relatively
concentrated portfolio, the value of our business is subject to
greater volatility than the value of companies with more
broadly diversified investments.
o Approximately 32% of the net asset value attributable to our
venture capital investment portfolio, or 16% of our net asset
value, as of March 31, 2004, is concentrated in one company,
NeuroMetrix, Inc., which is not a tiny technology company.
o Approximately 36% of the net asset value attributable to our
venture capital investment portfolio, or 19% of our net asset
value, as of March 31, 2004, is invested in venture capital
investments which are not tiny technology companies.
o Bank borrowing or the issuance of debt securities or preferred
stock by us to fund investments in portfolio companies or to
fund our operating expenses would make our total return to
common shareholders more volatile. The use of debt would
leverage our available common equity capital, magnifying the
impact of changes in the value of our investment portfolio on
our net asset value. In addition, the cost of debt or preferred
stock financing may exceed the return on the assets the
proceeds are used to acquire, in which case the use of leverage
will have an adverse impact on the holders of our Common Stock.
o Investing in our stock is highly speculative and an investor
could lose some or all of the amount invested.
o Our shares might trade at a discount from net asset value or at
premiums that are unsustainable over the long term and
currently trade at a substantial premium over net asset value
that may not be sustainable over the long term.
Other Information
Our website is www.TinyTechVC.com and is not incorporated by
reference into this Prospectus. We make available free of charge through our
website the following materials (which are not incorporated by reference
unless specifically stated in this Prospectus) as soon as reasonably
practicable after filing or furnishing them to the SEC:
o our annual report on Form 10-K;
o our quarterly reports on Form 10-Q;
o our current reports on Form 8-K; and
o amendments to those reports.
The Offering
Common Stock offered..................... We may offer, from time to time, up to a total of 7,000,000 shares
of our Common Stock on terms to be determined at the time of the
offering. Our Common Stock may be offered at prices and on terms
to be set forth in one or more Prospectus Supplements. The
offering price per share of our Common Stock before any
underwriting commissions or discounts will not be less than the
net asset value per share of our Common Stock.
Use of proceeds.......................... Although we will make initial investments exclusively in tiny
technology, we can make follow-on investments in non-tiny
technology companies currently in our portfolio. Further, while
considering venture capital investments, we may invest the
proceeds in U.S. government and government agency securities,
which are likely to yield less than our operating expense ratio.
We expect to invest or reserve for potential follow-on investment
the net proceeds of any sale of shares under this Prospectus
within two years from the completion of such sales. We may also
use the proceeds of this offering for operating expenses,
including due diligence expenses on potential investments.
Reserves for follow-on investments referred to above in any
particular portfolio holding may be no more than the greater of
twice the investment to date in that portfolio holding or five
times the initial investment in the case of seed-stage
investments.
Nasdaq National Market
symbol................................... TINY
TABLE OF FEES AND EXPENSES
The following tables are intended to assist you in understanding the
various costs and expenses directly or indirectly associated with investing in
our Common Stock. Amounts are for the current fiscal year after giving effect
to anticipated net proceeds of the offering, assuming that we incur the
estimated offering expenses.
Shareholder Transaction Expenses
Sales Load(1) (as a percentage of offering price) 0.00%
Offering Expenses (as a percentage of offering price) 0.60
Annual Expenses (as a percentage of net assets attributable to Common Stock)
Management Fees(2) N/A
Other Expenses(3)
Salaries and Benefits(4)(5)(6) 1.36%
Administration and Operations(7) .61
Professional Fees .18
Total Annual Expenses (8) 2.15%
- -------------------------------
(1) In the event that the shares of Common Stock to which this Prospectus
relates are sold to or through underwriters, a corresponding Prospectus
Supplement will disclose the sales load.
(2) The Company has no external management fees because it is internally
managed.
(3) "Other Expenses" are based on estimated amounts for the current fiscal
year.
(4) We have an Employee Profit-Sharing Plan that provides for profit sharing
equal to 20% of the net after-tax income we realize as reflected on our
Consolidated Statement of Operations for each year, less non-qualifying
gains, if any. Under the Employee Profit-Sharing Plan, the net income we
realize includes investment income, gains and losses we realize and
operating expenses (including taxes paid or payable by us), but does not
include dividends paid or distributions made to shareholders, payments
under the plan, gains and losses we have not realized and loss
carryovers from other years. The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 is considered
non-qualifying gain. At December 31, 2003, we did not have realized net
income for that year and accordingly the expense accrual associated with
this liability for 2003 was $0 or 0% of net assets. Under no
circumstances may this expense exceed 20% of the net after-tax income we
realize.
(5) We established a Mandatory Retirement Plan on March 20, 2003. In
conjunction with this plan, we are required to provide to one employee,
our President, Chief Operating Officer and Chief Financial Officer, a
retirement benefit that has an estimated present value of $450,000. We
are amortizing the expense of this benefit through December 31, 2004 in
the amounts of $225,000 in 2003 and $225,000 in 2004.
(6) Our President, Chief Operating Officer and Chief Financial Officer is
scheduled to retire on December 31, 2004, pursuant to the Mandatory
Retirement Plan. His salary and non-continuing benefits in 2004,
including the amortization of his retirement benefit, will total
approximately $517,300, or 0.36% of net assets attributable to Common
Stock.
(7) "Administration and Operations" include expenses incurred for
administration, operations, rent, directors' fees and expenses,
depreciation and custodian fees.
(8) Total annual expenses after December 31, 2004 will not include $517,300
for our President, Chief Operating Officer and Chief Financial Officer,
but will include a $100,000 increase in annual salary for Douglas W.
Jamison, a Vice President of the Company who has been designated by the
Board of Directors to replace our current President, Chief Operating
Officer and Chief Financial Officer as of January 1, 2005, and to
receive an increase in annual salary of $100,000 at that time.
Example
The following examples illustrate the dollar amount of cumulative
expenses that would be incurred over various periods with respect to a
hypothetical investment in our Common Stock. These amounts are based upon
payment by us of expenses at levels set forth in the above table, which
include $517,300 of remuneration and non-continuing benefits for our
President, Chief Operating Officer and Chief Financial Officer in the first
year.
You would pay the following expenses on a $10,000 investment,
assuming a 5% annual return:
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$277 $695 $1,138 $2,369
The foregoing table is to assist you in understanding the various
costs and expenses that an investor in our Common Stock will bear directly or
indirectly. The assumed 5% annual return is not a prediction of, and does not
represent, the projected or actual performance of our Common Stock. The above
example should not be considered a representation of future expenses, and
actual expenses and annual rates of return may be more or less than those
assumed for purposes of the example. The foregoing table does not include the
expenses of our Employee Profit Sharing plan, which would increase the amounts
shown in the table if we achieved returns in excess of our expenses.
INCORPORATION BY REFERENCE
The financial statements for the fiscal years ended December 31,
2003, 2002 and 2001 and the fiscal periods ended March 31, 2004 and 2003 and
the financial statements for each fiscal period ended thereafter have been
incorporated by reference into the Prospectus from the Company's Annual Report
on Form 10-K and Quarterly Report on Form 10-Q, each of which either
accompanies this Prospectus or has previously been provided to the person to
whom this Prospectus is being sent. We will furnish, without charge, a copy of
such financial statements upon request by writing to 111 West 57th Street,
Suite 1100, New York, New York 10019, Attention: Investor Relations, or
calling 212-582-0900.
RISK FACTORS
Investing in our Common Stock involves a number of significant risks
relating to our business and investment objective. You should carefully
consider the risks and uncertainties described below before you purchase any
of our Common Stock. These risks and uncertainties are not the only ones we
face. Unknown additional risks and uncertainties, or ones that we currently
consider immaterial, may also impair our business. If any of these risks or
uncertainties materialize, our business, financial condition or results of
operations could be materially adversely affected. In this event, the trading
price of our Common Stock could decline, and you could lose all or part of
your investment.
Risks related to the companies in our portfolio.
Investing in small, private companies involves a high degree of risk
and is highly speculative.
We have invested a substantial portion of our assets in privately
held development stage or start-up companies. These businesses tend to lack
management depth, to have limited or no history of operations and to have not
attained profitability. Tiny technology companies are especially risky,
involving scientific, technological and commercialization risks. Because of
the speculative nature of these investments, these securities have a
significantly greater risk of loss than traditional investment securities.
Some of our venture capital investments are likely to be complete losses or
unprofitable, and some will never realize their potential. We have been and
will continue to be risk seeking rather than risk averse in our approach to
venture capital and other investments. Neither our investments nor an
investment in our Common Stock is intended to constitute a balanced investment
program.
We may invest in companies working with technologies or intellectual
property that currently have few or no proven commercial applications.
Nanotechnology, in particular, is a developing area of technology, of
which much of the future commercial value is unknown, difficult to estimate
and subject to widely varying interpretations. There are as of yet relatively
few nanotechnology products commercially available. The timing of additional
future commercially available nanotechnology products is highly uncertain.
Our portfolio companies working with tiny technology may be
particularly susceptible to intellectual property litigation.
Research and commercialization efforts in tiny technology are being
undertaken by a wide variety of government, academic and private corporate
entities. As additional commercially viable applications of tiny technology
begin to emerge, ownership of intellectual property on which these products
are based may be contested. Any litigation over the ownership of, or rights
to, any of our portfolio companies' technologies or products would have a
material adverse effect on those companies' values and may have a material
adverse effect on the value of our Common Stock.
Our portfolio companies may not successfully market their products.
Even if our portfolio companies are able to develop commercially
viable products, the market for new products and services is highly
competitive, rapidly changing and especially sensitive to adverse general
economic conditions. Commercial success is difficult to predict, and the
marketing efforts of our portfolio companies may not be successful.
Unfavorable economic conditions could result in the inability of our
portfolio companies to access additional capital, leading to financial losses
in our portfolio.
Most of the companies in which we have made or will make investments
are susceptible to economic slowdowns or recessions. An economic slowdown or
adverse capital or credit market conditions may affect the ability of a
company in our portfolio to raise additional capital from venture capital or
other sources or to engage in a liquidity event such as an initial public
offering or merger. These conditions may lead to financial losses in our
portfolio, which could have a material adverse effect on the value of our
Common Stock.
The value of our portfolio and the value of our Common Stock could be
adversely affected if the technologies utilized by our portfolio companies are
found to cause health or environmental risks.
Our portfolio companies work with new technologies, which could have
potential environmental and health impacts. Tiny technology in general and
nanotechnology in particular are currently the subject of health and
environmental impact research. If health or environmental concerns about tiny
technology or nanotechnology were to arise, our portfolio companies may incur
additional research, legal and regulatory expenses, might have difficulty
raising capital or could be forced out of business. Such adverse health and
environmental effects would have an adverse effect on the value of our
portfolio and on the value of our Common Stock.
Risks related to the illiquidity of our investments.
We invest in illiquid securities and may not be able to dispose of
them when it is advantageous to do so, or ever.
Most of our investments are or will be equity or equity-linked
securities acquired directly from small companies. These equity securities are
generally subject to restrictions on resale or otherwise have no established
trading market. The illiquidity of most of our portfolio of equity securities
may adversely affect our ability to dispose of these securities at times when
it may be advantageous for us to liquidate these investments. We may never be
able to dispose of these securities.
Unfavorable economic conditions could impair our ability to engage in
liquidity events.
Our business of making private equity investments and positioning our
portfolio companies for liquidity events may be adversely affected by current
and future capital markets and economic conditions. The public equity markets
currently provide less opportunity for liquidity events than at times in the
past when there was more robust demand for initial public offerings, even for
more mature technology companies than those in which we typically invest. The
potential for public market liquidity could further decrease and could lead to
an inability to realize potential gains or could lead to financial losses in
our portfolio and a decrease in our revenues, net income and assets. Recent
government reforms affecting stock markets, investment banks and securities
research practices may make it more difficult for privately held companies to
complete successful initial public offerings of their equity securities.
Slowdowns in initial public offerings also have an adverse effect on the
frequency and valuations of acquisitions of privately held companies. The lack
of opportunities to sell investments in privately held companies also has an
adverse effect on the ability of these companies to raise capital from private
sources.
Even if our portfolio companies complete initial public offerings,
the returns on our investments may be uncertain.
When companies in which we have invested as private entities complete
initial public offerings of their securities, these newly issued securities
are by definition unseasoned issues. Unseasoned issues tend to be highly
volatile and have uncertain liquidity, which may negatively affect their
price. In addition, we are typically subject to lock-up provisions which
prohibit us from selling our investments into the public market for specified
periods of time after initial public offerings. The market price of securities
that we hold may decline substantially before we are able to sell these
securities. Most initial public offerings of technology companies are listed
on the Nasdaq National Market. Recent government reforms of the Nasdaq
National Market have made market making by broker-dealers less profitable,
which has caused broker-dealers to reduce their market making activities,
thereby making the market for unseasoned stocks less liquid.
Risks related to our company.
Because there is generally no established market in which to value
our investments, our valuation committee's value determinations may differ
materially from the values that a ready market or third party would attribute
to these investments.
There is generally no public market for the equity securities in
which we invest. Pursuant to the requirements of the Investment Company Act of
1940, which we refer to as the 1940 Act, we value substantially all of the
equity securities in our portfolio at fair value as determined in good faith
by the valuation committee of our board of directors within the guidelines
established by the board of directors. As a result, determining fair value
requires that judgment be applied to the specific facts and circumstances of
each portfolio investment pursuant to specified valuation principles and
processes. We are required by the 1940 Act to value specifically each
individual investment on a quarterly basis and record unrealized depreciation
for an investment that we believe has become impaired. Conversely, we must
record unrealized appreciation if we believe that the underlying portfolio
company has appreciated in value. Without a readily ascertainable market value
and because of the inherent uncertainty of valuation, the fair value that we
assign to our investments may differ from the values that would have been used
had a ready market existed for the investments, and the difference could be
material. Any changes in fair value are recorded in our consolidated
statements of operations as a change in the "Net (decrease) increase in
unrealized appreciation on investments." See "Determination of Net Asset
Value."
Because we are a non-diversified company with a relatively
concentrated portfolio, the value of our business is subject to greater
volatility than the value of companies with more broadly diversified
investments.
As a result of investing a greater portion of our assets in the
securities of a smaller number of issuers, we are classified as a
non-diversified company. We may be more vulnerable to events affecting a
single issuer or industry and therefore subject to greater volatility than a
company whose investments are more broadly diversified. Accordingly, an
investment in our Common Stock may present greater risk to you than an
investment in a diversified company.
We may be obligated to pay substantial amounts under our profit
sharing plan.
Our employee profit-sharing plan requires us to distribute to our
officers and employees 20% of any net after-tax realized income as reflected
on our consolidated statements of operations for that year, less any
non-qualifying gain. These distributions may have a significant effect on the
amount of distributions made to our shareholders, if any.
Approximately 32% of the net asset value attributable to our venture
capital investment portfolio, or 16% of our net asset value, as of March 31,
2004, is concentrated in one company, NeuroMetrix, Inc., which is not a tiny
technology company.
At March 31, 2004, we valued our investment in NeuroMetrix, Inc.,
which is not a tiny technology company, at $6,825,426, which represents 31.85%
of the net asset value attributable to our venture capital investment
portfolio, or 16.45% of our net asset value. Any downturn in the business
outlook of NeuroMetrix, Inc., or any failure of the products of NeuroMetrix,
Inc., to receive widespread acceptance in the marketplace, would have a
significant effect on our specific investment in NeuroMetrix, Inc., and the
overall value of our portfolio.
Approximately 36% of the net asset value attributable to our venture
capital investment portfolio, or 19% of our net asset value, as of March 31,
2004, is invested in venture capital investments which are not tiny technology
companies.
Although all 15 of our investments added since August 2001 have been
in tiny technology companies, and although we consider 14 of the companies in
our venture capital investment portfolio to be tiny technology companies, at
March 31, 2004, only 63.56% of the net asset value attributable to our venture
capital investment portfolio, or 32.82% of our net asset value, was invested
in tiny technology companies, which may limit our ability to achieve our
investment objective.
We are dependent upon key management personnel for future success.
We are dependent for the selection, structuring, closing and
monitoring of our investments on the diligence and skill of our senior
management and other key advisers. We utilize lawyers and outside consultants,
including two of our directors, Dr. Kelly S. Kirkpatrick and Lori D. Pressman,
to assist us in conducting due diligence when evaluating potential
investments. There is generally no publicly available information about the
companies in which we invest, and we rely significantly on the diligence of
our employees and advisers to obtain information in connection with our
investment decisions. Our future success to a significant extent depends on
the continued service and coordination of our senior management team, and
particularly depends on our Chairman and Chief Executive Officer, Charles E.
Harris. The departure of any of our executive officers, key employees or
advisers could materially adversely affect our ability to implement our
business strategy. We do not maintain for our benefit any key man life
insurance on any of our officers or employees. Our President, Chief Operating
Officer and Chief Financial Officer, Mel P. Melsheimer, is scheduled to retire
on December 31, 2004, pursuant to the Mandatory Retirement Plan. We could be
adversely affected by his retirement.
We will need to hire additional employees as the size of our
portfolio increases.
We anticipate that it will be necessary for us to add investment
professionals with expertise in venture capital and/or tiny technology to
accommodate the increasing size of our portfolio. We may need to provide
additional scientific, business or investment training for our hires. There is
competition for highly qualified personnel, and we may not be successful in
our efforts to recruit and retain highly qualified personnel.
The market for venture capital investments, including tiny technology
investments, is highly competitive.
We face substantial competition in our investing activities from many
competitors, including but not limited to: private venture capital funds;
investment affiliates of large industrial, technology, service and financial
companies; small business investment companies; wealthy individuals; and
foreign investors. Our most significant competitors typically have
significantly greater financial resources than we do. Many sources of funding
compete for a small number of attractive investment opportunities. Hence, we
face substantial competition in sourcing good investment opportunities on
terms of investment that are commercially attractive.
In addition to the difficulty of finding attractive investment
opportunities, our status as a regulated business development company may
hinder our ability to participate in investment opportunities or to protect
the value of existing investments.
We are required to disclose on a quarterly basis the names and
business descriptions of our portfolio companies and the value of any
portfolio securities. Most of our competitors are not subject to these
disclosure requirements. Our obligation to disclose this information could
hinder our ability to invest in some portfolio companies. Additionally, other
current and future regulations may make us less attractive as a potential
investor than a competitor not subject to the same regulations.
Our failure to make follow-on investments in our portfolio companies
could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make
additional investments in that portfolio company as "follow-on" investments,
in order to: (1) increase or maintain in whole or in part our ownership
percentage; (2) exercise warrants, options or convertible securities that were
acquired in the original or subsequent financing; or (3) attempt to preserve
or enhance the value of our investment. Recently, "pay to play" provisions
have become common in venture capital transactions. These provisions require
proportionate investment in subsequent rounds of financing in order to
preserve preferred rights such as anti-dilution protection or even to prevent
preferred shares from being converted to common shares.
We may elect not to make follow-on investments or otherwise lack
sufficient funds to make those investments. We have the discretion to make any
follow-on investments, subject to the availability of capital resources. The
failure to make follow-on investments may, in some circumstances, jeopardize
the continued viability of a portfolio company and our initial investment, or
may result in a missed opportunity for us to increase our participation in a
successful operation, or may cause us to lose some or all preferred rights
pursuant to "pay to play" provisions. Even if we have sufficient capital to
make a desired follow-on investment, we may elect not to make a follow-on
investment because we may not want to increase our concentration of risk,
because we prefer other opportunities or because we are inhibited by
compliance with business development company requirements or the desire to
maintain our tax status.
Bank borrowing or the issuance of debt securities or preferred stock
by us to fund investments in portfolio companies or to fund our operating
expenses would make our total return to common shareholders more volatile.
Use of debt or preferred stock as a source of capital entails two
primary risks. The first risk is that the use of debt leverages our available
common equity capital, magnifying the impact on net asset value of changes in
the value of our investment portfolio. For example, a business development
company that uses 33% leverage (that is, $50 of leverage per $100 of common
equity) will show a 1.5% increase or decline in net asset value for each 1%
increase or decline in the value of its total assets. The second risk is that
the cost of debt or preferred stock financing may exceed the return on the
assets the proceeds are used to acquire, thereby diminishing rather than
enhancing the return to common shareholders. To the extent that we utilize
debt or preferred stock financing for any purpose, these two risks would
likely make our total return to common shareholders more volatile. In
addition, we might be required to sell investments, in order to meet dividend,
interest or principal payments, when it may be disadvantageous for us to do
so.
As provided in the 1940 Act and subject to some exceptions, we can
issue debt or preferred stock so long as our total assets immediately after
the issuance, less some ordinary course liabilities, exceed 200% of the sum of
the debt and any preferred stock outstanding. The debt or preferred stock may
be convertible in accordance with SEC guidelines, which may permit us to
obtain leverage at more attractive rates. The requirement under the 1940 Act
to pay, in full, dividends on preferred shares or interest on debt before any
dividends may be paid on our Common Stock means that dividends on our Common
Stock from earnings may be reduced or eliminated. An inability to pay
dividends on our Common Stock could conceivably result in our ceasing to
qualify as a regulated investment company, or RIC, under the Code, which would
in most circumstances be materially adverse to the holders of our Common
Stock.
We are authorized to issue preferred stock, which would convey
special rights and privileges to its owners.
We are currently authorized to issue up to 2,000,000 shares of
preferred stock, under terms and conditions determined by our board of
directors. These shares would have a preference over our Common Stock with
respect to dividends and liquidation. The statutory class voting rights of any
preferred shares we would issue could make it more difficult for us to take
some actions that may, in the future, be proposed by the board and/or holders
of Common Stock, such as a merger, exchange of securities, liquidation or
alteration of the rights of a class of our securities if these actions were
perceived by the holders of the preferred shares as not in their best
interests. The issuance of preferred shares convertible into shares of Common
Stock might also reduce the net income and net asset value per share of our
Common Stock upon conversion. These effects, among others, could have an
adverse effect on your investment in our Common Stock.
Loss of status as a RIC would reduce our net asset value and
distributable income.
We currently intend to qualify as a RIC for 2003 under the tax Code.
As a RIC, we do not have to pay federal income taxes on our income (including
realized gains) that is distributed to our shareholders. Accordingly, we are
not permitted under accounting rules to establish reserves for taxes on our
unrealized capital gains. If we failed to qualify for RIC status, to the
extent that we had unrealized gains, we would have to establish reserves for
taxes, which would reduce our net asset value, net of a reduction in the
reserve for employee profit sharing, accordingly. To the extent that we, as a
RIC, were to decide to make a deemed distribution of net realized capital
gains and retain the net realized capital gains, we would have to establish
appropriate reserves for taxes upon making that decision. See "Taxation."
We operate in a regulated environment.
We are subject to substantive SEC regulations as a business
development company. Securities and tax laws and regulations governing our
activities may change in ways adverse to our and our shareholders' interests,
and interpretations of these laws and regulations may change with
unpredictable consequences. Any change in the laws or regulations that govern
our business could have an adverse impact on us or on our operations. Also, as
business and financial practices continue to evolve, they may render the
regulations under which we operate less appropriate and more burdensome than
they were when originally imposed. See "Certain Government Regulations."
Quarterly results fluctuate and are not indicative of future
quarterly performance.
Our quarterly operating results fluctuate as a result of a number of
factors. These factors include, among others, variations in and the timing of
the recognition of realized and unrealized gains or losses, the degree to
which we and our portfolio companies encounter competition in our markets and
general economic and capital markets conditions. As a result of these factors,
results for any one quarter should not be relied upon as being indicative of
performance in future quarters.
To the extent that we do not realize income or retain after-tax
realized capital gains, we may have a greater need for additional capital to
fund our investments and operating expenses.
As a RIC, we must annually distribute at least 90% of our investment
company taxable income as a dividend and may either distribute or retain our
realized net capital gains from investments. As a result, these earnings may
not be available to fund investments. If we fail to generate net realized
capital gains or to obtain funds from outside sources, it would have a
material adverse effect on our financial condition and results of operations
as well as our ability to make follow-on and new investments. Because of the
structure and objectives of our business, we generally expect to experience
net operating losses and rely on proceeds from sales of investments, rather
than on investment income, to defray a significant portion of our operating
expenses. These sales are unpredictable and may not occur. In addition, as a
business development company, we are generally required to maintain a ratio of
at least 200% of total assets to total borrowings, which may restrict our
ability to borrow to fund these requirements.
Investment in foreign securities could result in additional risks.
The Company may invest in foreign securities, although we currently
have no investments in foreign securities. If we invest in securities of
foreign issuers, we may be subject to risks not usually associated with owning
securities of U.S. issuers. These risks can include fluctuations in foreign
currencies, foreign currency exchange controls, social, political and economic
instability, differences in securities regulation and trading, expropriation
or nationalization of assets, and foreign taxation issues. In addition,
changes in government administrations or economic or monetary policies in the
United States or abroad could result in appreciation or depreciation of our
securities and could favorably or unfavorably affect our operations. It may
also be more difficult to obtain and enforce a judgment against a foreign
issuer. Any foreign investments made by us must be made in compliance with
U.S. and foreign currency restrictions and tax laws restricting the amounts
and types of foreign investments.
Risks related to this offering.
Investing in our stock is highly speculative and an investor could
lose some or all of the amount invested.
Our investment objective and strategies result in a high degree of
risk in our investments and may result in losses in the value of our
investment portfolio. Our investments in portfolio companies are highly
speculative and, therefore, an investor in our Common Stock may lose his or
her entire investment. The value of our Common Stock may decline and may be
affected by numerous market conditions, which could result in the loss of some
or all of the amount invested in our Common Stock. The securities markets
frequently experience extreme price and volume fluctuations which affect
market prices for securities of companies generally, and technology and very
small capitalization companies in particular. Because of our focus on the
technology and very small capitalization sectors, and because we are a small
capitalization company ourselves, our stock price is especially likely to be
affected by these market conditions. General economic conditions, and general
conditions in the Internet and information technology, life sciences,
nanotechnology, tiny technology, materials sciences and other high technology
industries, may also affect the price of our Common Stock.
We will have broad discretion over the use of proceeds of this
offering.
We will have significant flexibility in applying the proceeds of this
offering. We may also pay operating expenses, including due diligence expenses
of potential new investments, from the net proceeds. Our ability to achieve
our investment objective may be limited to the extent that the net proceeds of
the offering, pending full investment, are used to pay operating expenses.
Our shares might trade at discounts from net asset value or at
premiums that are unsustainable over the long term.
Shares of business development companies like us may, during some
periods, trade at prices higher than their net asset value and during other
periods, as frequently occurs with closed-end investment companies, trade at
prices lower than their net asset value. The possibility that our shares will
trade at discounts from net asset value or at premiums that are unsustainable
over the long term are risks separate and distinct from the risk that our net
asset value will decrease. The risk of purchasing shares of a business
development company that might trade at a discount or unsustainable premium is
more pronounced for investors who wish to sell their shares in a relatively
short period of time because, for those investors, realization of a gain or
loss on their investments is likely to be more dependent upon the existence of
a premium or discount than upon portfolio performance. Our Common Stock may
not trade at a price higher than or equal to net asset value. On June 1, 2004,
our stock closed at $14.65 per share, a premium of $11.64 over our net asset
value per share of $3.01 as of March 31, 2004.
Our former independent public accountant, Arthur Andersen LLP, has
been found guilty of a federal obstruction of justice charge, and you may be
unable to exercise effective remedies against it in any legal action.
Our former independent public accountant, Arthur Andersen LLP,
provided us with auditing services for prior fiscal periods through December
31, 2001, including issuing an audit report with respect to our audited
consolidated financial statements as of and for the year ended December 31,
2001 incorporated by reference in this Prospectus. On June 15, 2002, a jury in
Houston, Texas found Arthur Andersen LLP guilty of a federal obstruction of
justice charge arising from the federal government's investigation of Enron
Corp. On August 31, 2002, Arthur Andersen LLP ceased practicing before the
SEC.
We were unable to obtain Arthur Andersen LLP's consent to incorporate
by reference in this Prospectus its report with respect to our audited
consolidated financial statements as of and for the year ended December 31,
2001. Rule 437(a) under the Securities Act of 1933, or the Securities Act,
permits us to dispense with the requirement to file their consent. As a
result, you may not have an effective remedy against Arthur Andersen LLP in
connection with a material misstatement or omission with respect to our
audited consolidated financial statements that are incorporated by reference
in this Prospectus or any other filing we may make with the SEC, including,
with respect to this offering or any other offering registered under the
Securities Act, any claim under Section 1l of the Securities Act. In addition,
even if you were able to assert a claim, as a result of its conviction and
other lawsuits, Arthur Andersen LLP may fail or otherwise have insufficient
assets to satisfy claims made by investors or by us that might arise under
federal securities laws or otherwise relating to any alleged material
misstatement or omission with respect to our audited consolidated financial
statements.
You have no right to require us to repurchase your shares.
You do not have the right to require us to repurchase your shares of
Common Stock.
FORWARD-LOOKING INFORMATION
This Prospectus may contain "forward-looking statements" based on our
current expectations, assumptions, and estimates about us and our industry.
These forward-looking statements involve risks and uncertainties. Words such
as "believe," "anticipate," "estimate," "expect," "intend," "plan," "will,"
"may," "continue" and other similar expressions identify forward-looking
statements. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements. Our actual results could differ materially from
those anticipated in the forward-looking statements as a result of several
factors more fully described in "Risk Factors" and elsewhere in this
Prospectus. The forward-looking statements made in this Prospectus relate only
to events as of the date on which the statements are made. We undertake no
obligation to update publicly any forward-looking statements for any reason,
even if new information becomes available or other events occur in the future.
USE OF PROCEEDS
We estimate the total net proceeds of the offering to be up to
$112,000,000.
We expect to invest or reserve for potential follow-on investment the
net proceeds of any offering within two years from the completion of such
offerings. Reserves for follow-on investments referred to above in any
particular initial investment may be no more than the greater of twice the
investment to date or five times the initial investment in the case of
seed-stage investments. Although we intend to make our initial investments
exclusively in companies that we believe are involved significantly in tiny
technology, we may also make follow-on investments in existing portfolio
companies involved in other technologies. Pending investment in portfolio
companies, we intend to invest the net proceeds of any offering of our Common
Stock in time deposits and/or income-producing securities that are issued or
guaranteed by the federal government or an agency of the federal government or
a government owned corporation, which are likely to yield less than our
operating expense ratio. We may also use the proceeds of this offering for
operating expenses, including due diligence expenses on potential investments.
If we pay operating expenses from the proceeds, it will reduce the net
proceeds of the offering that we will have available for investment.
PRICE RANGE OF COMMON STOCK
Our Common Stock is traded on the Nasdaq National Market under the
symbol "TINY."
The following table sets forth for the quarters indicated, the high
and low sale prices on the Nasdaq National Market per share of our Common
Stock and the net asset value and the premium or discount from net asset value
per share at which the shares of Common Stock were trading, expressed as a
percentage of net asset value, at each of the high and low sale prices
provided.
Premium or Discount as a
Market Price Net Asset Value % of NAV
------------------ ("NAV") Per Share at -----------------------
Quarter Ended High Low End of Period High Low
- -----------------------------------------------------------------------------------------------------------------
March 31, 2000 $35.75 $9.00 $5.08 603.7% 77.2%
June 30, 2000 18.50 5.13 3.88 376.8 32.2
September 30, 2000 10.75 5.50 4.64 131.7 18.5
December 31, 2000 7.13 2.25 3.51 103.1 (35.9)
March 31, 2001 4.25 2.06 3.09 37.5 (33.3)
June 30, 2001 3.29 2.01 3.29 0.0 (38.9)
September 30, 2001 2.86 1.60 2.92 (2.1) (45.2)
December 31, 2001 2.33 1.55 2.75 (15.3) (43.6)
March 31, 2002 5.50 1.80 2.63 109.1 (31.6)
June 30, 2002 5.10 2.74 2.68 90.3 2.2
September 30, 2002 2.99 2.00 2.61 14.6 (23.4)
December 31, 2002 2.50 1.85 2.37 5.5 (21.9)
March 31, 2003 3.99 2.36 2.26 76.5 4.4
June 30, 2003 7.95 2.71 2.22 258.1 22.1
September 30, 2003 9.49 4.47 2.11 349.8 111.8
December 31, 2003 12.29 6.18 2.95 316.6 109.5
March 31, 2004 20.70 11.47 3.01 587.7 281.1
The last reported price for our Common Stock on June 1, 2004 was
$14.65 per share. As of May 12, 2004, we had approximately 130 shareholders of
record.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information contained in this section should be read in
conjunction with our 2003 Consolidated Financial Statements and the Notes
thereto. In addition, this Prospectus contains certain forward-looking
statements. These statements include the plans and objectives of management
for future operations and financial objectives and can be identified by the
use of forward-looking terminology such as "believe," "anticipate,"
"estimate," "expect," "intend," "plan," "will," "may" or "continue" or the
negative thereof or other variations thereon or comparable terminology. These
forward-looking statements are subject to the inherent uncertainties in
predicting future results and conditions.
Information presented for portfolio companies has been obtained from
the portfolio companies.
Background and Overview
We incorporated under the laws of the state of New York in August
1981. In 1983, we completed an initial public offering and invested $406,936
in Otisville BioTech, Inc., which also completed an initial public offering
later that year. In 1984, Charles E. Harris purchased a controlling interest
in us, thereby also becoming the control person in Otisville. We then divested
our other assets and became a financial services company, with the investment
in Otisville as the initial focus of our business activity. We hired new
management for Otisville, and Otisville acquired new technology targeting the
development of a human blood substitute.
By 1988, we operated two insurance brokerages and a trust company as
wholly-owned subsidiaries. In 1989, Otisville changed its name to Alliance
Pharmaceutical Corporation, and by 1990, we had completed selling our $406,936
investment in Alliance for total proceeds of $3,923,559.
In 1992, we sold our insurance brokerage and trust company
subsidiaries to their respective managements and registered as an investment
company under the 1940 Act, commencing operations as a closed-end,
non-diversified investment company. In 1995, we elected to become a business
development company subject to the provisions of Sections 55 through 65 of the
1940 Act. We have made early stage venture capital investments in a variety of
industries since 1983. In 1994, we made our first tiny technology investment.
Since August 2001, we have made initial investments exclusively in tiny
technology, including our last 15 initial investments.
Since our investment in Otisville in 1983, we have made a total of 57
venture capital investments, including four investments, via private
placements, in securities of publicly traded companies. We have sold 38 of
these 57 investments, realizing total proceeds of $108,159,142 on our invested
capital of $40,094,851. Seventeen of these 38 investments were profitable. The
average and median holding periods for these 38 investments were 3.5 years and
3.2 years, respectively, from the first dollar invested to the last dollar
received. At March 31, 2004, we valued the 18 venture capital investments
remaining in our portfolio at $21,428,191, or 51.6%, of our net assets, net of
unrealized depreciation of $1,563,651. At March 31, 2004, the average and
median holding periods for our 18 current venture capital investments were 2.9
years and 2.0 years, respectively, from first dollar invested to March 31,
2004. Because most of these investments entailed more than one round of
financing, the average and median periods of time that our money was invested
were shorter than the average and median holding periods as measured from
first dollar invested to last dollar received.
We have invested a substantial portion of our assets in private,
development stage or start-up companies. These private businesses tend to be
thinly capitalized, unproven, small companies that lack management depth, have
little or no history of operations and are developing unproven technologies.
At March 31, 2004, $21,428,191, or 51.6%, of our net assets consisted of
venture capital investments at fair value, net of unrealized depreciation of
$1,563,651. At December 31, 2003, $15,106,576, or 37.1%, of our net assets
consisted of venture capital investments at fair value, of which net
unrealized depreciation was $2,375,303. At December 31, 2002, $12,036,077, or
44.2%, of our net assets consisted of venture capital investments at fair
value, of which net unrealized appreciation was $2,718,389.
Because none of our current venture capital investments have readily
available market values, we value our venture capital investments each quarter
at fair value as determined in good faith by our valuation committee within
guidelines established by our board of directors in accordance with the 1940
Act. See "Determination of Net Asset Value."
We have broad discretion in the investment of our capital. However,
we invest primarily in illiquid equity securities of private companies.
Generally, these investments take the form of preferred stock, are subject to
restrictions on resale and have no established trading market. Our principal
objective is to achieve long-term capital appreciation. Therefore, a
significant portion of our investment portfolio provides little or no income
in the form of dividends or interest. We do earn interest income from
fixed-income securities, including U.S. government and government agency
securities. The amount of interest income we earn varies with the average
balance of our fixed-income portfolio and the average yield on this portfolio
and is not expected to be material to our results of operations.
General business and capital markets conditions in 2002 and 2003 were
adverse for the venture capital industry. There were few opportunities to take
venture capital-backed companies public or sell them to established companies.
During this period, it was also difficult to finance venture capital-backed
companies privately and, in general, for venture capital funds themselves to
raise capital.
We present the financial results of our operations utilizing
accounting principles generally accepted in the United States for investment
companies. On this basis, the principal measure of our financial performance
during any period is the net increase/(decrease) in our net assets resulting
from our operating activities, which is the sum of the following three
elements:
Net Operating Income / (Loss) - the difference between our income
from interest, dividends, and fees and our operating expenses.
Net Realized Gain / (Loss) on Investments - the difference between
the net proceeds of sales of portfolio securities and their stated cost.
Net Increase / (Decrease) in Unrealized Appreciation on Investments -
the net change in the fair value of our investment portfolio.
Because of the structure and objectives of our business, we generally
expect to experience net operating losses and seek to generate increases in
our net assets from operations through the long term appreciation of our
venture capital investments. We have in the past relied, and continue to rely,
on proceeds from sales of investments, rather than on investment income, to
defray a significant portion of our operating expenses. Because sales of our
investments are unpredictable, we attempt to maintain adequate working capital
to provide for fiscal periods when we have no sales of investments.
SELECTED CONDENSED CONSOLIDATED FINANCIAL DATA
BALANCE SHEET DATA
Financial Position as of: December 31,
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Total assets $ 44,115,128 $ 35,951,969 $ 39,682,367 $ 43,343,423 $ 65,320,768
Total liabilities $ 3,432,390 $ 8,695,923 $ 15,347,597 $ 11,509,948 $ 11,685,963
Net assets $ 40,682,738 $ 27,256,046 $ 24,334,770 $ 31,833,475 $ 53,634,805
Cash dividends paid $ 0.00 $ 0.00 $ 0.00 $ 184,817 $ 3,647,017
Net asset value per
outstanding share $ 2.95 $ 2.37 $ 2.75 $ 3.51 $ 5.80
Cash dividends paid per
outstanding share $ 0.00 $ 0.00 $ 0.00 $ 0.02 0.35
Shares outstanding 13,798,845 11,498,845 8,864,231 9,064,231 9,240,831
OPERATING DATA
For the twelve months ended
December 31,
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Total investment income $ 167,785 $ 253,461 $ 510,661 $ 687,050 $ 287,684
Total expenses(1) $ 2,731,527 $ 2,124,549 $ 1,035,221 $ (2,623,200) $ 9,924,020
Net operating (loss) income $ (2,563,742) $ (1,871,088) $ (524,560) $ 3,310,250 $ (9,636,336)
Total tax expense (benefit) $ 13,761 $ 199,309 $ 27,951 $ (51,869) $ 733,970
Net realized gain (loss)
on investments $ (984,925) $ 2,390,302 $ 1,276,366 $ 18,963,832 $ 8,615,670
Net realized income (loss) $ (3,548,667) $ 519,214 $ 751,806 $ 22,274,082 $ (1,020,666)
Net increase (decrease) in
unrealized appreciation on
investments $ 343,397 $ (3,241,408) $ (7,641,044) $(37,781,289) $ 38,102,047
Net increase (decrease)
in net assets resulting
from operations $ (3,205,270) $ (2,722,194) $ (6,889,238) $(15,507,204) $ 37,081,381
Increase (decrease) in net
assets resulting from
operations per outstanding
share $ (0.28) $ (0.24) $ (0.78) $ (1.71) 4.01
(1) Included in total expenses are the following profit sharing
(reversals)/accruals: $(163,049) in 2002; $(984,021) in 2001;
$(4,812,675) in 2000; and $8,110,908 in 1999.
SELECTED QUARTERLY DATA (UNAUDITED)
2004 2003
----------------------------------------------------------------------------------
1st Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------------------------------------------------------------------------------
Total investment
income $ 56,536 $ 64,676 $ 50,564 $ 30,612 $ 21,933
Net operating loss $ 749,865 $ 584,460 $ 726,989 $ 572,346 $ 679,947
Net increase
(decrease) in net
assets resulting
from operations $ 820,515 $ (1,215,127) $ (544,709) $ (1,270,298) $ (175,136)
Net increase
(decrease) in net
assets resulting
from operations
per outstanding
share $ 0.06 $ (0.11) $ (0.05) $ (0.11) $ (0.01)
2002
-----------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
-----------------------------------------------------------------------
Total investment income $ 59,462 $ 60,368 $ 77,413 $ 56,218
Net operating loss $ 556,233 $ 654,718 $ 479,433 $ 180,704
Net Increase (decrease) increase
in net assets resulting from
operations $ (1,036,934) $ 434,289 $ 660,988 $ (2,780,537)
Net Increase (decrease) increase
in net assets resulting from
operations per outstanding share $ (0.12) $ 0.05 $ 0.06 $ (0.24)
Results of Operations
Three months ended March 31, 2004, as compared to the three months ended March
31, 2003
We had a net increase in net assets resulting from operations of
$820,515 in the three months ended March 31, 2004, as compared with a net
decrease in net assets resulting from operations of $1,215,127 in the three
months ended March 31, 2003.
Investment Income and Expenses:
We had net operating losses of $749,865 and $584,460 for the three
months ended March 31, 2004, and March 31, 2003, respectively. In the three
months ended March 31, 2004, our larger net operating loss reflected a net
increase in expenses primarily related to increases in salaries and benefits
and in expenses for administration and operations.
Operating expenses were $806,401 and $649,136 for the three months
ended March 31, 2004, and March 31, 2003, respectively. In the three months
ended March 31, 2004, as compared with the three months ended March 31, 2003,
salaries and benefits increased by $107,879 or 29.8%, primarily as a result of
an additional employee; administration and operations increased by $64,187, or
67.5%, primarily as a result of an increase in travel and entertainment
expenses for due diligence work on potential portfolio companies and a shift
in the timing of an annual contribution to the MIT Entrepreneurship Center
that we made in the first quarter of 2004 and in the second quarter of 2003.
Realized Gains and Losses on Portfolio Securities:
- -------------------------------------------------
During the three months ended March 31, 2004, and March 31, 2003, we
realized gains of $793,389 and $432, respectively.
During the three months ended March 31, 2004, we realized net gains
of $793,389, consisting primarily of a realized gain of $1,681,259 resulting
from the sale of our investment in NanoGram Devices Corporation, offset by a
realized loss of $915,108 resulting from the sale of our shares of Series D
Convertible Preferred Stock in NeoPhotonics Corporation.
Unrealized Appreciation and Depreciation of Portfolio Securities:
- ----------------------------------------------------------------
Net unrealized depreciation on investments decreased by $783,787, or
33.0%, during the three months ended March 31, 2004, from $2,376,716 at
December 31, 2003, to $1,592,929 at March 31, 2004.
During the three months ended March 31, 2004, we recorded a net
decrease of $811,652 in unrealized depreciation of our venture capital
investments, primarily as a result of the realization of the loss of $915,108
on the sale of our shares of Series D Convertible Preferred stock in
NeoPhotonics Corporation.
Years Ended December 31, 2003, 2002, and 2001
During the three years ended December 31, 2003, 2002, and 2001, we
had net decreases in net assets resulting from operations of $3,205,270,
$2,722,194 and $6,889,238, respectively.
Investment Income and Expenses:
- -------------------------------
During the three years ended December 31, 2003, 2002, and 2001, we
had net operating losses of $2,563,742, $1,871,088 and $524,560, respectively.
The variation in these results is primarily owing to the changes in operating
expenses. During the three years ended December 31, 2003, 2002, and 2001,
operating expenses were $2,731,527, $2,124,549 and $1,035,221, respectively.
The increase during 2003 was primarily owing to increases in salary and
benefits. During 2003, the full year effect of a new employee who started in
September 2002 was realized. In addition, we recorded expense of $225,000
owing to the establishment of a Mandatory Retirement Plan in 2003 to be
amortized over the two-year period of 2003 and 2004 at the rate of $225,000
per annum. The increase in expenses in 2002 was primarily owing to the
$163,049 reversal of the profit sharing accrual in 2002 versus the $984,021
reversal of the profit sharing accrual in 2001, as well as an increase in
salaries and benefits, primarily owing to an increase in the retirement
medical benefit expense and the expense of a new employee who started in
September 2002, and an increase in professional fees, primarily as a result of
expenses associated with new investments and preparation of our proxy
statement.
Realized Gains and Losses on Sales of Portfolio Securities:
- -----------------------------------------------------------
During the three years ended December 31, 2003, 2002, and 2001, we
realized net (losses) gains on sales of portfolio securities of ($971,164),
$3,284,737 and $1,394,781, respectively.
During 2003, we realized a loss of $1,000,001 on the tax write-off of
our investment in Kriton Medical, Inc., which had been previously written-off
for book purposes. As a result of the loss realized in 2003 on the tax
write-off of Kriton Medical, Inc., unrealized appreciation increased by
$1,000,001.
During 2002, we realized a gain of $4,776,360 from the liquidation of
our partnership interest in PHZ Capital Partners L.P., and losses of $350,583
and $1,248,825 from the liquidation of Informio, Inc., and the sale of our
previously written-off investment in Schwoo, Inc., respectively.
During 2001, we realized gains on the sales of our investments in
Nanophase Technologies Corporation of $2,762,696 and Genomica Corporation of
$1,022,905. We realized losses on the sales of our investments in:
Essential.com, Inc., in the amount of $1,349,512; shares of SciQuest.com, Inc.
purchased in the open market, in the amount of $1,258,679; and MedLogic Global
Corporation, in the amount of $1,033,765. We also realized a gain of
$1,266,729 from our partnership interest in PHZ Capital Partners L.P. As a
result of the gains and losses realized during 2001, unrealized appreciation
decreased by $3,948,271.
Unrealized Appreciation and Depreciation of Portfolio Securities:
- -----------------------------------------------------------------
During the year ended December 31, 2003, net unrealized depreciation
on investments decreased by $343,397. During the years ended December 31,
2002, and 2001, net unrealized appreciation decreased by $3,936,534 and
$7,731,508, respectively. The decrease in net unrealized depreciation during
2003 was primarily owing to decreases in the valuations of our venture capital
investments of $1,421,220, including increases in unrealized depreciation of
Agile Material and Technologies, Inc., of $750,000, Experion Systems, Inc., of
$325,662 and NeoPhotonics Corporation of $345,558, offset by a decrease in
unrealized depreciation of Continuum Photonics, Inc., of $226,046 and an
increase in unrealized appreciation in Nanotechnologies, Inc., of $357,963. In
addition, unrealized appreciation increased by $1,000,001 as a result of the
loss realized in 2003 on the tax write-off of Kriton Medical, Inc., which had
previously been written off for book purposes.
The decrease during 2002 was primarily owing to decreases in the
valuations of our venture capital investments of $3,933,834, including a
decrease in unrealized appreciation of NeuroMetrix, Inc. of $1,986,081.
Unrealized appreciation (depreciation) on investments was ($2,720,113) and
$1,216,420 at December 31, 2002, and 2001, respectively.
The decrease in net unrealized appreciation during 2001 was primarily
owing to decreases in the valuations of our venture capital investments,
including decreases in the valuations of our holdings of Nanophase
Technologies Corporation, Genomica Corporation and Schwoo, Inc. of $5,499,664,
$1,540,375 and $1,248,827, respectively, offset by increases in unrealized
appreciation of $1,528,082 and $1,033,775 as a result of the realization of
the losses on the sales of our investments in SciQuest.com, Inc. and MedLogic
Global Corporation.
Financial Condition
Three Months ended March 31, 2004
Our total assets and net assets were $55,105,581 and $41,503,253,
respectively, at March 31, 2004, compared with $44,115,128 and $40,682,738 at
December 31, 2003.
Net asset value per share ("NAV") was $3.01 at March 31, 2004, versus
$2.95 at December 31, 2003. Our shares outstanding remained unchanged during
the three months ended March 31, 2004.
Significant developments in the three months ended March 31, 2004,
were an increase in payable to broker for unsettled trade of $10,583,080 and
an increase in the value of our investment in U.S. government and government
obligations of $4,492,780.
The increase in the value of our venture capital investments, from
$15,106,576 at December 31, 2003, to $21,428,191 at March 31, 2004, resulted
primarily from two new venture capital investments and five follow-on
investments, partially offset by a net decrease in the net value of our
previous venture capital investments, reflecting the sale of NanoGram Devices.
The following table is a summary of additions to our portfolio of
venture capital investments during the three months ended March 31, 2004:
New Investment Amount
-------------- -------------
Molecular Imprints, Inc. $2,000,000
NeoPhotonics Corporation $1,925,000
Follow-on Investment
Agile Materials & Technologies, Inc. $ 75,901
Continuum Photonics, Inc. $ 739,000
Experion Systems, Inc. $ 121,262
NanoOpto Corporation $ 612,500
NeuroMetrix, Inc. $1,749,999
----------
Total $7,223,662
==========
The following tables summarize the fair values of our portfolios of
venture capital investments and U.S. Government and agency Obligations, as
compared with their cost, at March 31, 2004, December 31, 2003, and December
31, 2002:
March 31, December 31,
2004 2003 2002
------------- -------------------------------------------
Venture capital investments,
at cost $22,991,842 $17,481,879 $14,754,466
Unrealized depreciation(1) 1,563,651 2,375,303 2,718,389
------------- ------------ ----------
Venture capital investments,
at fair value $21,428,191 $15,106,576 $12,036,077
=========== =========== ===========
March 31, December 31,
2004 2003 2002
------------- -------------------------------------------
U.S. Government and Agency
Obligations, at cost $31,642,544 $27,121,899 $15,452,469
Unrealized depreciation(1) 29,278 1,413 1,724
----------- ----------- -----------
U.S. Government and Agency
Obligations, at fair value $31,613,266 $27,120,486 $15,450,745
=========== =========== ===========
(1)At March 31, 2004, December 31, 2003, and December 31, 2002, the
accumulated unrealized depreciation on investments, including deferred taxes,
was $2,437,848, $3,221,635 and $3,565,032, respectively.
The following table summarizes the fair value composition of our
venture capital investment portfolio at March 31, 2004, December 31, 2003, and
December 31, 2002:
March 31, December 31,
Category 2004 2003 2002
-------- ------------- -------------------------------------------
Tiny Technology 63.6% 60.7% 49.0%
Other Venture Capital Investments 36.4% 39.3% 51.0%
------- ------- -------
Total Venture Capital Investments 100.0% 100.0% 100.0%
====== ====== ======
Year ended December 31, 2003
At December 31, 2003, our total assets and net assets were
$44,115,128 and $40,682,738, respectively. Our NAV per share at that date was
$2.95, and our shares outstanding increased to 13,798,845 versus 11,498,845 at
December 31, 2002.
During the 12 months ended December 31, 2003, significant financial
developments included the receipt of net proceeds of $16,631,962 pursuant to
the issuance of 2,300,000 new shares of our Common Stock and a decrease in
payable to broker for unsettled trade of $5,696,725. In addition, the value of
our venture capital investments increased by $3,070,499, to $15,106,576 at
December 31, 2003, primarily owing to three new venture capital investments
and five follow-on investments totaling $3,727,718 and increases in the
valuations of our venture capital investments of $848,883, offset by
write-downs in the valuations of our venture capital investments of
$1,506,102.
The following table is a summary of additions to our portfolio of
venture capital investments during the year ended December 31, 2003:
New Investment Amount
-------------- ------
Chlorogen, Inc. $ 525,900
NanoGram Devices Corporation $ 750,000
Nanosys, Inc. $1,500,000
Follow-on Investment
Chlorogen, Inc. $ 259,100
NanoOpto Corporation $ 125,000
Nanotechnologies, Inc. $ 169,718
Nantero, Inc. $ 323,000
NeoPhotonics, Inc. $ 75,000
------------
Total $3,727,718
Year Ended December 31, 2002
At December 31, 2002, our total assets and net assets were
$35,951,969 and $27,256,046, respectively. Our NAV at that date was $2.37, and
our shares outstanding increased to 11,498,845 versus 8,864,231 at December
31, 2001.
During the 12 months ended December 31, 2002, significant financial
developments included: (1) the payment of $271,467 in federal income taxes as
a result of our deemed dividend distribution to shareholders; (2) a net
decrease in the unrealized appreciation of our venture capital investments of
$3,933,834, including a decrease in the unrealized appreciation of
NeuroMetrix, Inc., of $1,986,081; (3) a decrease in bank loan payable of
$12,495,777; (4) the receipt of net proceeds of $5,643,470 pursuant to the
issuance and exercise of transferable rights for 2,634,614 new shares of our
Common Stock; and (5) the receipt of $5,700,000 in cash and a recorded
receivable in the amount of $786,492 related to the liquidation of our
partnership interest in PHZ Capital Partners L.P.
In addition, the value of our venture capital investments decreased
by $1,084,901, to $12,036,077 at December 31, 2002, primarily owing to seven
new venture capital investments and two follow-on investments totaling
$7,195,988, partially offset by write-downs in the valuations of our venture
capital investments of $5,213,959 and the liquidations of Informio, Inc., and
our partnership interest in PHZ Capital Partners L.P., which decreased the
value of our venture capital investments by a total of $3,072,382 from the
value at December 31, 2001.
The following table is a summary of additions to our portfolio of
venture capital investments for the year ended December 31, 2002:
New Investment Amount
-------------- ------
Agile Materials & Technologies, Inc. $1,000,000
Continuum Photonics, Inc. $1,000,000
Nanopharma Corp. $ 700,000
NanoOpto Corporation $ 625,000
Nanotechnologies, Inc. $ 750,000
Neo Photonics Corporation $1,000,000
Optiva, Inc. $1,250,000
Follow-on Investment
--------------------
Experion Systems, Inc. $ 517,706
NeuroMetrix, Inc. $ 353,282
-----------
Total $7,195,988
The following tables summarize the fair value of our portfolios of
venture capital investments and U.S. Government and Agency Obligations, as
compared with their cost, at December 31, 2003, and December 31, 2002:
December 31,
2003 2002
-------------------------------------------
Venture capital investments, at cost $17,481,879 $14,754,466
Unrealized depreciation(1) 2,375,303 2,718,389
------------ ----------
Venture capital investments, at fair value $15,106,576 $12,036,077
=========== ===========
December 31,
2003 2002
-------------------------------------------
U.S. Government and Agency Obligations, at cost $27,121,899 $15,452,469
Unrealized depreciation(1) 1,413 1,724
---------------- ----------------
U.S. Government and Agency Obligations,
at fair value $27,120,486 $15,450,745
=========== ===========
(1)At December 31, 2003, and December 31, 2002, the accumulated unrealized
depreciation on investments, including deferred taxes, was $3,221,635 and
$3,565,032, respectively.
The following table summarizes the fair value composition of our
venture capital investment portfolio at December 31, 2003, and December 31,
2002:
December 31,
Category 2003 2002
-------- -------------------------------------
Tiny Technology 60.7% 49.0%
Other Venture Capital Investments 39.3% 51.0%
------- -------
Total Venture Capital Investments 100.0% 100.0%
====== ======
Cash Flow
Year Ended December 31, 2003
Cash flow used in operating activities for the year ended December
31, 2003, was $6,592,321, reflecting the following changes from December 31,
2002, to December 31, 2003: an increase to restricted funds of $455,134; a
payment of a payable to a broker for an unsettled trade of $5,696,725; and a
decrease to current income tax liability of $857,656. In addition, net
realized and unrealized loss on investments was $1,047,140, and the net
decrease in net assets resulting from operations was $3,624,643.
Cash used in investing activities for the year ended December 31,
2003, was $15,582,923, primarily reflecting an increase in our investment in
U.S. Treasury Bills of $11,669,430 and investments in private placements of
$3,727,718.
Cash provided by financing activities for the year ended December 31,
2003, was $16,633,462, primarily reflecting net proceeds of $16,631,962 from
the issuance of 2,300,000 new shares of our Common Stock. We expect to invest
or earmark for investment the net proceeds of this issuance within
approximately one year, depending on the available investment opportunities
for the types of investments that we make. Although we intend to make our
initial investments exclusively in companies that we believe are involved
significantly in tiny technology, we may also make follow-on investments in
existing portfolio companies involved in other technologies. Pending
investment in portfolio companies, we intend to invest the net proceeds of any
offering of shares of our Common Stock in time deposits and/or
income-producing securities that are issued or guaranteed by the federal
government or an agency of the federal government of a government owned
corporation, which are likely to yield less than our operating expenses. We
may also pay operating expenses, including due diligence expenses on potential
investments, from the proceeds, which will reduce the net proceeds of any
offering of shares of our Common Stock that we will have available for
investment.
Year Ended December 31, 2002
Cash flow provided by operating activities for the year ended
December 31, 2002, was $1,923,048, reflecting the following changes from
December 31, 2001, to December 31, 2002: a payable to a broker for an
unsettled trade of $5,969,725; an increase in funds held in escrow of
$750,000; and an increase in a receivable from a partnership liquidation of
$786,492. In addition, net realized and unrealized loss on investments was
$651,797, and the net decrease in net assets resulting from operations was
$2,722,194.
Cash provided by investing activities for the year ended December 31,
2002, was $10,751,980, reflecting a decrease in our investment in U.S.
Treasury Bills of $10,358,006 and the proceeds from the liquidation of
investments of $7,631,100, offset by investments in private placements of
$7,195,988.
Cash used in financing activities for the year ended December 31,
2002, was $6,842,807, reflecting the payment of the outstanding balance on the
asset line of credit of $12,495,777, offset by the net proceeds from a rights
offering of $5,643,470. We intended to invest in tiny technology, under normal
circumstances, directly or indirectly, the net proceeds of the rights offering
in accordance with our investment objectives and policies, within the 12
months following the receipt of the net proceeds of the rights offering,
depending on the available investment opportunities.
Liquidity and Capital Resources
Our primary sources of liquidity are cash, receivables and freely
marketable securities, net of short-term indebtedness. Our secondary sources
of liquidity are restricted securities of companies that are publicly traded.
We currently have no restricted securities of companies that are publicly
traded.
Three Months ended March 31, 2004
At March 31, 2004, and December 31, 2003, our total net primary
liquidity was $21,451,597 and $27,563,886, respectively.
The decrease in our primary source of liquidity from December 31,
2003, to March 31, 2004, is primarily owing to the receipt of the proceeds
from the sale of our investment in NanoGram Devices Corporation offset by our
investments in Agile Materials & Technologies, Inc., Continuum Photonics,
Inc., Experion Systems, Inc., Molecular Imprints, Inc., NanoOpto Corporation,
NeoPhotonics Corporation and NeuroMetrix, Inc., and use of funds for net
operating expenses.
Year Ended December 31, 2003
At December 31, 2003, 2002, and 2001, our net primary liquidity was
$27,563,886, $16,508,057 and $13,459,654, respectively. On each of those
corresponding dates, our secondary liquidity was $0, as we had no restricted
securities of companies that are publicly traded.
Our net primary sources of liquidity are more than adequate to cover
our gross cash operating expenses over the next 12 months. Our gross cash
operating expenses totaled $2,455,454, $2,256,991 and $1,992,341 in 2003, 2002
and 2001, respectively.
During the year ended December 31, 2003, the increase in our net
primary liquidity was primarily owing to: (1) our payment of federal, state
and local taxes; (2) our investments in Chlorogen, Inc., NanoGram Devices
Corporation, NanoOpto Corporation, Nanosys, Inc., Nanotechnologies, Inc.,
Nantero, Inc., and NeoPhotonics, Inc.; and (3) our use of funds for operating
expenses; offset by our receipt of $16,631,962 of net proceeds from an
offering of our Common Stock that closed on December 30, 2003.
On November 19, 2001, we established an asset account line of credit.
The asset account line of credit is secured by our U.S. government and
government agency securities with which we secure the line. Under the asset
account line of credit, we may borrow up to 95% of the current value of our
U.S. government and government agency securities. Our outstanding balance
under the asset line of credit at both December 31, 2003, and December 31,
2002, was $0. When utilized, the asset line of credit bears interest at a rate
of the Broker Call Rate plus 50 basis points.
Year Ended December 31, 2002
At December 31, 2002, and 2001, our net primary liquidity was
$16,508,057 and $13,459,654, respectively. On each of the corresponding dates,
our secondary liquidity was $0. Our tertiary source of liquidity was our
partnership interest in PHZ Capital Partners L.P., from which we received cash
distributions in 2002 and 2001 of $6,588,661 and $172,068, respectively. We
liquidated our 20% partnership interest in PHZ for $5,700,000 effective
December 31, 2002, and we received a final distribution of $786,492 on January
16, 2003. At December 31, 2002, this final distribution of $786,492 was
included in net primary liquidity as a receivable.
During the year ended December 31, 2002, the increase in our net
primary liquidity was primarily owing to: (1) our payment of federal income
taxes; (2) our investments in Nanopharma Corp., NanoOpto Corporation,
NeoPhotonics Corporation, Experion Systems, Inc., Continuum Photonics, Inc.,
Nanotechnologies, Inc., Optiva, Inc., Agile Materials & Technologies, Inc.,
and NeuroMetrix, Inc.; (3) our funds held in escrow for a pending venture
capital investment; and (4) our use of funds for operating expenses; offset by
our receipt of $5,643,470 of net proceeds from a rights offering of our Common
Stock that closed July 31, 2002.
Critical Accounting Policies
Critical accounting policies are those that are both important to the
presentation of our financial condition and results of operations and require
management's most difficult, complex or subjective judgments. Our critical
accounting policies are those applicable to the valuation of investments.
Valuation of Portfolio Investments
As a business development company, we invest primarily in illiquid
securities including debt and equity securities of private companies. The
investments are generally subject to restrictions on resale and generally have
no established trading market. We value substantially all of our equity
investments at fair value as determined in good faith by our valuation
committee on a quarterly basis. The valuation committee, comprised of at least
three or more non-interested board members, reviews and approves the valuation
of our investments within the guidelines established by the board of
directors. Fair value is generally defined as the amount that an investment
could be sold for in an orderly disposition over a reasonable time. Generally,
to increase objectivity in valuing our assets, external measures of value,
such as public markets or third party transactions, are utilized whenever
possible. Valuation is not based on long term work-out value, nor immediate
liquidation value, nor incremental value for potential changes that may take
place in the future.
Recent Developments
On April 13, 2004, we made a $150,000 follow-on investment in the
form of a Convertible Bridge Note of a privately held portfolio company.
On April 20, 2004, we made a $75,901 follow-on investment in the form
of a Convertible Bridge Note of a privately held portfolio company.
On May 7, 2004, we made a $50,000 follow-on investment in a privately
held portfolio company and a $250,000 initial investment in a privately held
portfolio company.
On May 10, 2004, we made a $12,091 follow-on investment in a
privately held portfolio company by purchasing shares from selling
shareholders.
On May 27, 2004, we made a $1,000,000 new investment in a privately
held company.
BUSINESS
We are a venture capital company specializing in tiny technology. We
operate as a business development company under the 1940 Act. Our investment
objective is to achieve long-term capital appreciation, rather than current
income, by making venture capital investments in early stage companies. While
our portfolio includes non-tiny technology investments made prior to 2001, we
now make our initial investments exclusively in tiny technology companies. By
making these investments, we seek to provide our shareholders with an
increasingly specific focus on tiny technology through a portfolio of venture
capital investments that address a variety of markets and products. We believe
that we are the only publicly traded U.S. venture capital company specializing
in tiny technology.
As is usual in the venture capital industry, our venture capital
investments are primarily in convertible preferred stock, which is usually the
most senior security in a portfolio company's equity capital structure until
the company has substantial revenues, and which gives us seniority over the
holders of Common Stock (usually the founders) while preserving fully our
participation in the upside potential of the portfolio company through the
conversion feature and, in many cases, a dividend right payable in kind (which
increases our participation in the portfolio company) or potentially in cash.
We have a long history of investing in venture capital and of
business development. Our approach is traditional, in that we prefer a patient
examination of available early stage opportunities, thorough due diligence and
close involvement with management. Unlike most private equity and venture
capital funds, we will not be subject to any requirement to return capital to
investors. Such requirements typically stipulate that these funds can only be
invested once and, together with any capital gains on such investment, must be
returned to investors after a pre-agreed time period. These provisions often
force private equity and venture capital funds to seek investments that are
likely to be able to be sold relatively quickly or to seek returns on their
investments through mergers, public equity offerings or other liquidity events
more quickly than they otherwise might, potentially resulting in both a lower
overall return to investors and an adverse impact on their portfolio
companies.
In addition, to the investor, we offer:
o a portfolio consisting of investments that are generally
available only to a small, highly specialized group of
investors;
o a qualified team of professionals including four full time
members of management, each of whom are designated as Managing
Directors and vote on all purchases and sales of private equity
investments, Charles E. Harris, Mel P. Melsheimer, Daniel V.
Leff and Douglas W. Jamison, and two directors who are also
consultants, Dr. Kelly S. Kirkpatrick and Lori D. Pressman, who
collectively have expertise in venture capital, intellectual
property and nanotechnology to evaluate and monitor
investments;
o the opportunity to benefit from our experience in a new field
expected to permeate a variety of industries; and
o through the ownership of our publicly traded shares, a measure
of liquidity not available in typical underlying venture
capital portfolio investments.
Microsystems, microelectromechanical systems, which we refer to as
MEMS, and nanotechnology are often referred to collectively as "tiny
technology," or "small technology," by scientists and others in this field.
Tiny technology is multidisciplinary and widely applicable, and it
incorporates technology that is significantly smaller than is currently in
general use. Microsystems are measured in micrometers, which are units of
measurement in millionths of a meter. Nanotechnology is measured in
nanometers, which are units of measurement in billionths of a meter. Because
it is a new field, tiny technology has significant scientific, engineering and
commercialization risks.
Tiny technology, particularly nanotechnology, is distinguished by its
applicability to a wide range of industries. As a venture capital company, we
make it possible, through the ownership of our shares, for our shareholders to
participate in this emerging field at an earlier stage than would typically be
possible for them. By making investments in companies that control
intellectual property relevant to tiny technology, we are building a portfolio
that we believe will be difficult to replicate in the future, as we believe it
will likely become increasingly difficult to create new intellectual property
in tiny technology.
Since registering as an investment company in 1992, we have invested
in a variety of industries. In 1994, we invested in our first nanotechnology
company, Nanophase Technologies Corporation. In 1995, we elected to be
regulated as a business development company. Recognizing the potential of tiny
technology, we continued to monitor developments in the field, and since 2001
we have made tiny technology the exclusive focus of our initial investment
activity. Since August 2001, all 15 of our initial investments have been in
companies involved in the development of products and technologies based on
tiny technology.
Our portfolio now includes a total of 19 companies, of which we
consider 14 to be involved in tiny technology. While we intend to make initial
investments exclusively in companies that we believe are involved
significantly in tiny technology, we may also make follow-on investments in
existing non-tiny technology portfolio companies. The balance of our funds is
primarily invested in short-term U.S. government and government agency
securities. We are an internally managed investment company because our
officers and employees, under the general supervision of our board of
directors, control our operations. We have no investment adviser.
Subject to our compliance with business development company and tax
code requirements, there are no limitations on the types of securities or
other assets, foreign or domestic, in which we may invest. Investments may
include the following:
o equity, equity-related securities (including warrants) and debt
with equity features from either private or public issuers,
whether in corporate, partnership or other form, including
development stage or start-up entities;
o debt obligations of all types having varying terms with respect
to security or credit support, subordination, purchase price,
interest payments and maturity; and
o to a limited extent, intellectual property, including patents,
research and development in technology or product development
that may lead to patents or other marketable technology.
Neither our investments nor an investment in our securities
constitutes a balanced investment program. We have been and will continue to
be risk seeking rather than risk averse in our investment approach. We reserve
the fullest possible freedom of action regarding the types of investments we
make and our relationship with our portfolio companies, subject to our
certificate of incorporation, applicable law and regulations, and policy
statements described herein. Our tiny technology investment policy is not a
"fundamental policy" under the 1940 Act and, accordingly, may be changed
without shareholder approval, although we will give shareholders at least 60
days prior written notice of any change.
Our business is subject to federal regulation under the 1940 Act,
under which we have elected to operate as a business development company. As a
business development company, we are subject to regulatory requirements, the
most significant of which relate to our investments and borrowings. We are
required to invest at least 70% of our assets in qualifying assets and, over
time, at least 50% in "eligible portfolio companies." We must also maintain a
coverage ratio of assets to senior securities (such as debt and preferred
stock) of at least 200% immediately after giving effect to the issuance of any
senior securities. We are also required to offer managerial assistance to our
portfolio companies, in addition to our investment. For tax purposes, we are a
RIC under the Internal Revenue Code of 1986. Because we do not have a
diversification policy, both our status as a business development company and
our status as a RIC allow us to commit all of our assets to relatively few
investments in comparison to a company that is required to diversify its
assets.
We believe that increasing our size should lower our expenses as a
proportion of average net assets because some of our costs, such as
administration and public company expenses, are fixed and can be spread over a
larger asset base and will decline as a percentage of assets as our assets
increase. In addition, with more assets, we expect the average size of our
investments to increase. Each due diligence investigation entails expenses
whether or not we complete the transaction, and the cost of due diligence,
negotiation and documentation of our investments does not vary significantly
with the size of the investment or intended investment.
Some expenses are expected to increase as new investments are made.
We plan to add personnel to enable us to enlarge the scope of our activities
and our expertise in tiny technology, and our hiring of new employees will
increase with more assets under management. We also believe that a larger
number of outstanding shares and a larger number of beneficial owners of
shares could increase the level of our visibility and improve the trading
liquidity of our shares on the Nasdaq National Market. We may not realize any
of these benefits.
Tiny Technology
Tiny technology refers to microsystems, MEMS and nanotechnology, a
variety of enabling technologies with critical dimensions below 100
micrometers, including both organic and inorganic processes. Tiny technology
is neither an industry nor a single technology. Tiny technology manifests
itself in tools, materials and devices that address broad markets, including
instrumentation, electronics, photonics, computing, medical devices,
pharmaceutical manufacturing, drug delivery and drug discovery. The
development and commercialization of tiny technology often require the
integration of multiple disciplines, including biology, physics, chemistry,
materials sciences, computer science and the engineering sciences.
Examples of tiny technology-enabled products currently on the market
are quite diverse. They include accelerometers used in automobiles to sense
impact and deploy airbags, cosmetics with ingredients that block ultraviolet
light but that are invisible to the human eye, nanoclays used for strength in
the running boards of minivans, textiles with liquid-stain repellant surfaces
and fast acting painkillers.
Within tiny technology, microsystems and MEMS both refer to
materials, devices and processes that are on a micrometer size scale. A
micrometer, which is also referred to as a micron, is 0.000001 meter, or one
millionth of a meter. In practice, any device from 100 microns down to 0.1
micron in size may be considered "micro." Nanotechnology refers to devices and
processes with critical dimensions below 0.1 micron, equal to 100 nanometers.
A nanometer is 0.000000001 meter, or one billionth of a meter. It is at the
scale below 100 nanometers, the nanoscale, that quantum effects begin to
dominate classical macroscale physics. At the nanoscale, size- and
shape-dependent properties of materials allow previously unattainable material
and device performance.
MEMS
MEMS often refer to three-dimensional devices with features between
one and 100 microns that integrate electrical and mechanical structures. MEMS
devices often contain a combination of sensors, actuators, mechanical
structures and electronics that detect or respond to thermal, biological,
chemical or optical information. To date, most commercial MEMS devices are
batch fabricated out of silicon, using techniques based on standard
semiconductor processes. Examples of devices incorporating MEMS technology
include airbag accelerometers, smart pens for digital signatures, the Sony
AIBO(TM) entertainment robot and Texas Instruments' Digital Light Processing
Cinema(TM) system.
Microsystems
Microsystems are similar to MEMS, but without mechanical parts.
Microsystems are microscale machines that sense information from the
environment and provide a response to it. A microsystem often integrates
mechanical, fluidic, optical and pneumatic components into a single system.
Examples of two established microsystem technologies include
microarrays and lab-on-a-chip. Microarrays can identify thousands of genes
simultaneously and usually perform one type of analysis multiple times.
Lab-on-a-chip is a small chip containing microfluidic channels that quickly
separate liquids and gases in order to permit microsensors to analyze the
properties of the liquids and gases. The following are additional fields in
which microsystems are currently being used:
o Military/Aerospace -- telemetry, communications, guidance
systems, control circuitry and avionics.
o Geophysical Exploration -- seismic data acquisition and
geophysical measurement equipment.
o Medical Instrumentation -- instrument motor controls and
diagnostic devices.
o Satellite Systems -- power monitoring and control circuits.
o Industrial Electronic Systems -- measurement and diagnostics on
rotating machinery.
o Opto-Electronics -- sub-miniature temperature controls and
laser diode drivers for data transmission.
Nanotechnology
There are various definitions of nanotechnology. Regardless of the
definition used, the technology being defined qualifies as tiny technology. A
commonly used measure of nanotechnology includes all materials, devices and
processes with critical dimensions below 100 nanometers. A nanometer is
0.000000001 meter, or one billionth of a meter. Nanotechnology is defined by
the U.S. Government's National Nanotechnology Initiative as research and
technology development at the atomic, molecular or macromolecular levels, in
the length scale of approximately 1 - 100 nanometer range, to provide a
fundamental understanding of phenomena and materials at the nanoscale and to
create and use structures, devices and systems that have novel properties and
functions because of their small and/or intermediate size.
The nanoscale is the scale at which quantum effects begin to dominate
classical macroscale physics. At the nanoscale, size- and shape-dependent
properties of materials allow heretofore unattainable material and device
performance. Nanotechnology science and its implications are currently the
subject of intense research and development efforts in the governmental,
academic and corporate sectors, in the United States and internationally.
According to the National Institute of Science and Technology, in 2003,
worldwide research and development efforts in nanotechnology are expected to
exceed $3 billion.
Government research funding and patenting activity, prerequisites to
successful commercialization of nanotechnology, have been growing rapidly in
recent years. Currently, researchers in the field are collaborating with
entrepreneurs and venture capitalists to form companies around nanotechnology
platforms. According to the National Institute of Science and Technology, in
April 2003, more than 1,700 companies in 34 nations were reportedly pursuing
the commercialization of nanotechnology.
The first generation of nanotechnology products consists of
instrumentation that permits visualization and manipulation of matter at the
nanoscale and passive nanostructures such as coatings, nanoparticles and
polymers. Examples of commercial instrumentation include nanoimprint
lithography equipment, new variations of the atomic force microscope and
highly sensitive gene and protein detecting arrays. Examples of commercial
nanostructures include cosmetics with ingredients that block ultraviolet light
but that are invisible to the human eye, nanoclays used for strength in the
running boards of minivans, textiles with liquid-stain repellant surfaces,
fast acting painkillers, quantum dot semiconductors that fluoresce different
colors based on the size of the particles and nanoscale chemical mechanical
polishing slurries for wafer polishing.
We believe that the next generation of nanotechnology products will
likely consist of active nanostructures, including transistors, targeted drugs
and chemicals, actuators and adaptive structures. We believe that these
products are at least two to three years away from commercial application.
Examples of products being developed include semiconductor nanowires that act
as tiny transistors; functionalized, drug-delivering polymers that allow the
release of therapeutics to be controlled by temperature, pH or a magnetic
field at specified locations within the body; and engineered membrane
structures for filtration.
We project that longer-term product opportunities may include
integrated nanosystems involving heterogeneous nanocomponents and various
assembling techniques. Patent applications explaining the science of these
discoveries have recently been filed, and the first commercial entities formed
to develop these technologies are emerging from universities, federal labs and
industrial research centers. Future product opportunities may include
exponentially denser and faster electronic devices, with individual molecules
acting as transistors; tissues and organs engineered from self-assembling
polymers that form biomimetic structures; and new forms of computing developed
by exploiting the superposition of quantum particles.
Although the practical application of tiny technology requires great
expertise to implement in manufacturing processes, we believe that tiny
technology's broad applicability presents significant and diverse market
opportunities. Our strategy is to invest in the best of these tiny technology
companies, with emphasis on nanotechnology companies. This strategy includes
making a number of these investments in the current environment, which is
characterized by diminished investment by venture capital companies and
depressed valuations for privately held, early stage companies.
GENERAL DESCRIPTION OF OUR PORTFOLIO COMPANIES
The following are brief descriptions of each portfolio company in
which we are invested. The portfolio companies are presented in two
categories: companies where we directly or indirectly own 5% to 25% of the
outstanding voting securities of the portfolio company or where we hold one or
more seats on the portfolio company's board of directors and, therefore, are
deemed to be an affiliated person under the 1940 Act; and companies where we
directly or indirectly own less than 5% of the outstanding voting securities
of the portfolio company and where we have no other affiliations. The value
described below for each portfolio company is its fair value. Each portfolio
company that we believe is significantly involved in tiny technology is
designated by an asterisk (*).
Non-Controlled Affiliated Companies:
*Agile Materials & Technologies, Inc., located at 93 Castilian Drive,
Goleta, California 93117, is developing and commercializing variable
integrated passive electronic components utilizing thin-film
ferroelectric materials in innovative circuit designs for commercial and
military radio-frequency electronics. As of March 31, 2004, we held
3,732,736 shares of Series A Convertible Preferred Stock (representing
14.76% of the total Series A Convertible Preferred Stock outstanding) and
a $75,901 Convertible Bridge Note with warrants of Agile. As of the date
above, our valuation committee fair valued the Series A Preferred Stock
and Convertible Bridge Note with warrants of Agile held by us at
$187,284. The Chief Executive Officer of the company is Charles A.
Bischof. On April 20, 2004, we invested an additional $75,901 in Agile in
exchange for a Convertible Bridge Note with Warrants.
*Chlorogen, Inc., located at 893 North Warson Road, St. Louis, Missouri
63141, is developing a high-yield, plant-based protein production
technology. In this production technology, DNA molecules are packaged as
nanosized expression cassettes and inserted into the plant chloroplast by
a high velocity "gene gun." The genes from the expression cassettes are
integrated into the chloroplast genome, resulting in the manufacture of
the selected protein. As of March 31, 2004, we held 4,478,038 shares of
Series A Convertible Preferred Stock (representing 13.57% of the total
Series A Convertible Preferred Stock outstanding) of Chlorogen. As of the
date above, our valuation committee fair valued the Series A Preferred
Stock of Chlorogen held by us at $785,000. The Chief Executive Officer of
the company is David N. Duncan.
Experion Systems, Inc., located at 8 Clock Tower Place, Maynard,
Massachusetts 01754, develops and sells an e-business software package
known as Guided Selling Systems for financial institutions to sell
mortgages and other financial products to their members. Experion's
initial customers are credit unions. As of March 31, 2004, we held
294,118 shares of Series A Convertible Preferred Stock (representing
22.86% of the total shares of Series A Convertible Preferred Stock
outstanding), 35,294 shares of Series B Convertible Preferred Stock
(representing 8.31% of the total shares of Series B Convertible Preferred
Stock outstanding), 222,184 shares of Series C Convertible Preferred
Stock (representing 16.71% of the total shares of Series C Convertible
Preferred Stock outstanding) and 64,501 shares of Series D Convertible
Preferred Stock (representing 16.17% of the total shares of Series D
Convertible Preferred Stock outstanding) of Experion. As of the above
date, our valuation committee fair valued the total amount of shares of
Experion held by us at $832,600. Charles E. Harris serves as a Director
of the company. Ross Blair is the Chief Executive Officer of the company,
and Dr. Glen Urban, the David Austin Professor of Marketing at the MIT
Sloan School, is the Chairman of the company.
*NanoOpto Corporation, located at 1600 Cottontail Lane, Somerset, New
Jersey 08873, is developing and manufacturing high performance,
integrated optical communications and optical drive sub-components on a
chip, based on patented technology. As of March 31, 2004, we held 267,857
shares of Series A-1 Convertible Preferred Stock (representing 11.49% of
the total Series A-1 Convertible Preferred Stock outstanding) and
1,733,664 shares of Series B Convertible Preferred Stock (representing
9.51% of the total Series B Convertible Preferred Stock outstanding) of
NanoOpto. As of the date above, our valuation committee fair valued the
total amount of shares of NanoOpto held by us at $785,067. The Chief
Executive Officer of the company is Barry J. Weinbaum.
*Nanopharma Corp., located at 191 Commonwealth Avenue, Boston,
Massachusetts 02116, is a privately held company spun off from
Massachusetts General Hospital. Nanopharma is a research-based
pharmaceutical company founded to develop advanced drug delivery systems.
Nanopharma's main goal is to provide fully biodegradable nanoscopic drug
delivery vehicles based on proprietary molecular constructs and
"biological stealth" materials. The company plans to pursue an
out-licensing program for its platform technologies. As of March 31,
2004, we held 684,516 shares of Series A Convertible Preferred Stock
(representing 87.5% of the total Series A Convertible Preferred Stock
outstanding) of Nanopharma. As of the date above, our valuation committee
fair valued the Series A Convertible Preferred Stock of Nanopharma held
by us at $700,000. Charles E. Harris is a Director of the company. The
Chief Executive Officer of the company is Michael Tarnow. On April 13,
2004, we invested an additional $150,000 in Nanopharma in exchange for a
Convertible Bridge Note.
*Nanotechnologies, Inc., located at 1908 Kramer Lane, Building B, Suite
L, Austin, Texas 78758, is developing for production a wide variety of
high-performance nanoscale materials for industry. As of March 31, 2004,
we held 1,538,837 shares of Series B Convertible Preferred Stock
(representing 11.77% of the total Series B Preferred Stock outstanding)
and 235,720 shares of Series C Convertible Preferred Stock (representing
6.48 % of the total Series C Preferred Stock outstanding) of
Nanotechnologies. As of the date above, our valuation committee fair
valued the total amount of shares of Nanotechnologies held by us at
$1,277,681. The Chief Executive Officer of the company is Randy Bell. Mel
P. Melsheimer serves as a Director of the company.
NeuroMetrix, Inc., located at 62 Fourth Avenue, Waltham, Massachusetts
02451, is a spin-off from the Massachusetts Institute of Technology.
NeuroMetrix develops and sells medical diagnostic products based on
patented intellectual property related to developing portable instruments
that permit low cost, non-invasive diagnostic tests. The company's core
technology is focused on utilizing low-level, non-invasively measured,
electrophysiological signals from nerves and muscles to perform an array
of clinical diagnostic tests. The company's current products test for and
monitor lower back pain, carpal tunnel syndrome and diabetic neuropathy.
The company is operating in a large, untapped point-of-care
neurodiagnostic market. The market opportunity is estimated at over $1
billion with over 90% of it estimated to be in monitoring lower back
pain, carpal tunnel syndrome and diabetic neuropathy. There is minimal
direct competition but strong indirect competition that takes two forms,
ElectroMyoGraphy (EMG) and neurologists. EMG requires expensive capital
equipment and is targeted at specialists. Neurologists are expensive,
require referral and provide no revenue for referring physicians. The
company has a small but rapidly growing market share. The company now has
over 1,000 customers. The company achieved initial 510(k) clearance from
the Food and Drug Administration in 1998. Revenue is affected by
government regulations specific to reimbursement procedures. The company
is highly dependent on its intellectual property platform position. As of
March 31, 2004, we held 875,000 shares of Series A Convertible Preferred
Stock (representing 100% of the total Series A Convertible Preferred
Stock outstanding), 625,000 shares of Series B Convertible Preferred
Stock (representing 100% of the total Series B Convertible Preferred
Stock outstanding), 1,148,100 shares of Series C-2 Convertible Preferred
Stock (representing 100.00% of the total Series C-2 Convertible Preferred
Stock outstanding), 499,996 shares of Series E Convertible Preferred
Stock (representing 6.0% of the total Series E Convertible Preferred
Stock outstanding) and 1,402,187 shares of Series E-1 Convertible
Preferred Stock (representing 16.72% of the total Series E-1 Convertible
Preferred Stock outstanding) of NeuroMetrix. As of the date above, our
valuation committee fair valued the total amount of shares of NeuroMetrix
held by us at $6,825,426. Charles E. Harris serves as a Director of the
company. The company's Chief Executive Officer is Dr. Shai N. Gozani, the
Chief Operating Officer is Gary Gregory and the Senior Vice President of
Engineering is Michael Williams.
*Questech Corporation, located at 92 Park Street, Rutland, Vermont 05701,
manufactures and sells tile and trim products, based on its proprietary
technology, with revenue generated from stock products. We originally
invested in Questech on May 26, 1994. We did not invest in Questech as a
tiny technology company, but Questech's proprietary technology is
dependent on micro-scale processes. Thus, Questech may be regarded as a
tiny technology holding. As of March 31, 2004, we held 646,954 shares of
Common Stock (representing 8.09% of the total Common Stock outstanding)
of Questech, as well as warrants to purchase 1,966 shares of Common Stock
of the company at $5.00 per share and 18,500 shares of Common Stock of
the company at $1.50 per share. As of the date above, our valuation
committee fair valued the Common Stock of Questech held by us at
$724,588. Mel P. Melsheimer serves as a Director of the company. The
Chief Executive Officer of the company is Barry J. Culkin.
Unaffiliated Companies:
Alpha Simplex Group, LLC, located at One Cambridge Center, 9th Floor,
Cambridge, Massachusetts 02139, is an investment advisory firm. The
company conducts a quantitative based hedge-fund operation. Alpha was
founded by Dr. Andrew W. Lo, the Harris & Harris Group Professor at the
MIT Sloan School. Charles E. Harris serves as an adviser to the company.
As of March 31, 2004, we held 50,000 units (representing 0.5% of the
total units outstanding) of Alpha, at no cost. As of the date above, our
valuation committee fair valued the units held by us at $125,000. The
Managing Member of the company is Dr. Andrew W. Lo.
*Continuum Photonics, Inc., located at 45 Manning Road, Billerica,
Massachusetts 01821, is developing a family of MEMS switches for optical
network applications. The switches are based on Continuum's proprietary
piezoelectric ceramic substrates. As of March 31, 2004, we held 2,000,000
shares of the Series B Convertible Preferred Stock (representing 5.56% of
the total Series B Convertible Preferred Stock outstanding) and 2,368,590
shares of Series C Convertible Preferred Stock (representing 4.29% of the
total Series C Convertible Preferred Stock outstanding) of Continuum. As
of the date above, our valuation committee fair valued the total amount
of Shares of Continuum held by us at $1,515,119. The Chief Executive
Officer of the company is Jeffrey D. Farmer.
Exponential Business Development Company, located at 216 Walton Street,
Syracuse, New York 13202, is a venture capital partnership that invests
in early stage manufacturing, software development and communication
technology industries in New York's Capitol region. As of March 31, 2004,
we held one Limited Partnership Unit (representing 0.87% of the total
Limited Partnership Units outstanding) of the company. As of the date
above, our valuation committee fair valued the Limited Partnership Unit
held by us at $25,000. The Administrative Partner of the company is Dirk
E. Sonneborn.
Heartware, Inc., located at 3351 Executive Way, Miramar, Florida 33025,
is a privately held company engaged in research and development of
implantable rotary blood pumps for patients who suffer from congestive
heart failure. On July 10, 2003, we received 47,620 shares of Series A-2
Non-Voting Preferred stock of Heartware, Inc., a new company formed to
acquire the assets and assume certain liabilities of Kriton Medical, Inc.
("Kriton") as part of Kriton's bankruptcy. As of March 31, 2004, we held
47,620 shares of Series A-2 Non-Voting Preferred Stock (representing
10.90% of the total Series A-2 Non-Voting Preferred Stock outstanding) of
Heartware. As of the date above, our valuation committee fair valued the
Series A-2 Non-Voting Preferred Stock of Heartware held by us at $0. The
Chief Executive Officer of the company is Seth Harrison.
Molecular Imprints, Inc., located at 1807-C West Braker Lane, Austin, TX
78758, is a privately held company that is providing enabling lithography
systems and technology for manufacturing applications in the areas of
nano devices, micro structures, advanced packaging, bio devices, optical
components and semiconductor devices. As of March 31, 2004, we held
1,333,333 shares of Series B Convertible Preferred Stock (representing
6.79% of the total shares of Series B Preferred Stock outstanding) of
Molecular Imprints. As of the date above, our valuation committee fair
valued the Series B Convertible Preferred Stock of Moleculac Imprints
held by us at $2,000,000. The Chief Executive Officer of the company is
Dr. Norman E. Schumaker.
*NanoGram Corporation, located at 2911 Zanker Road, San Jose, California
95134, owns a patent portfolio of approximately 75 patents and a
complementary family of trademarks. NanoGram plans to license its broad
intellectual property portfolio in fields including, nanomaterials-based
films, discovery of new nanomaterials compositions, and rapid synthesis
of nanopowders and films. As of March 31, 2004 we held 63,210 shares of
Series 1 Preferred Stock (representing 1.81% of the total shares of
Series 1 Convertible Preferred Stock outstanding) of NanoGram. As of the
date above, our valuation committee fair valued the Series 1 Convertible
Preferred Stock of NanoGram held by us at $21,672. On May 7, 2004, we
invested an additional $50,000 in exchange for a Convertible Bridge Note.
The Chief Executive Officer of the company is Timothy S. Jenks.
*Nanosys, Inc., located at 2625 Hanover Street, Palo Alto, California
94304, is a company with broad-based intellectual property that is
initially commercializing applications in macroelectronics,
photovoltaics, and chemical and biological sensing. These applications
incorporate novel zero and one-dimensional, nanometer-scale materials,
such as nanowires and nanodots (quantum dots), as their principal active
elements. As of March 31, 2004, we held 803,428 shares of Series C
Convertible Preferred Stock (representing 4.02% of the total Series C
Convertible Preferred Stock outstanding) of Nanosys. As of the date
above, our valuation committee fair valued the Series C Preferred Stock
of Nanosys held by us at $1,500,000. The Chief Executive Officer of the
company is Calvin Chow.
*Nantero, Inc., located at 25-D Olympia Avenue, Woburn, Massachusetts
01801, is a spin-off from Harvard University. Nantero intends to be a
fabless semiconductor company, focusing on the development of
non-volatile random access memory based on carbon nanotubes. As of March
31, 2004, we held 345,070 shares of Series A Convertible Preferred Stock
(representing 8.17% of the total Series A Preferred Stock outstanding)
and 207,051 shares of Series B Convertible Preferred Stock (representing
3.08% of the total Series B Convertible Preferred Stock outstanding of
Nantero. As of the date above, our valuation committee fair valued the
total amount of shares of Nantero held by us at $861,309. The Chief
Executive Officer of the company is Greg Schmergel.
*NeoPhotonics Corporation, located at 2911 Zanker Road, San Jose,
California 95134, is developing planar optical devices and components to
manufacture and offer to leading optical component manufacturers using
its patented nanomaterials deposition technology. The company is
developing functional component arrays to offer integrated optical
"systems on a chip" to component vendors. As of March 31, 2004, we held
56,250 shares of Common Stock (representing 7.25% of the total Common
Stock outstanding), 1,821,155 shares of Series 1 Convertible Preferred
Stock (representing 4.22% of the total Series 1 Convertible Preferred
Stock) and Warrants to purchase 28,636 shares of Common Stock
(representing 10.50% of the total Warrants outstanding). As of the date
above, our valuation committee fair valued the total amount of shares of
NeoPhotonics held by us at $2,012,445. On May 10, 2004, for a total of
$12,091, we purchased from a selling shareholder, 4,330 shares of Common
Stock, bringing our total ownership of Common Stock to 60,580 shares
(representing 7.80% of the total shares of Common Stock outstanding);
10,101 shares of Series 1 Convertible Preferred Stock bringing our total
ownership of Series 1 Convertible Preferred Stock to 1,828,283 shares
(representing 4.24% of the total shares of Series 1 Convertible Preferred
Stock outstanding); and Warrants to purchase 1,790 shares of Common Stock
bringing our total ownership of Warrants to purchase shares of Common
Stock to 30,426 (representing 11.2% of the total Warrants to purchase
Common Stock outstanding) of NeoPhotonics. The Chief Executive Officer of
the company is Timothy S. Jenks.
*Optiva, Inc., located at 377 Oyster Point Boulevard, Suite 13, South San
Francisco, California 94080, is developing and commercializing a new
class of nanomaterials for advanced optical applications initially for
the flat panel display industry. As of March 31, 2004, we held 1,249,999
shares of the Series C Preferred Stock (representing 4.13% of the total
Series C Convertible Preferred Stock outstanding) of Optiva. As of the
date above, our valuation committee fair valued the Series C Convertible
Preferred Stock of Optiva held by us at $1,250,000. The Chief Executive
Officer of the company is Peter Hopper.
*Starfire Systems, Inc., located at 10 Hermes Road, Malta, New York
12020, offers a family of patented silicon carbide forming polymers for
the manufacture of advanced ceramic materials applications. On May 7,
2004, we made our initial investment of $250,000 in exchange for 125,000
shares of Common Stock (representing 1.06% of the total shares of Common
Stock outstanding) and 200,000 shares of Series A-1 Convertible Preferred
Stock (representing 5.64% of the total shares of Series A-1 Convertible
Preferred Stock outstanding). The Chief Executive Officer of the company
is Richard Saburro.
With the exceptions of Alpha, NeuroMetrix, Questech and Experion,
each of the foregoing portfolio companies is in its developmental stage or is
a start-up business. Although Alpha, NeuroMetrix, Questech and Experion are
each generating revenues that are material to them, they are still relatively
early-stage companies with the attendant risks. Any of the companies may
require additional funding that may not be obtainable at all or on the terms
of their most recent fundings, which would result in partial or complete
write-downs in value. In general, private equity is difficult to obtain,
especially in the current economic environment. Each company is dependent upon
a single or small number of customers and/or key operating personnel. All of
the foregoing companies rely heavily upon the technology associated with their
respective business or, in the case of Exponential, with the companies in
which it invests. Therefore, each company places great importance on its
relevant patents, trademarks, licenses, algorithms, trade secrets, franchises
or concessions. Lastly, each company is particularly vulnerable to general
economic, private equity and capital markets conditions and to changes in
government regulation, interest rates or technology.
DETERMINATION OF NET ASSET VALUE
Our investments can be classified into five broad categories for
valuation purposes:
o Equity-related securities;
o Investments in intellectual property or patents or research and
development in technology or product development;
o Long-term fixed-income securities;
o Short-term fixed-income investments; and
o All other investments.
The 1940 Act requires periodic valuation of each investment in our
portfolio to determine net asset value. Under the 1940 Act, unrestricted
securities with readily available market quotations are to be valued at the
current market value; all other assets must be valued at "fair value" as
determined in good faith by or under the direction of the board of directors.
Our board of directors is responsible for (1) determining overall
valuation guidelines and (2) ensuring the valuation of investments within the
prescribed guidelines.
Our valuation committee, comprised of at least three or more
independent board members, is responsible for reviewing and approving the
valuation of our assets within the guidelines established by the board of
directors.
Fair value is generally defined as the amount that an investment
could be sold for in an orderly disposition over a reasonable time. Generally,
to increase objectivity in valuing our assets, external measures of value,
such as public markets or third-party transactions, are utilized whenever
possible. Valuation is not based on long-term work-out value, nor immediate
liquidation value, nor incremental value for potential changes that may take
place in the future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as these amounts depend on future circumstances and cannot
reasonably be determined until the individual investments are actually
liquidated.
Our valuation policy with respect to the five broad investment
categories is as follows:
Equity-Related Securities
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
Cost. The cost method is based on our original cost. This method is
generally used in the early stages of a company's development until
significant positive or negative events occur subsequent to the date of the
original investment that dictate a change to another valuation method. Some
examples of these events are: (1) a major recapitalization; (2) a major
refinancing; (3) a significant third-party transaction; (4) the development of
a meaningful public market for the company's Common Stock; and (5) significant
positive or negative changes in a company's business.
Private Market. The private market method uses actual, executed,
historical transactions in a company's securities by responsible third parties
as a basis for valuation. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
Public Market. The public market method is used when there is an
established public market for the class of the company's securities held by
us. We discount market value for securities that are subject to significant
legal and contractual restrictions. Other securities, for which market
quotations are readily available, are carried at market value as of the time
of valuation. Market value for securities traded on securities exchanges or on
the Nasdaq National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter market and
listed securities for which no sale was reported on that day, market value is
the mean of the closing bid price and asked price on that day. This method is
the preferred method of valuation when there is an established public market
for a company's securities, as that market provides the most objective basis
for valuation.
Analytical Method. The analytical method is generally used to value
an investment position when there is no established public or private market
in the company's securities or when the factual information available to us
dictates that an investment should no longer be valued under either the cost
or private market method. This valuation method is inherently imprecise and
ultimately the result of reconciling the judgments of our valuation committee
members, based on the data available to them. The resulting valuation,
although stated as a precise number, is necessarily within a range of values
that vary depending upon the significance attributed to the various factors
being considered. Some of the factors considered may include the financial
condition and operating results of the company, the long-term potential of the
business of the company, the values of similar securities issued by companies
in similar businesses, the proportion of the company's securities we own and
the nature of any rights to require the company to register restricted
securities under applicable securities laws.
Investments in Intellectual Property or Patents or Research and Development in
Technology or Product Development
These investments are carried at fair value using the following basic
methods of valuation:
Cost. The cost method is based on our original cost. This method is
generally used in the early stages of commercializing or developing
intellectual property or patents or research and development in technology or
product development until significant positive or adverse events occur
subsequent to the date of the original investment that dictate a change to
another valuation method.
Private Market. The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
Analytical Method. The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to us dictates that an investment should no
longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of our valuation committee members. The resulting
valuation, although stated as a precise number, is necessarily within a range
of values that vary depending upon the significance attributed to the various
factors being considered. Some of the factors considered may include the
results of research and development, product development progress, commercial
prospects, term of patent and projected markets.
As of March 31, 2004, we do not have any investments in intellectual
property or patents or research and development in technologies or products.
Long-Term Fixed-Income Securities
Fixed-income securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available. Securities for which market
quotations are not readily available are carried at fair value using one or
more of the following basic methods of valuation:
o Fixed-income securities are valued by independent pricing
services that provide market quotations based primarily on
quotations from dealers and brokers, market transactions, and
other sources.
o Other fixed-income securities that are not readily marketable
are valued at fair value by our valuation committee.
Short-Term Fixed-Income Investments
Short-term fixed-income investments are valued at market value at the
time of valuation. We value short-term debt with remaining maturity of 60 days
or less at amortized cost.
All Other Investments
All other investments are reported at fair value as determined in
good faith by the valuation committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the valuation committee's
judgment of fair values as of the valuation date using the outlined basic
methods of valuation. They do not necessarily represent an amount of money
that would be realized if we had to sell the securities in an immediate
liquidation. Thus, valuations as of any particular date are not necessarily
indicative of amounts that we may ultimately realize as a result of future
sales or other dispositions of investments we hold.
As of March 31, 2004, we do not have any of these investments.
INVESTMENT POLICIES
Investments and Strategies
The following is a summary description of the types of assets in
which we may invest, the investment strategies we may utilize and the
attendant risks associated with our investments and strategies. For a full
description of our investments and strategies, please refer to our Annual
Report on Form 10-K incorporated by reference to this Prospectus.
Equity, Equity-Related Securities and Debt with Equity Features
We may invest in equity, equity-related securities and debt with
equity features. These securities include Common Stock, preferred stock, debt
instruments convertible into common or preferred stock, limited partnership
interests, other beneficial ownership interests and warrants, options or other
rights to acquire any of the foregoing.
We may make investments in companies with operating histories that
are unprofitable or marginally profitable, that have negative net worth or
that are involved in bankruptcy or reorganization proceedings. These
investments would involve businesses that management believes have turn around
potential through the infusion of additional capital and management
assistance. In addition, we may make investments in connection with the
acquisition or divestiture of companies or divisions of companies. There is a
significantly greater risk of loss with these types of securities than is the
case with traditional investment securities.
We may also invest in publicly traded securities of whatever nature,
including relatively small, emerging growth companies that management believes
have long-term growth possibilities.
Warrants, options and convertible or exchangeable securities
generally give the investor the right to acquire specified equity securities
of an issuer at a specified price during a specified period or on a specified
date. Warrants and options fluctuate in value in relation to the value of the
underlying security and the remaining life of the warrant or option, while
convertible or exchangeable securities fluctuate in value both in relation to
the intrinsic value of the security without the conversion or exchange feature
and in relation to the value of the conversion or exchange feature, which is
like a warrant or option. When we invest in these securities, we incur the
risk that the option feature will expire worthless, thereby either eliminating
or diminishing the value of our investment.
Investments in equity securities of private companies involve
securities that are restricted as to sale and cannot be sold in the open
market without registration under the Securities Act of 1933 or pursuant to a
specific exemption from these registrations. Opportunities for sale are more
limited than in the case of marketable securities, although these investments
may be purchased at more advantageous prices and may offer attractive
investment opportunities. Even if one of our portfolio companies completes an
initial public offering, we are typically subject to a lock-up agreement, and
the stock price may decline substantially before we are free to sell. Even if
we have registration rights to make our investments more marketable, a
considerable amount of time may elapse between a decision to sell or register
the securities for sale and the time when we are able to sell the securities.
The prices obtainable upon sale may be adversely affected by market conditions
or negative conditions affecting the issuer during the intervening time.
Venture Capital Investments
We expect to invest in development stage or start-up businesses.
Substantially all of our long-term investments are in thinly capitalized,
unproven, small companies focused on risky technologies. These businesses also
tend to lack management depth, to have limited or no history of operations and
to have not attained profitability. Because of the speculative nature of these
investments, these securities have a significantly greater risk of loss than
traditional investment securities. Some of our venture capital investments are
likely to be complete losses or unprofitable and some will never realize their
potential.
We may own 100% of the securities of a start-up investment for a
period of time and may control the company for a substantial period. Start-up
companies are more vulnerable than better capitalized companies to adverse
business or economic developments. Start-up businesses generally have limited
product lines, service niches, markets and/or financial resources. Start-up
companies are not well-known to the investing public and are subject to
potential bankruptcy, general movements in markets and perceptions of
potential growth.
In connection with our venture capital investments, we may
participate in providing a variety of services to our portfolio companies,
including the following:
o recruiting management;
o formulating operating strategies;
o formulating intellectual property strategies;
o assisting in financial planning;
o providing management in the initial start-up stages; and
o establishing corporate goals.
We may assist in raising additional capital for these companies from
other potential investors and may subordinate our own investment to that of
other investors. We may also find it necessary or appropriate to provide
additional capital of our own. We may introduce these companies to potential
joint venture partners, suppliers and customers. In addition, we may assist in
establishing relationships with investment bankers and other professionals. We
may also assist with mergers and acquisitions. We do not derive income from
these companies for the performance of any of the above services.
We may control, be represented on or have observer rights on the
board of directors of a portfolio company by one or more of our officers or
directors, who may also serve as officers of the portfolio company. We
indemnify our officers and directors for serving on the boards of directors or
as officers of portfolio companies, which exposes us to additional risks.
Particularly during the early stages of an investment, we may in effect be
conducting the operations of the portfolio company. As a venture company
emerges from the developmental stage with greater management depth and
experience, we expect that our role in the portfolio company's operations will
diminish. Our goal is to assist each company in establishing its own
independent capitalization, management and board of directors. We expect to be
able to reduce our interest in those start-up companies which become
successful.
Debt Obligations
We may hold debt securities for income and as a reserve pending more
speculative investments. Debt obligations may include U.S. government and
government agency securities, commercial paper, bankers' acceptances,
receivables or other asset-based financing, notes, bonds, debentures, or other
debt obligations of any nature and repurchase agreements related to these
securities. These obligations may have varying terms with respect to security
or credit support, subordination, purchase price, interest payments and
maturity from private, public or governmental issuers of any type located
anywhere in the world. We may invest in debt obligations of companies with
operating histories that are unprofitable or marginally profitable, that have
negative net worth or are involved in bankruptcy or reorganization
proceedings, or that are start-up or development stage entities. In addition,
we may participate in the acquisition or divestiture of companies or divisions
of companies through issuance or receipt of debt obligations.
It is likely that our investments in debt obligations will be of
varying quality, including non-rated, highly speculative debt investments with
limited marketability. Investments in lower-rated and non-rated securities,
commonly referred to as "junk bonds," are subject to special risks, including
a greater risk of loss of principal and non-payment of interest. Generally,
lower-rated securities offer a higher return potential than higher-rated
securities but involve greater volatility of price and greater risk of loss of
income and principal, including the possibility of default or bankruptcy of
the issuers of these securities. Lower-rated securities and comparable
non-rated securities will likely have large uncertainties or major risk
exposure to adverse conditions and are predominantly speculative with respect
to the issuer's capacity to pay interest and repay principal in accordance
with the terms of the obligation. The occurrence of adverse conditions and
uncertainties to issuers of lower-rated securities would likely reduce the
value of lower-rated securities held by us, with a commensurate effect on the
value of our shares.
The markets in which lower-rated securities or comparable non-rated
securities are traded generally are more limited than those in which
higher-rated securities are traded. The existence of limited markets for these
securities may restrict our ability to obtain accurate market quotations for
the purposes of valuing lower-rated or non-rated securities and calculating
net asset value or to sell securities at their fair value. Any economic
downturn could adversely affect the ability of issuers' lower-rated securities
to repay principal and pay interest thereon. The market values of lower-rated
and non-rated securities also tend to be more sensitive to individual
corporate developments and changes in economic conditions than higher-rated
securities. In addition, lower-rated securities and comparable non-rated
securities generally present a higher degree of credit risk. Issuers of
lower-rated securities and comparable non-rated securities are often highly
leveraged and may not have more traditional methods of financing available to
them, so that their ability to service their debt obligations during an
economic downturn or during sustained periods of rising interest rates may be
impaired. The risk of loss owing to default by these issuers is significantly
greater because lower-rated securities and comparable non-rated securities
generally are unsecured and frequently are subordinated to the prior payment
of senior indebtedness. We may incur additional expenses to the extent that we
are required to seek recovery upon a default in the payment of principal or
interest on our portfolio holdings.
The market value of investments in debt securities that carry no
equity participation usually reflects yields generally available on securities
of similar quality and type at the time purchased. When interest rates
decline, the market value of a debt portfolio already invested at higher
yields can be expected to rise if the securities are protected against early
call. Similarly, when interest rates increase, the market value of a debt
portfolio already invested at lower yields can be expected to decline.
Deterioration in credit quality also generally causes a decline in market
value of the security, while an improvement in credit quality generally leads
to increased value.
Foreign Securities
We may make investments in securities of issuers whose principal
operations are conducted outside the United States, and whose earnings and
securities are stated in foreign currency. In order to maintain our status as
a business development company, our investments in the stocks of companies
organized outside the U.S. would be limited to 30% of our assets, because we
must invest at least 70% of our assets in "qualifying assets" and foreign
companies are not "qualifying assets." We do not anticipate investing a
significant portion of our assets in foreign companies.
Compared to otherwise comparable investments in securities of U.S.
issuers, currency exchange risk of securities of foreign issuers is a
significant variable. The value of these investments to us will vary with the
relation of the currency in which they are denominated to the U.S. dollar, as
well as with intrinsic elements of value such as credit risk, interest rates
and performance of the issuer. Investments in foreign securities also involve
risks relating to economic and political developments, including
nationalization, expropriation, currency exchange freezes and local recession.
Securities of many foreign issuers are less liquid and more volatile than
those of comparable U.S. issuers. Interest and dividend income and capital
gains on our foreign securities may be subject to withholding and other taxes
that may not be recoverable by us. We may seek to hedge all or part of the
currency risk of our investments in foreign securities through the use of
futures, options and forward currency purchases or sales.
Intellectual Property
We believe there is a role for organizations that can assist in
technology transfer. Scientists and institutions that develop and patent
intellectual property perceive the need for and rewards of entrepreneurial
commercialization of their inventions.
Our form of investment may be:
o funding research and development in the development of a
technology;
o obtaining licensing rights to intellectual property or patents;
o acquiring intellectual property or patents; or
o forming and funding companies or joint ventures to further
commercialize intellectual property.
Income from our investments in intellectual property or its
development may take the form of participation in licensing or royalty income,
fee income, or some other form of remuneration. Investment in developmental
intellectual property rights involves a high degree of risk that can result in
the loss of our entire investment as well as additional risks including
uncertainties as to the valuation of an investment and potential difficulty in
liquidating an investment. Further, investments in intellectual property
generally require investor patience as investment return may be realized only
after or over a long period. At some point during the commercialization of a
technology, our investment may be transformed into ownership of securities of
a development stage or Start-Up Company as discussed under "Venture Capital
Investments" above.
Other Strategies
In pursuit of our investment strategy, we may employ one or more of
the following strategies in order to enhance investment results.
Borrowing and Margin Transactions
We may from time to time borrow money or obtain credit by any lawful
means from banks, lending institutions, other entities or individuals, in
negotiated transactions. We may issue, publicly or privately, bonds,
debentures or notes, in series or otherwise, with interest rates and other
terms and provisions, including conversion rights, on a secured or unsecured
basis, for any purpose, up to the maximum amounts and percentages permitted
for closed-end investment companies under the 1940 Act. The 1940 Act currently
prohibits us from borrowing any money or issuing any other senior securities
(other than preferred stock and other than temporary borrowings of up to 5% of
our assets), if in giving effect to the borrowing or issuance, the value of
our total assets would be less than 200% of our total liabilities (other than
liabilities not constituting senior securities). We may pledge assets to
secure any borrowings. We currently have no leverage and have no current
intention to issue preferred stock.
A primary purpose of our borrowing power is for leverage, to increase
our ability to acquire investments both by acquiring larger positions and by
acquiring more positions. Borrowings for leverage accentuate any increase or
decrease in the market value of our investments and thus our net asset value.
Since any decline in the net asset value of our investments will be borne
first by holders of Common Stock, the effect of leverage in a declining market
would be a greater decrease in net asset value applicable to the Common Stock
than if we were not leveraged. Any decrease would likely be reflected in a
decline in the market price of the Common Stock. To the extent the income
derived from assets acquired with borrowed funds exceeds the interest and
other expenses associated with borrowing, our total income will be greater
than if borrowings were not used. Conversely, if the income from assets is not
sufficient to cover the borrowing costs, our total income will be less than if
borrowings were not used. If our current income is not sufficient to meet our
borrowing costs (repayment of principal and interest), we might have to
liquidate our investments when it may be disadvantageous to do so. Our
borrowings for the purpose of buying most liquid equity securities will be
subject to the margin rules, which require excess liquid collateral marked to
market daily. If we are unable to post sufficient collateral, we would be
required to sell securities to remain in compliance with the margin rules.
These sales might be at disadvantageous times or prices.
Repurchase of Shares
Our shareholders do not have the right to compel us to redeem our
shares. We may, however, purchase outstanding shares of our Common Stock from
time to time, subject to approval of our board of directors and compliance
with applicable corporate and securities laws. The board of directors may
authorize purchases from time to time when they are deemed to be in the best
interests of our shareholders, but could do so only after notification to
shareholders. The board of directors may or may not decide to undertake any
purchases of our Common Stock.
Our repurchases of our common shares would decrease our total assets
and would therefore likely have the effect of increasing our expense ratio.
Subject to our investment restrictions, we may borrow money to finance the
repurchase of our Common Stock in the open market pursuant to any tender
offer. Interest on any borrowings to finance share repurchase transactions
will reduce our net assets. If, because of market fluctuations or other
reasons, the value of our assets falls below the required 1940 Act coverage
requirements, we may have to reduce our borrowed debt to the extent necessary
to comply with the requirement. To achieve a reduction, it is possible that we
may be required to sell portfolio securities at inopportune times when it may
be disadvantageous to do so. Since 1998, we have repurchased a total of
1,828,740 shares of our Common Stock at a total cost of $3,405,531, or $1.86
per share. Because we intend to continue investing in tiny technology, our
board of directors does not currently intend to authorize the purchase of
additional shares of our Common Stock.
Portfolio Company Turnover
Changes with respect to portfolio companies will be made as our
management considers necessary in seeking to achieve our investment objective.
The rate of portfolio turnover will not be treated as a limiting or relevant
factor when circumstances exist which are considered by management to make
portfolio changes advisable.
Although we expect that many of our investments will be relatively
long term in nature, we may make changes in our particular portfolio holdings
whenever it is considered that an investment no longer has substantial growth
potential or has reached its anticipated level of performance, or (especially
when cash is not otherwise available) that another investment appears to have
a relatively greater opportunity for capital appreciation. We may also make
general portfolio changes to increase our cash to position us in a defensive
posture. We may make portfolio changes without regard to the length of time we
have held an investment, or whether a sale results in profit or loss, or
whether a purchase results in the reacquisition of an investment which we may
have only recently sold.
The portfolio turnover rate may vary greatly from year to year as
well as during a year and may also be affected by cash requirements.
Investment Restrictions
When we were a regulated investment company, pursuant to a
requirement under the 1940 Act, we provided that our investment objective and
the following investment restrictions were fundamental and could not be
changed without the approval of the holders of a majority of our outstanding
voting securities (defined in the 1940 Act as the lesser of (a) more than 50%
of the outstanding shares or (b) 67% or more of the shares represented at a
meeting at which more than 50% of the outstanding shares are represented). The
provisions of the 1940 Act regarding fundamental investment restrictions and
objectives are not applicable to business development companies and
accordingly we believe that the following restrictions do not apply to us
although we have as a matter of fact conducted our operations consistently
with them. Satisfaction of these restrictions was measured only at the time of
a transaction, with the result that later changes in percentage resulting from
changing market values, for example, would not be considered a deviation from
policy. Under these restrictions, prior to becoming a business development
company, we could not:
(1) invest more than 25% of the value of our total assets in any
one industry;
(2) issue senior securities other than:
(a) preferred stock not in excess of the excess of 50% of our
total assets over any senior securities described in
clause (b) below that are outstanding,
(b) senior securities other than preferred stock (including
borrowing money, including on margin if margin securities
are owned and through entering into reverse repurchase
agreements, and providing guaranties) not in excess of 33
1/3% of our total assets, and
(c) borrowings of up to 5% of our total assets for temporary
purposes without regard to the amount of senior securities
outstanding under clauses (a) and (b) above; provided,
however, that our obligations under interest rate swaps,
when issued and forward commitment transactions and
similar transactions are not treated as senior securities
if covering assets are appropriately segregated; or pledge
our assets other than to secure the issuances or in
connection with hedging transactions, short sales,
when-issued and forward commitment transactions and
similar investment strategies.
For purposes of clauses (a), (b) and (c) above, "total assets"
shall be calculated after giving effect to the net proceeds of
any issuance and net of any liabilities and indebtedness that
do not constitute senior securities except for liabilities and
indebtedness as are excluded from treatment as senior
securities by the proviso to this item (2);
(3) make loans of money or property to any person, except through
loans and guaranties to entities, loans of portfolio
securities, the acquisition of fixed income obligations
consistent with our investment objective and policies or the
acquisition of securities subject to repurchase agreements;
(4) underwrite the securities of other issuers, except to the
extent that in connection with the disposition of portfolio
securities or the sale of our own securities we may be deemed
to be an underwriter;
(5) purchase or sell real estate or interests therein in excess of
our total assets;
(6) purchase or sell commodities or purchase or sell commodity
contracts except for hedging purposes or in connection with
business operations and except for precious metals and coins;
or
(7) make any short sale of securities except in conformity with
applicable laws, rules and regulations and unless, in giving
effect to the sale, the market value of all securities sold
short does not exceed 25%, except short sales "against the box"
which are not subject to the limitation, of the value of our
total assets and our aggregate short sales of a particular
class of securities does not exceed 25% of the then-outstanding
securities of that class.
MANAGEMENT OF THE COMPANY
Board of Directors and Certain Executive Officers
Set forth below are the names, ages, positions and principal
occupations during the past five years of our directors and executive
officers. We have no advisory board. Our business address and that of our
officers and directors is 111 West 57th Street, Suite 1100, New York, New York
10019.
Positions(s) Term of Office
Held with and Length of Principal Occupations During Other Directorships
Name and Age Registrant Time Served Past 5 Years Held by Director
- -----------------------------------------------------------------------------------------------------------------
INTERESTED DIRECTORS:
Charles E. Harris* Director, Director, Chief Executive Officer and Harris & Harris
Age: 61 Chief Chairman and Managing Director of the Enterprises, Inc.,
Age: 61 Executive Chief Executive Company. NeuroMetrix, Inc.,
Officer, Officer since Experion Systems,
Managing 1984; Chief Inc. and Nanopharma
Director and Compliance Corp.
Chairman of Officer from
the Board 1997 to 2001;
Managing
Director since
2004
Dr. Kelly S. Director and Since 2002 Business consultant. None
Kirkpatrick* Consultant Director, Columbia
Age: 37 Nanotechnology Initiative and
Director for
Research and
Technology
Initiatives,
Office of the
Executive Vice
Provost, Columbia
University, 2000
to 2002. White
House Office of
Science and
Technology Policy,
1998 to 2000.
Lori D. Pressman* Director and Since 2002 Business consultant. None
Age: 46 Consultant Technology Licensing Officer,
1989 to 1995; Assistant
Director, 1996 to 2000;
Technology Licensing Office,
Massachusetts Institute of
Technology.
INDEPENDENT DIRECTORS:
Dr. C. Wayne Bardin Director Since 1994 Consultant. President, None
Age: 69 Thyreos Corp., 1998 to 2003.
Dr. Phillip A. Bauman Director Since 1998 Orthopedic surgeon. Assistant None
Age: 48 Professor, Columbia
University.
G. Morgan Browne Director Since 1992 Former Chief Financial OSI Pharmaceuticals,
Age: 68 Officer, Cold Spring Harbor Inc.
Laboratory, 2001 to 2003,
Administrative Director, Cold
Spring Harbor Laboratory, 1995
to 2000.
Dugald A. Fletcher Director Since 1996 President and Director, Gabelli Convertible
Age: 74 Fletcher & Company, Inc. Securities and Income
Fund. Trustee of the
Gabelli Growth Fund.
Mark A. Parsells Director Since November Chairman, President and Chief Fusura LLC, Experion
Age: 44 2003 Executive Officer of Fusura Systems, Inc.,
LLC. Wilmington
Renaissance Corporation
and Winterthur Business
Associates.
Charles E. Ramsey Director Since 2002 Retired Founder and Principal Experion Systems,
Age: 61 of Ramsey/Beirne Associates, Inc., The Seedling
Inc. Chair of Bridges to Group, Inc.
Community.
James E. Roberts Director Since 1995 Executive Vice President and None
Age: 58 Underwriting Officer, Alea
North America Company -
Reinsurance Division, since
2002. Vice Chairman,
Chartwell Reinsurance
Company. Chief Executive
Officer, The Insurance
Corporation of New York,
Dakota Specialty Insurance Co.
and ReCor Insurance Company,
Inc., 1999 to 2000. Vice
Chairman, Trenwick America
Reinsurance Corporation, 1995
to 2000.
OFFICERS:
Charles E. Harris* Director, Director, Chief Executive Officer of the Harris & Harris
Age: 61 Chief Chairman and Company. Enterprises, Inc.,
Executive Chief Executive NeuroMetrix, Inc.
Officer, Officer since Experion Systems,
Managing 1984; Chief Inc. and Nanopharma
Director and Compliance Corp.
Chairman of Officer from
the Board 1997 to 2001;
Managing
Director since
2004.
Mel P. Melsheimer President, President, Chief President, Managing Director, Questech Corporation,
Age: 64 Managing Operating Chief Operating Officer, Chief Harris & Harris
Director, Officer and Financial Officer, Chief Enterprises, Inc. and
Chief Chief Financial Compliance Officer and Nanotechnologies, Inc.
Operating Officer since Treasurer of the Company.
Officer, Chief 1997; Chief President of Harris & Harris
Financial Compliance Enterprises, Inc.
Officer, Chief Officer and
Compliance Treasurer since
Officer and 2001; Managing
Treasurer Director since
2004
Daniel V. Leff Executive Vice Since January Executive Vice President and None
Age: 35 President, 2004 Managing Director of the
Managing Company. Senior Associate at
Director Sevin Rosen Funds from 2001 to
2003. Venture Capital Consultant
for Redpoint Ventures from 2000
- 2001. Manager, Strategic
Investments of Intel Corporation
from 1997 to 2000.
Douglas W. Jamison Vice President Vice President Vice President and Managing None
Age: 34 and Managing since September Director of the Company.
Director 2002; Managing Senior technology manager,
Director since University of Utah Technology
2004 Transfer Office, 1997 to 2002.
Daniel B. Wolfe Vice President Vice President Vice President of the
Age: 27 beginning July Company. Consultant for
2004 Nanosys, Inc. from 2002
through 2004. Consultant for
CW Group 2001 through 2004.
Consultant for Bioscale, Inc.
January 2003 through 2004.
Co-Founder and President of
Scientific Venture
Assessments, Inc., February
2002 through January 2002.
Helene B. Shavin Vice Vice President Vice President, Controller and None
Age: 50 President, and Controller Assistant Secretary of the
Controller and since 2001; Company. Vice President and
Assistant Assistant Controller of Harris & Harris
Secretary Secretary since Enterprises, Inc. since 2001.
2002 Vice President, Citicorp
Venture Capital, 1986 to 2000.
- ----------------
* Charles E. Harris is an "interested person" of the Company, as
defined in the 1940 Act, as a beneficial owner of more than 5% of our stock,
as a control person of ours and as one of our officers. In addition, each of
Dr. Kelly S. Kirkpatrick and Lori D. Pressman may be considered to be an
"interested person" of the Company because of the work each does consulting
for the Company.
Messrs. Harris, Melsheimer, Leff and Jamison are primarily
responsible for the day to day management of our portfolio, and have served in
this capacity since 1984, 1997, 2004 and 2002, respectively.
We do not consider that any person other than Charles E. Harris
"controls" the Company within the meaning of this item.
Executive Officers
Charles E. Harris. Mr. Harris currently serves as our Chairman, Chief
Executive Officer and as a Managing Director. He has served as our Chief
Executive Officer since July 1984 and as a Managing Director since January
2004. He has been a member of our board of directors and served as Chairman of
the board since April 1984. He also served as our Chief Compliance Officer
from February 1997 to February 2001. He was a member of the Advisory Panel for
the Congressional Office of Technology Assessment. Prior to joining us, he was
Chairman of Wood, Struthers and Winthrop Management Corporation, the
investment advisory subsidiary of Donaldson, Lufkin and Jenrette. He is
currently a member of the New York Society of Security Analysts. He acts as a
Trustee and head of the audit committee of Cold Spring Harbor Laboratory, a
not-for-profit institution that conducts research and education programs in
the fields of molecular biology and genetics. He also serves as a Trustee and
head of the audit committee of the Nidus Center, a life sciences business
incubator in St. Louis, Missouri. He is a life-sustaining fellow of MIT and a
shareholder of its Entrepreneurship Center. He is an "interested person" as
defined in Section 2(a)(19) of the 1940 Act, as a beneficial owner of more
than 5% of our Common Stock, as a control person and as one of our officers.
Mel P. Melsheimer. Mr. Melsheimer has served as our President, Chief
Operating Officer and Chief Financial Officer since February 1997. Since
February 2001, he has also served as our Chief Compliance Officer, since July
2001, as Treasurer and since January 2004, as a Managing Director. From March
1994 to February 1997, he served as a nearly full-time consultant to us or as
an officer to one of our portfolio companies. From November 1992 to February
1994, he served as Executive Vice President, Chief Operating Officer and
Secretary of Dairy Holdings, Inc.
Daniel V. Leff. Mr. Leff has served as our Executive Vice President
and as a Managing Director since January 2004. Prior to joining us, he was a
Senior Associate with Sevin Rosen Funds in the firm's Dallas, Texas office,
where he focused on early-stage investment opportunities in semiconductors,
components, and various emerging technology areas. Previously he worked for
Redpoint Ventures in the firm's Los Angeles office. In addition, he previously
held engineering, marketing and strategic investment positions with Intel
Corporation. He received his Ph.D. degree in Physical Chemistry from UCLA's
Department of Chemistry and Biochemistry, where his thesis advisor was
Professor James R. Heath (recipient of the 2000 Feynman Prize in
Nanotechnology). He also received a B.S. in Chemistry from the University of
California, Berkeley and an MBA from The Anderson School at UCLA, where he was
an Anderson Venture Fellow. He has published several articles in peer-reviewed
scientific journals and has been awarded two patents in the field of
Nanotechnology. He is also a member of the business advisory boards of the
NanoBusiness Alliance and the California NanoSystems Institute (CNSI).
Douglas W. Jamison. Mr. Jamison has served as our Vice President
since September 2002 and as a Managing Director since January 2004. Prior to
joining us, he worked for five years as a Senior Technology Manager at the
University of Utah Technology Transfer Office, where he managed intellectual
property. On January 14, 2004, the Directors named Mr. Jamison as the future
President of the Company after Mr. Melsheimer's scheduled retirement on
December 31, 2004. He is a member of the Scientific Advisory Board of
Chlorogen, Inc., in which the Company has an investment. His professional
societies include the Association of University Technology Managers, for which
he serves on its Survey Statistics and Metrics Committee, the American
Association for the Advancement of Science and the Institute of Electrical and
Electronics Engineers. He is a member of the Advisory Board, Massachusetts
Technology Collaborative Nanotechnology Venture Forum, of the Advisory Board,
Converging Technology Bar Association and the Advisory Board, Nanotechnology
Law & Business (Journal for Attorneys, Entrepreneurs and Investors Involved in
Small Scale Technologies).
Daniel B. Wolfe. Mr. Wolfe will serve as a Vice President starting in
July 2004. Prior to joining us, he served as a consultant to Nanosys, Inc., CW
Group and Bioscale, Inc. From February 2000 to January 2002, he was the
Co-founder and President of Scientific Venture Assessments, Inc., a provider
of scientific analysis of prospective investments for private equity
placements and scientific expertise to high-technology companies. He is
completing a Ph.D. from Harvard University, where he is conducting research
under Professor George Whitesides.
Helene B. Shavin. Ms. Shavin has served as our Vice President and
Controller since 2001 and as our Assistant Secretary since 2002. Prior to
joining us, she was a Vice President with Citicorp Venture Capital from 1986
to 2000.
Board of Directors
Our board of directors supervises our management. The
responsibilities of each director include, among other things, the oversight
of the investment approval process, the quarterly valuation of our assets, and
the oversight of our financing arrangements.
Interested Directors:
Charles E. Harris. See biography under "Executive Officers."
Kelly S. Kirkpatrick. Dr. Kirkpatrick has served as a member of our
board of directors since March 2002. She has served as a consultant to us on
nanotechnology and in our due diligence work on Agile Materials &
Technologies, Inc. and Optiva, Inc. She is an independent business consultant
assessing and advising on early stage, technology start-ups for venture
capital companies. From 2000 to 2002, she served in the Office of the
Executive Vice Provost of Columbia University as Director of the Columbia
University Nanotechnology Initiative and as Director for Research and
Technology Initiatives. From 1998 to 2000, she served in the White House
Office of Science and Technology Policy as a Senior Policy Analyst involved in
the National Nanotechnology Initiative. From 1997 to 1998, she was a Science
Policy Coordinator for Sandia National Laboratories. From 1995 to 1996, she
served in the office of Senator Joseph Lieberman as Legislative Assistant,
Congressional Science and Engineering Fellow. She may be considered to be an
"interested person" of the Company because of the consulting work she does for
us.
Lori D. Pressman. Ms. Pressman has served as a member of our board of
directors since March 2002. She has served as a consultant to us on tiny
technology, intellectual property and in our due diligence work on Chlorogen,
Inc., Continuum Photonics, Inc., NanoOpto Corporation, Nanopharma Corp.,
Nanosys, Inc., Nantero, Inc. and NeoPhotonics Corporation. She also acts as an
observer for us at board meetings of certain investee companies in the Boston
area. She is a business consultant providing advisory services to start-ups
and venture capital companies. She consults internationally on technology
transfer practices and metrics for non-profit and government organizations.
From 1999 to 2001, she was Chair of the Survey Statistics and Metrics
Committee of the Association of University Technology Managers. From September
1989 to July 2000, she was employed by MIT in its Technology Licensing Office.
She served as its Technology Licensing Officer from 1989 to 1995 and as
Assistant Director from 1996 to 2000. From September 1984 to September 1989,
she was Senior Development Engineer at Lasertron, Inc. She may be considered
to be an "interested person" of the Company because of the consulting work she
does for us.
Independent Directors:
C. Wayne Bardin. Dr. Bardin has served as a member of our board of
directors since December 1994. From 1998 to 2003, he served as President of
Thyreos Corp., a privately held, start-up pharmaceutical company. From 1978
through 1996, he was Vice President of The Population Council. His
professional appointments have included: Professor of Medicine, Chief of the
Division of Endocrinology, The Milton S. Hershey Medical Center of
Pennsylvania State University and Senior Investigator, Endocrinology Branch,
National Cancer Institute. He has also served as a consultant to several
pharmaceutical companies. He has been appointed to the editorial boards of 15
journals. He has also served on national and international committees and
boards for the National Institutes of Health, World Health Organization, The
Ford Foundation and numerous scientific societies.
Phillip A. Bauman. Dr. Bauman has served as a member of our board of
directors since February 1998. He is Senior Attending in Orthopedic Surgery at
St. Luke's/Roosevelt Hospital Center in Manhattan and has served as an elected
member of the executive committee of the Medical Board since 2000. He has been
Assistant Professor of Orthopedic Surgery at Columbia University since 1998
and a Vice President of Orthopedic Associates of New York since 1994. He was
elected a fellow of the American Academy of Orthopaedic Surgeons in 1991. He
is an active member of the American Orthopaedic Society for Sports Medicine,
the New York State Society of Orthopaedic Surgeons and the American Medical
Association.
G. Morgan Browne. Mr. Browne has served as a member of our board of
directors since June 1992. From 2001 to 2003, he served as Chief Financial
Officer of Cold Spring Harbor Laboratory, a not-for-profit institution that
conducts research and education programs in the fields of molecular biology
and genetics. From 1985 to 2001, he was the Administrative Director of Cold
Spring Harbor Laboratory. In prior years, he was active in the management of
numerous scientifically based companies as an officer, as an individual
consultant and as an associate of Laurent Oppenheim Associates, Industrial
Management Consultants. He is a Director of OSI Pharmaceuticals, Inc., a
publicly held company principally engaged in drug discovery based on gene
transcription. He was a founding director of the New York Biotechnology
Association and a founding director of the Long Island Research Institute.
Dugald A. Fletcher. Mr. Fletcher has served as a member of our board
of directors since 1996. He has served as President of Fletcher & Company,
Inc., a management consulting firm since 1984. Until the end of 1997, he was
Chairman of Binnings Building Products Company, Inc. His previous business
appointments include: adviser to Gabelli/Rosenthal LP, a leveraged buyout
fund; Chairman of Keller Industries, building and consumer products; Senior
Vice President of Booz-Allen & Hamilton; President of Booz-Allen Acquisition
Services; Executive Vice President and a Director of Paine Webber, Inc.; and
President of Baker, Weeks and Co., Inc., a New York Stock Exchange member
firm. He is currently a Trustee of the Gabelli Growth Fund and a Director of
the Gabelli Convertible and Income Securities Fund, Inc.
Mark A. Parsells. Mr. Parsells has served as a member of our board of
directors since November 2003. He is the Chairman, President and Chief
Executive Officer of Fusura LLC, an AIG company that is an Internet-based,
direct to consumer auto insurance business. Since February 2004, he is the
Chairman, President and Chief Executive Officer of Montpelier Ventures, a
management consulting firm. He graduated from Emory University (BA), Cornell
University (MBA) and Vlerick Leuven Gent Business School (MBA). Previously, he
was President and Chief Operating Officer of Citibank Online, worked in
executive positions for Bank One and American Express and acted as Special
Assistant to U.S. Senator John Heinz.
Charles E. Ramsey. Mr. Ramsey has served as a member of our board of
directors since October 2002. He is a retired founder and principal of
Ramsey/Beirne Associates, Inc., an executive search firm that specialized in
recruiting top officers for high technology companies, many of which were
backed by venture capital. An active investor, he is a director of three
privately held companies, including Experion Systems, Inc., in which we own an
equity interest. He works on construction projects in Nicaragua as a member of
the Nicaraguan Initiative Committee for the Presbyterian Churches of the
Hudson River and as Chair of Bridges to Community, a non-governmental
organization dedicated to construction projects in Nicaragua.
James E. Roberts. Mr. Roberts has served as a member of our board of
directors since 1995. Since 2002, he has been Executive Vice President and
Chief Underwriting Officer of the Reinsurance Division of Alea North America
Company. From October 1999 to November 2002, he was Chairman and Chief
Executive Officer of the Insurance Corporation of New York, Dakota Specialty
Insurance Company, and Recor Insurance Company Inc., all members of the
Trenwick Group, Ltd. From October 1999 to March 2000, he served as Vice
Chairman of Chartwell Reinsurance Company. Prior to assuming those positions,
he was Vice Chairman of Trenwick America Reinsurance Corporation from May 1995
to March 2000.
Committees of the Board of Directors
Our board of directors maintains an Executive Committee, an Audit
Committee, a Compensation Committee, a Nominating Committee, a Valuation
Committee, a Pricing Committee and an Independent Directors Committee. All of
the members of each committee other than Mr. Harris (who sits on the Executive
Committee and the Pricing Committee) are non-interested directors (as defined
in Section 2(a)(19) of the 1940 Act).
The Executive Committee has and may exercise those rights, powers and
authority that the board of directors from time to time grants to it, except
where action by the full board is required by statute, an order of the SEC or
our charter or bylaws. The Executive Committee did not meet as a separate
committee and did not act by unanimous written consent in 2003. The members of
the Executive Committee are Messrs. Harris (Chairman), Roberts and Browne and
Dr. Bardin.
The Audit Committee operates pursuant to a charter. The charter was
approved by the board of directors on March 13, 2003. The charter was revised
on November 13, 2003 and was approved by the Audit Committee, and approved by
the board of directors on March 10, 2004. The charter sets forth the
responsibilities of the Audit Committee. The Audit Committee's
responsibilities include recommending the selection of our independent
registered public accounting firm, reviewing with the independent registered
public accounting firm the planning, scope and results of their audit and our
financial statements and the fees for services performed, reviewing with the
independent registered public accounting firm the adequacy of internal control
systems, reviewing our annual financial statements and receiving our audit
reports and financial statements. The members of the Audit Committee are
Messrs. Fletcher (Chairman) and Browne and Dr. Bauman, all of whom are
considered independent under the rules promulgated by the Nasdaq National
Market.
The Compensation Committee determines the compensation for our
executive officers and the amount of salary and bonus to be included in the
compensation package for each of our officers and employees. The members of
the Compensation Committee are Messrs. Roberts (Chairman), Parsells and Ramsey
and Dr. Bauman.
The Nominating Committee recommends candidates for election as
directors to the board of directors and makes recommendations to the board as
to our corporate governance policies. The members of the Nominating Committee
are Messrs. Bardin (Chairman), Parsells and Ramsey and Dr. Bauman.
The Valuation Committee reviews and approves the valuation of our
assets, from time to time, as prescribed by the 1940 Act, pursuant to the
guidelines established by our board of directors. The members of the Valuation
Committee are Messrs. Fletcher (Chairman), Browne, Parsells and Roberts and
Dr. Bardin.
The Pricing Committee was established by the board of directors on
October 21, 2003. The Pricing Committee is responsible for approving the price
of any offering of our shares of stock, approving the number of shares being
offered in such offering, providing final approval of the underwriting
agreement and handling any other details as are necessary to effect the
transaction. The members of the Pricing Committee are Messrs. Harris
(Chairman), Fletcher and Mayer.
The Board of Directors approved the appointment of an Independent
Directors Committee on March 10, 2004, which will have the responsibility of
proposing corporate governance and long-term planning matters to the Board of
Directors.
The following table sets forth the dollar range of equity securities
beneficially owned by each director as of December 31, 2003.
Dollar Range of Equity Securities
Name of Director Beneficially Owned (1)(2)(3)
- -------------------------------------------------------------------------------
Interested Directors:
- --------------------
Charles E. Harris Over $100,000
Dr. Kelly S. Kirkpatrick(4) $50,001 - $100,000
Lori D. Pressman(4) $50,001-$100,000
Independent Directors:
- ---------------------
Dr. C. Wayne Bardin Over $100,000
Dr. Phillip A. Bauman Over $100,000
G. Morgan Browne Over $100,000
Dugald A. Fletcher Over $100,000
Mark A. Parsells None
Charles E. Ramsey Over $100,000
James E. Roberts Over $100,000
- -------------------
(1) Beneficial ownership has been determined in accordance with Rule
16a-1(a)(2) of the 1934 Act.
(2) The dollar ranges are: none, $1-$10,000, $10,001-$50,000,
$50,001-$100,000 and over $100,000.
(3) The dollar ranges are based on the price of the equity securities as of
December 31, 2003.
(4) Denotes an individual who may be considered an "interested person"
because of consulting work performed for us.
Principal Shareholders
Set forth below is information as of May 13, 2004 with respect to the
beneficial ownership of our Common Stock by (i) each person who is known by us
to be the beneficial owner of more than 5% of the outstanding shares of the
Common Stock, (ii) each of our directors and executive directors and (iii) all
of our directors and executive officers as a group. Except as otherwise
indicated, to our knowledge, all shares are beneficially owned and investment
and voting power is held by the persons named as owners. Except for holdings
by directors and executive officers, the information in the table below is
from publicly available information that may be as of dates earlier than May
13, 2004. At this time, we are unaware of any shareholder owning 5% or more of
the outstanding shares of Common Stock other than the ones noted below. Unless
otherwise provided, the address of each holder is c/o Harris & Harris Group,
Inc., 111 West 57th Street, Suite 1100, New York, New York 10019.
Amount and Nature of Percentage of Outstanding Common
Name and Address of Beneficial Owner Beneficial Ownership Shares Owned
------------------------------------------------------------------------------------------------------------
Directors and Executive Officers:
Charles E. and Susan T. Harris.............. 1,050,893(1) 7.6
Dr. C. Wayne Bardin......................... 21,316(2) *
Dr. Phillip A. Bauman....................... 22,476(3) *
G. Morgan Browne............................ 34,172 *
Dugald A. Fletcher.......................... 13,370 *
Douglas W. Jamison.......................... 625 *
Dr. Kelly S. Kirkpatrick.................... 3,313 *
Daniel V. Leff.............................. 0 *
Mel P. Melsheimer........................... 80,210(4) *
Mark A. Parsells............................ 0 *
Lori D. Pressman............................ 3,871 *
Charles E. Ramsey........................... 28,046 *
James E. Roberts............................ 16,392 *
Helene Shavin............................... 3,000 *
All directors and executive officers as
a group (15 persons)........................ 1,277,684 9.3
5% Shareholders:
Jonathan Rothschild
c/o Arterio, Inc.
1061-B Shary Circle
Concord, California 94518.................. 770,330 5.6
Masters Capital Management LLC/Michael
Masters(5)
3060 Peachtree Road, N.E., Suite 1815
Atlanta, Georgia 30305..................... 886,962(6) 6.4
- ----------------
* Less than 1%.
(1) Includes 1,039,559 shares owned by Mrs. Harris and 11,334 shares owned by
Mr. Harris.
(2) Includes 3,786 shares owned by Bardin LLC for the Bardin LLC
Profit-Sharing Keogh.
(3) Includes 5,637 shares owned by Ms. Milbry C. Polk, Dr. Bauman's wife; 100
shares owned by Adelaide Polk-Bauman, Dr. Bauman's daughter; 100 shares
owned by Milbry Polk-Bauman, Dr. Bauman's daughter; and 100 shares owned
by Mary Polk-Bauman, Dr. Bauman's daughter. Ms. Milbry C. Polk is the
custodian for the accounts of the three children.
(4) Includes 13,334 shares which are owned jointly by Mel P. Melsheimer and
his wife.
(5) Pursuant to a Schedule 13G/A dated February 9, 2004, Masters Capital
Management LLC ("Masters") and Michael Masters beneficially owned 568,200
shares and Marlin Fund Offshore, Ltd. beneficially owned 318,762 shares
(all with shared voting and dispositive power).
(6) See Footnote 5.
Remuneration of Directors and Others
The following table sets forth the compensation paid by us for the
fiscal year ended December 31, 2003 to our directors and others. During the
fiscal year ended December 31, 2003, we did not pay any pension or retirement
benefits.
Total Compensation Paid to
Name of Director Aggregate Compensation ($) Directors ($)
- --------------------------------------------------------------------------------------------------------------
Independent Directors:
Dr. C. Wayne Bardin 19,000 19,000
Dr. Phillip A. Bauman 18,000 18,000
G. Morgan Browne(1) 21,462 21,462
Dugald A. Fletcher 19,000 19,000
James E. Roberts 16,000 16,000
Glenn E. Mayer(6) 18,000 18,000
Mark A. Parsells(2) 1,214 1,214
Charles E. Ramsey 13,000 13,000
Interested Directors:
Charles E. Harris(3) 0 0
Dr. Kelly S. Kirkpatrick(4) 18,926 18,926
Lori D. Pressman(5) 75,725 75,725
- --------------------
(1) Includes $462 for reimbursement for travel expenses to attend board
meetings.
(2) Includes $414 for reimbursement for travel expenses to attend board
meetings.
(3) Mr. Harris is an "interested person" as defined in the 1940 Act.
(4) Includes $1,613 for reimbursement for travel expenses to attend board
meetings and $1,313 for consulting services. Dr. Kirkpatrick may be
considered an "interested person" because of consulting work performed
for us.
(5) Includes $1,725 for reimbursement for travel expenses to attend board
meetings and $57,000 for consulting services. Ms. Pressman may be
considered an "interested person" because of consulting work performed
for us.
(6) Mr. Mayer was not a nominee for reelection at the Annual Meeting of
Shareholders held on May 12, 2004.
Effective June 18, 1998, directors who were not officers received
$1,000 for each meeting of the board of directors and $1,000 for each
committee meeting they attended in addition to a monthly retainer of $500.
Prior to June 18, 1998, the directors were paid $500 for committee meetings
and no monthly retainer. We also reimburse our directors for travel, lodging
and related expenses they incur in attending board and committee meetings. The
total compensation and reimbursement for expenses paid to all directors in
2003 was $162,014.
In 1998, the board of directors approved that effective January 1,
1998, 50% of all director fees be used to purchase our Common Stock from us.
However, effective March 1, 1999, the board of directors approved that
directors purchase our Common Stock in the open market, rather than from us.
In 2001, the outside directors (i.e., all directors except Mr. Harris) bought
a total of 7,944 shares in the open market. In 2002, the outside directors
bought 9,524 shares in the open market and 43,426 shares through exercise of
rights in a public offering of our Common Stock.
Remuneration of Chief Executive Officer and Other Executive Officers
The following table sets forth a summary for each of the last three
years ended December 31 of the cash and non-cash compensation paid to our
chief executive officer and our other executive officers.
Annual Compensation
Other Annual All Other
Name and Salary Bonus Compensation Compensation
Principal Position Year ($) ($)(1) ($)(2) ($)(3)
------------------------------------------------------------------------------------------------------
Charles E. Harris 2003 224,567 0 43,006 318,296
Chairman of the Board & Chief 2002 221,217 10,503 46,570 165,468
Executive Officer(4) 2001 215,510 0 48,453 232,000
Mel P. Melsheimer 2003 254,106 0 0 14,000
President, Chief Operating 2002 250,327 3,224 0 12,500
Officer, Chief Financial 2001 243,869 0 0 10,500
Officer, Treasurer & Chief
Compliance Officer
Helene B. Shavin 2003 89,241 0 0 14,000
Controller 2002 85,353 1,161 0 11,000
2001 13,333 0 0 1,867
Susan T. Harris 2003 9,522 0 0 0
Secretary(5) 2002 12,703 0 0 2,332
2001 12,376 0 0 1,578
Douglas W. Jamison 2003 137,182 0 0 12,000
Vice President 2002 35,936 0 0 1,050
- ----------------
(1) For 2002, these amounts represent the actual amounts earned as a result
of realized gains during the year ended December 31, 2002 under the
Harris & Harris Group Employee Profit-Sharing Plan and paid out in 2003.
You may find more information on our Employee Profit-Sharing Plan under
Incentive Compensation Plans.
(2) Other than those for Mr. Harris, amounts of "Other Annual Compensation"
earned by the named executive officers for the periods presented did not
meet the threshold reporting requirements.
(3) Except for Mr. Harris, amounts reported represent our contributions on
behalf of the named executive to the Harris & Harris Group, Inc. 401(k)
Plan. For 2003, Mr. Harris's "All Other Compensation" consists of:
$14,000 401(k) Plan employer contribution; $298,306 for his 2003 SERP
contribution; and $5,990 in life insurance premiums for the benefit of
his beneficiaries. With respect to 2002 and 2003, an additional $73,739
was accrued for Mr. Harris's SERP account in 2002, but was not paid until
2003.
(4) Mr. Harris has an employment agreement with us.
(5) Ms. Harris also earned $2,000 in 2003 for her participation at board
meetings as secretary, but was not paid until 2004.
Incentive Compensation Plans
As of January 1, 1998, we began implementing the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan, which we refer to as the 1998 Plan,
which provided for profit sharing equal to 20% of our net realized income as
reflected on the Consolidated Statements of Operations for that year, less
nonqualifying gains, if any. We terminated the 1998 Plan as of December 31,
1999, subject to the payment of any amounts owed on the 1999 realized gains
under the 1998 Plan.
As of January 1, 2000, we implemented the Harris & Harris Group, Inc.
Employee Profit-Sharing Plan, which we refer to as the Plan, which provides
for profit sharing by our officers and employees equal to 20% of our
"qualifying income" for that plan year. For the purposes of the Plan,
qualifying income is defined as net realized income as reflected on our
consolidated statements of operations for that year, less nonqualifying gains,
if any.
Under the Plan, our net realized income includes investment income,
realized gains and losses, and operating expenses (including taxes paid or
payable by us), but is calculated without including dividends paid or
distributions made to shareholders, payments under the Plan, unrealized gains
and losses, and loss carry-overs from other years. The portion of net
after-tax realized gains attributable to asset values as of September 30, 1997
is considered nonqualifying gain, which reduces qualifying income.
As soon as practicable following the year-end audit, the Compensation
Committee will determine whether, and if so how much, qualifying income exists
for a plan year. Once determined, 90% of the qualifying income will be paid
out to plan participants pursuant to the distribution percentages set forth in
the Plan. The remaining 10% will be paid out after we have filed our federal
tax return for that plan year. At December 31, 2002, the distribution amounts
for each officer and employee were as follows: Charles E. Harris, 13.790%
($10,503); Mel P. Melsheimer, 4.233% ($3,224); Helene B. Shavin, 1.524%
($1,161); and Jacqueline M. Matthews, 0.453% ($345), which together equal 20%
($15,233). In one case, for a former employee who left other than due to
termination for cause, any amount earned will be accrued and may subsequently
be paid to the participant.
On April 26, 2000, our shareholders approved the performance goals
under the Plan in accordance with Section 162(m) of the Code, effective as of
January 1, 2000. The Code generally provides that a public company such as we
are may not deduct compensation paid to its chief executive officer or to any
of its four most highly compensated officers to the extent that the
compensation paid to the officer/employee exceeds $1,000,000 in any tax year,
unless the payment is made upon the attainment of objective performance goals
that are approved by our shareholders.
As of January 1, 2003, we implemented the Amended and Restated Harris
& Harris Group, Inc. Employee Profit-Sharing Plan, which we refer to as the
2002 Plan.
On October 15, 2002, our shareholders approved the performance goals
under the 2002 Plan in accordance with Section 162(m) of the Code, effective
as of January 1, 2003.
Under the 2002 Plan, our net realized income includes investment
income, realized qualifying gains and losses, and operating expenses
(including taxes paid or payable by us), but is calculated without including
dividends paid or loss carry-overs from other years, which we refer to as
qualifying income.
Under the 2002 Plan, awards previously granted to the four current
Participants (Messrs. Harris and Melsheimer and Ms. Shavin and Matthews,
herein referred to as the "grandfathered participants") will be reduced by 10%
with respect to "Non-Tiny Technology Investments" (as defined in the 2002
Plan) and by 25% with respect to "Tiny Technology Investments" (as defined in
the 2002 Plan) and will become permanent. These reduced awards are herein
referred to as "grandfathered participations." The amount by which the awards
are reduced will be allocable and reallocable each year by the Compensation
Committee among current and new participants as awards under the 2002 Plan.
The grandfathered participations will be honored by us whether or not the
grandfathered participant is still employed by us or is still alive (in the
event of death, the grandfathered participations will be paid to the
grandfathered participant's estate), unless the grandfathered participant is
dismissed for cause, in which case all awards, including the grandfathered
participations, will be immediately cancelled and forfeited. With regard to
new investments and follow-on investments made after the date on which the
first new employee begins participating in the 2002 Plan, both current and new
participants will be required to be employed by us at the end of a plan year
in order to participate in profit-sharing on our investments with respect to
that year.
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which we
remain a "business development company" within the meaning of the 1940 Act be
greater than 20% of our "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards as calculated exceed that
amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the
Compensation Committee at any time. Notwithstanding the foregoing, the
grandfathered participations may not be further modified. Nothing in the 2002
Plan will preclude the Compensation Committee from naming additional
participants in the 2002 Plan or, except for grandfathered participations,
changing the Award Percentage of any Participant (subject to the overall
percentage limitations contained in the 2002 Plan). Currently under the 2002
Plan, the distribution amounts for non-grandfathered investments for each
officer and employee currently are as follows: Charles E. Harris, 7.790%; Mel
P. Melsheimer, 3.733%; Douglas W. Jamison, 3.5%; Daniel V. Leff, 3.0%; Helene
B. Shavin, 1.524%; and Jacqueline M. Matthews, 0.453%, which together equal
20%.
The grandfathered participations are set forth below:
Grandfathered Participations
----------------------------
Name of Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
-------------------------------------------------------------------------------------------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews 0.40770 0.33975
TOTAL 18.00000 15.00000
Accordingly, an additional 2% of Qualifying Income with respect to
grandfathered Non-Tiny Technology Investments, 5% of Qualifying Income with
respect to grandfathered Tiny Technology Investments and the full 20% of
Qualifying Income with respect to new investments are available for allocation
and reallocation from year to year. Currently Douglas W. Jamison and Daniel V.
Leff are each allocated 0.80% of the Non-Tiny Technology Grandfathered
Participations and 2% of the Tiny Technology Grandfathered Participations.
During 2002, we decreased the profit-sharing accrual by $163,049,
bringing the cumulative accrual under the Plan to $15,233 at December 31,
2002. The amounts payable under the Plan for net realized income during the
year ended December 31, 2002 are $15,233. We paid out 90% in March 2003 and
the remaining 10% upon the completion and filing of our 2002 federal tax
return. During 2003, we made no accrual for profit sharing.
Other Information
We are not subject to any material pending or, to our knowledge,
threatened legal proceedings.
Our custodian is J.P. Morgan Chase Bank, 345 Park Avenue, New York,
New York 10154-1002.
Our transfer and dividend-paying agent is The Bank of New York, 101
Barclay Street, New York, New York 10286.
DIVIDENDS AND DISTRIBUTIONS
As a regulated investment company under the Code, we will not be
subject to U.S. federal income tax on our investment company taxable income
that we distribute to shareholders, provided that at least 90% of our
investment company taxable income for that taxable year is distributed to our
shareholders. We may choose to retain our net capital gains for investment and
pay the associated federal corporate income tax.
To the extent that we retain any net capital gain, we may pay deemed
capital gain dividends to shareholders. If we do pay a deemed capital gain
dividend, you will not receive a cash distribution, but instead you will
receive a tax credit equal to your proportionate share of the tax paid by us.
When we declare a deemed dividend, our dividend-paying agent will send you an
IRS Form 2439 which will reflect receipt of the deemed dividend income and the
tax credit. This tax credit, which we pay at the applicable corporate rate, is
normally at a higher rate than the rate payable by individual shareholders on
the deemed dividend income. The excess credit can be used by the shareholder
to offset other taxes due in that year or to generate a tax refund to the
shareholder. In addition, each shareholder's tax basis in his shares of Common
Stock is increased by the excess of the capital gain on which we paid taxes
over the amount of taxes we paid. See "Taxation."
We did not pay a cash dividend or declare a deemed capital gain
dividend for 2002. On January 22, 2002, we announced a deemed capital gain
dividend for 2001 of $0.0875 per share for a total of $775,620.
TAXATION
Taxation of the Company
We have elected and qualified and intend to continue to qualify to be
taxed as a regulated investment company under Subchapter M of the Code.
Accordingly, we must, among other things, (a) derive in each taxable year at
least 90% of our gross income (including tax-exempt interest) from dividends,
interest, payments with respect to certain securities loans, and gains from
the sale or other disposition of stock, securities or foreign currencies, or
other income (including but not limited to gain from options, futures and
forward contracts) derived with respect to our business of investing in stock,
securities or currencies; and (b) diversify our holdings so that, at the end
of each fiscal quarter (i) at least 50% of the market value of our total
assets is represented by cash and cash items, U.S. Government securities, the
securities of other regulated investment companies and other securities, with
other securities limited, in respect of any one issuer, to an amount not
greater than 5% of the value of our total assets and not more than 10% of the
outstanding voting securities of any issuer (subject to the exception
described below), and (ii) not more than 25% of the market value of our total
assets is invested in the securities of any issuer (other than U.S. Government
securities and the securities of other regulated investment companies) or of
any two or more issuers that we control and that are determined to be engaged
in the same business or similar or related trades or businesses.
In the case of a regulated investment company which furnishes capital
to development corporations, there is an exception to the rule relating to the
diversification of investments described above. This exception is available
only to registered management investment companies which the SEC determines to
be principally engaged in the furnishing of capital to other corporations
which are principally engaged in the development or exploitation of
inventions, technological improvements, new processes, or products not
previously generally available ("SEC Certification"). We have received SEC
Certification since 1999, including for 2002, but it is possible that we may
not receive SEC Certification in future years. Pursuant to the SEC
Certification, we are generally entitled to include, in the computation of the
50% value of our assets (described in (b)(i) above), the value of any
securities of an issuer, whether or not we own more than 10% of the
outstanding voting securities of the issuer, if the basis of the securities,
when added to our basis of any other securities of the issuer that we own,
does not exceed 5% of the value of our total assets.
As a regulated investment company, in any fiscal year with respect to
which we distribute at least 90% of the sum of our (i) investment company
taxable income (which includes, among other items, dividends, interest and the
excess of any net short-term capital gains over net long-term capital losses
and other taxable income other than any net capital gain reduced by deductible
expenses) determined without regard to the deduction for dividends paid and
(ii) net tax exempt interest (the excess of its gross tax exempt interest over
certain disallowed deductions), we (but not our shareholders) generally will
not be subject to U.S. federal income tax on investment company taxable income
and net capital gains that we distribute to shareholders. To the extent that
we retain our net capital gains for investment, we will be subject to U.S.
federal income tax. We may choose to retain our net capital gains for
investment and pay the associated federal corporate income tax.
Amounts not distributed on a timely basis in accordance with a
calendar year distribution requirement are subject to a nondeductible 4%
excise tax payable by us. To avoid this tax, we must distribute (or be deemed
to have distributed) during each calendar year an amount equal to the sum of:
(1) at least 98% of our ordinary income (not taking into account
any capital gains or losses) for the calendar year;
(2) at least 98% of our capital gains in excess of our capital
losses (adjusted for certain ordinary losses) for a one-year
period generally ending on October 31 of the calendar year
(unless an election is made by a company with a November or
December year-end to use the company's fiscal year); and
(3) any undistributed amounts from previous years on which we paid
no U.S. federal income tax.
While we intend to distribute any income and capital gains in the
manner necessary to minimize imposition of the 4% excise tax, sufficient
amounts of our taxable income and capital gains may not be distributed to
avoid entirely the imposition of the tax. In that event, we will be liable for
the tax only on the amount by which we do not meet the foregoing distribution
requirement.
If in any particular taxable year, we do not qualify as a regulated
investment company, all of our taxable income (including its net capital
gains) will be subject to tax at regular corporate rates without any deduction
for distributions to shareholders, and distributions will be taxable to the
shareholders as ordinary dividends to the extent of our current and
accumulated earnings and profits.
We may decide to be taxed as a corporation even if we would otherwise
qualify as a regulated investment company.
Company Investments
We may make certain investments which would subject us to special
provisions of the Code that, among other things, may affect the character of
the gains or losses realized by us and require us to recognize income or gain
without receiving cash with which to make distributions.
In the event we invest in foreign securities, we may be subject to
withholding and other foreign taxes with respect to those securities. We do
not expect to satisfy the requirement to pass through to the shareholders
their share of the foreign taxes paid by us.
Due to our expected investments, in general, distributions will not
be eligible for the dividends received deduction allowed to corporate
shareholders and will not qualify for the reduced rate of tax for qualified
dividend income allowed to individuals.
Taxation of Shareholders
Distributions we pay to you from our ordinary income or from an
excess of net short-term capital gains over net long-term capital losses
(together referred to hereinafter as "ordinary income dividends") are taxable
to you as ordinary income to the extent of our earnings and profits.
Distributions made to you from an excess of net long-term capital gains over
net short-term capital losses ("capital gain dividends"), including capital
gain dividends credited to you but retained by us, are taxable to you as
long-term capital gains, regardless of the length of time you have owned our
shares. Distributions in excess of our earnings and profits will first reduce
the adjusted tax basis of your shares and, after the adjusted tax basis is
reduced to zero, will constitute capital gains to you (assuming the shares are
held as a capital asset). Generally, you will be provided with a written
notice designating the amount of any (i) ordinary income dividends no later
than 30 days after the close of the taxable year, and (ii) capital gain
dividends or other distributions no later than 60 days after the close of the
taxable year.
In the event that we retain any net capital gains, we may designate
the retained amounts as undistributed capital gains in a notice to our
shareholders. If a designation is made, shareholders would include in income,
as long-term capital gains, their proportionate share of the undistributed
amounts, but would be allowed a credit or refund, as the case may be, for
their proportionate share of the corporate tax paid by us. In addition, the
tax basis of shares owned by a shareholder would be increased by an amount
equal to the difference between (i) the amount included in the shareholder's
income as long-term capital gains and (ii) the shareholder's proportionate
share of the corporate tax paid by us.
Dividends and other taxable distributions are taxable to you even
though they are reinvested in additional shares of our common tock. If we pay
you a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of these
months, then the dividend will be treated for tax purposes as being paid by us
and received by you on December 31 of the year in which the dividend was
declared.
A shareholder will realize gain or loss on the sale or exchange of
our common shares in an amount equal to the difference between the
shareholder's adjusted basis in the shares sold or exchanged and the amount
realized on their disposition. Generally, gain recognized by a shareholder on
the sale or other disposition of our common shares will result in capital gain
or loss to you, and will be a long-term capital gain or loss if the shares
have been held for more than one year at the time of sale. Any loss upon the
sale or exchange of our shares held for six months or less will be treated as
a long-term capital loss to the extent of any capital gain dividends received
(including amounts credited as an undistributed capital gain dividend) by you.
A loss realized on a sale or exchange of our shares will be disallowed if
other substantially identical shares are acquired (whether through the
automatic reinvestment of dividends or otherwise) within a 61-day period
beginning 30 days before and ending 30 days after the date that the shares are
disposed of. In this case, the basis of the shares acquired will be adjusted
to reflect the disallowed loss.
In general, federal withholding taxes at a 30% rate (or a lower rate
pursuant to a tax treaty) will apply to distributions to shareholders (except
to those distributions designated by us as capital gain dividends) that are
nonresident aliens or foreign partnerships, trusts or corporations (a
"non-U.S. investor"). Different tax consequences may result if a non-U.S.
investor is engaged in a trade or business in the United States or, in the
case of an individual, is present in the United States for 183 or more days
during a taxable year and certain other conditions are met.
Backup Withholding
We are required in some circumstances to backup withhold on taxable
dividends and other payments paid to non-corporate holders of our shares who
do not furnish us with their correct taxpayer identification number and
certifications, or who are otherwise subject to backup withholding. Backup
withholding is not an additional tax. Any amounts withheld from payments made
to you may be refunded or credited against your U.S. federal income tax
liability, if any, provided that the required information is furnished to the
Internal Revenue Service.
The foregoing is a general discussion of the provisions of the Code
and the Treasury regulations in effect as they directly govern our taxation
and our shareholders. These provisions are subject to change by legislative or
administrative action, and any change may be retroactive. The discussion does
not purport to deal with all of the U.S. federal income tax consequences
applicable to us, or which may be important to particular shareholders in
light of their individual investment circumstances or to some types of
shareholders subject to special tax rules, such as financial institutions,
broker-dealers, insurance companies, tax-exempt organizations, partnerships or
other pass-through entities, persons holding notes in connection with a
hedging, straddle, conversion or other integrated transaction, persons engaged
in a trade or business in the United States or persons who have ceased to be
U.S. citizens or to be taxed as resident aliens. Shareholders are urged to
consult their tax advisers regarding specific questions as to U.S. federal,
foreign, state and local income or other taxes.
CERTAIN GOVERNMENT REGULATIONS
A business development company is regulated by the 1940 Act. A
business development company must be organized in the United States for the
purpose of investing in primarily private companies and making managerial
assistance available to them. A business development company may use capital
provided by public shareholders and from other sources to invest in private
investments. A business development company provides shareholders the ability
to retain the liquidity of a publicly traded stock, while sharing in the
possible benefits, if any, of investing primarily in privately owned
companies.
As a business development company, we may not acquire any assets
other than "qualifying assets" unless, at the time we make the acquisition,
the value of our qualifying assets represents at least 70% of the value of our
total assets. The principal categories of qualifying assets relevant to our
business are:
o securities purchased in transactions not involving any public
offering, the issuer of which is an eligible portfolio company;
o securities received in exchange for or distributed with respect
to securities described in the bullet above or pursuant to the
exercise of options, warrants or rights relating to the
securities; and
o cash, cash items, government securities or high quality debt
securities (within the meaning of the 1940 Act), maturing in one
year or less from the time of investment.
An eligible portfolio company is generally a domestic company that is
not an investment company (other than a small business investment company
wholly owned by a business development company) and that:
o does not have a class of securities registered on an exchange
or a class of securities with respect to which a broker may
extend margin credit;
o is actively controlled by the business development company and
has an affiliate of a business development company on its board
of directors; or
o meets other criteria as may be established by the SEC.
Control under the 1940 Act is presumed to exist where a business
development company beneficially owns more than 25% of the outstanding voting
securities of the portfolio company.
To include securities described above as qualifying assets for the
purpose of the 70% test, a business development company must make available to
the issuer of those securities (whether directly or through cooperating
parties) significant managerial assistance such as providing significant
guidance and counsel concerning the management, operations or business
objectives and policies of a portfolio company. We offer to provide managerial
assistance to each of our portfolio companies.
As a business development company, we are entitled to issue senior
securities in the form of stock or indebtedness, including bank borrowings and
debt securities, as long as our senior securities have an asset coverage of at
least 200% immediately after each issuance. See "Risk Factors."
We may also be prohibited under the 1940 Act from knowingly
participating in certain transactions with our affiliates without the prior
approval of members of our board of directors who are not interested persons
and, in some cases, may have to seek prior approval from the SEC.
As with other companies regulated by the 1940 Act, a business
development company must adhere to substantive regulatory requirements. A
majority of our directors must be persons who are not interested persons, as
that term is defined in the 1940 Act. Additionally, we are required to provide
and maintain a bond issued by a reputable fidelity insurance company to
protect us against larceny and embezzlement. Furthermore, as a business
development company, we are prohibited from protecting any director or officer
against any liability to us or our shareholders arising from willful
malfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of that person's office.
We maintain a code of ethics that establishes procedures for personal
investment and restricts some transactions by our personnel. Our code of
ethics generally does not permit investment by our employees in private
securities that may be purchased or held by us. The code of ethics is filed as
an exhibit to our registration statement of which this Prospectus is a part.
You may read and copy the code of ethics at the SEC's Public Reference Room in
Washington, D.C. You may obtain information on operations of the Public
Reference Room by calling the SEC at (800) SEC-0330. In addition, the code of
ethics is available on the EDGAR Database on the SEC Internet site at
http://www.sec.gov. You may obtain copies of the code of ethics, after paying
a duplicating fee, by electronic request at the following email address:
publicinfo@sec.gov, or by writing to the SEC's Public Reference Section, 450
5th Street, N.W., Washington, D.C. 20549.
We may not change the nature of our business so as to cease to be, or
withdraw our election as, a business development company unless authorized by
vote of a "majority of the outstanding voting securities," as defined in the
1940 Act, of our shares. A majority of the outstanding voting securities of a
company is defined under the 1940 Act as the lesser of: (i) 67% or more of the
company's shares present at a meeting if more than 50% of the outstanding
shares of the company are present and represented by proxy or (ii) more than
50% of the outstanding shares of the company.
Pending further clarification from the SEC, as a consequence of the
foregoing classifications and eligibility criteria, we will not treat as an
eligible portfolio company pursuant to the first alternative criterion
described above (that is, no class of securities outstanding against which a
broker may extend margin credit) any company that, at the time of our
investment, has outstanding any debt securities or equity securities against
which the margin rules adopted by the Federal Reserve Board authorize a broker
to extend credit.
CAPITALIZATION
We are authorized to issue 25,000,000 shares of Common Stock, par
value $0.01 per share, and 2,000,000 shares of preferred stock, par value
$0.10 per share. Each share within a particular class or series thereof has
equal voting, dividend, distribution and liquidation rights. When issued, in
accordance with the terms thereof, shares of Common Stock will be fully paid
and non-assessable. All shares issued as a result of exercise of the rights
will be newly issued shares. Shares of Common Stock are not redeemable and
have no preemptive, conversion or cumulative voting rights.
The following table shows the number of shares of (i) capital stock
authorized, (ii) the amount held by us or for our own account and (iii)
capital stock outstanding for each class of our authorized securities as of
December 31, 2003.
Amount Held by Company or
Title of Class Amount Authorized for its Own Account Amount Outstanding
- ----------------------------------------------------------------------------------------------------------
Common Stock 25,000,000 1,828,740 13,798,845
Preferred Stock 2,000,000 0 0
Issuance of Preferred Stock
Our board of directors is authorized by our articles of incorporation
to issue up to 2,000,000 shares of preferred stock having a par value of $0.10
per share. The board of directors is authorized to divide the preferred stock
into one or more series and to determine the terms of each series, including
but not limited to the voting rights, redemption provisions, dividend rate and
liquidation preference. Any terms must be consistent with the requirements of
the 1940 Act. The 1940 Act currently prohibits us from issuing any preferred
stock if after giving effect to the issuance the value of our total assets,
less all liabilities and indebtedness other than senior securities, would be
less than 200% of the aggregate amount of senior securities representing
indebtedness plus the aggregate involuntary liquidation value of our preferred
stock (other than up to 5% borrowings for temporary purposes). Leveraging with
preferred stock raises the same general potential for loss or gain and other
risks as does leveraging with borrowings described above.
Options and Warrants
We have no options or warrants outstanding. Under the 1940 Act, we
cannot issue options and/or warrants for more than 25% of our outstanding
voting securities.
PLAN OF DISTRIBUTION
We may sell our Common Stock through underwriters or dealers,
directly to one or more purchasers through agents or through a combination of
any such methods of sale. Any underwriter or agent involved in the offer and
sale of our Common Stock will be named in the applicable Prospectus
Supplement.
The distribution of our Common Stock may be effected from time to
time in one or more transactions at a fixed price or prices, which may be
changed, at prevailing market prices at the time of sale, at prices related to
such prevailing market prices, or at negotiated prices, provided, however,
that the offering price per share less any underwriting commissions or
discounts must equal or exceed the net asset value per share of our Common
Stock.
In connection with the sale of our Common Stock, underwriters or
agents may receive compensation from us in the form of discounts, concessions
or commissions. Underwriters may sell our Common Stock to or through dealers,
and such dealers may receive compensation in the form of discounts,
concessions or commissions from the underwriters and/or commissions from the
purchasers for whom they may act as agents. Underwriters, dealers and agents
that participate in the distribution of our Common Stock may be deemed to be
underwriters under the Securities Act of 1933, and any discounts and
commissions they receive from us and any profit realized by them on the resale
of our Common Stock may be deemed to be underwriting discounts and commissions
under the Securities Act of 1933. Any such underwriter or agent will be
identified and any such compensation received from us will be described in the
applicable Prospectus Supplement. The maximum commission or discount to be
received by any NASD member or independent broker-dealer will not exceed 8%.
We will not pay any compensation to any underwriter or agent in the form of
warrants, options, consulting or structuring fees or similar arrangements.
Any Common Stock sold pursuant to a Prospectus Supplement will be
listed on the Nasdaq National Market.
Under agreements into which we may enter, underwriters, dealers and
agents who participate in the distribution of our Common Stock may be entitled
to indemnification by us against certain liabilities, including liabilities
under the Securities Act of 1933. Underwriters, dealers and agents may engage
in transactions with us, or perform services for us, in the ordinary course of
business.
If so indicated in the applicable Prospectus Supplement, we will
authorize underwriters or other persons acting as our agents to solicit offers
by certain institutions to purchase our Common Stock from us pursuant to
contracts providing for payment and delivery on a future date. Institutions
with which such contacts may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions and others, but in all cases such institutions must be
approved by us. The obligations of any purchaser under any such contract will
be subject to the condition that the purchase of the Common Stock shall not at
the time of delivery be prohibited under the laws of the jurisdiction to which
such purchaser is subject. The underwriters and such other agents will not
have any responsibility in respect of the validity or performance of such
contracts. Such contracts will be subject only to those conditions set forth
in the Prospectus Supplement, and the Prospectus Supplement will set forth the
commission payable for solicitation of such contracts.
In connection with an offering of our Common Stock in December 2003,
we and our most senior executive officers have agreed that for a period of 90
days after the date of this Prospectus, we and they will not, without the
prior written consent of Punk, Ziegel & Company, directly or indirectly:
offer, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant
for the sale of or otherwise dispose of or transfer (subject to certain
exceptions) any shares of our Common Stock or securities convertible into or
exchangeable or exercisable for shares of our Common Stock, whether now owned
or acquired after the date of this Prospectus by any person or with respect to
which any person acquires after the date of this Prospectus the power of
disposition, or file any registration statement under the Securities Act with
respect to any of the foregoing for a period of 180 days, or enter into any
swap or other agreement or any other agreement that transfers, in whole or in
part, directly or indirectly, the economic consequence of ownership of shares
of our Common Stock whether any swap or transaction is to be settled by
delivery of our Common Stock or other securities, in cash or otherwise.
In order to comply with the securities laws of certain states, if
applicable, our Common Stock offered hereby will be sold in such jurisdictions
only through registered or licensed brokers or dealers.
LEGAL MATTERS
Certain legal matters will be passed on by Skadden, Arps, Slate,
Meagher & Flom LLP, New York, New York, our special counsel in connection with
the offering of Common Stock.
EXPERTS
Our audited financial statements as of December 31, 2003 and for each
of the two years in the period then ended have been incorporated by reference
from our 2003 Annual Report on Form 10-K in reliance on the report of
PricewaterhouseCoopers LLP, independent registered public accounting firm,
given on the authority of that firm as experts in accounting and auditing.
PricewaterhouseCoopers LLP is located at 1177 Avenue of the Americas, New
York, New York 10036. At the 2003 annual meeting, shareholders ratified the
appointment of PricewaterhouseCoopers LLP as our independent registered public
accounting firm to audit our December 31, 2003 financial statements.
The financial statements, as of and for the year ended December 31,
2001 incorporated by reference in this Prospectus were audited by Arthur
Andersen LLP, independent public accountant, as indicated in their report with
respect thereto, are included herein in reliance upon the authority of said
firm as experts in giving said report. Arthur Andersen LLP has not consented
to the inclusion of their report in this Prospectus, and we have not obtained
their consent to do so in reliance upon Rule 437a of the Securities Act of
1933. Because Arthur Andersen LLP has not consented to the inclusion of their
report in this Prospectus, you will not be able to recover against Arthur
Andersen LLP under Section 11(a) of the Securities Act for any untrue
statements of a material fact contained in the financial statements audited by
Arthur Andersen LLP or any omissions to state a material fact required to be
stated therein.
We will furnish, without charge, a copy of such financial statements
upon request by writing to 111 West 57th Street, Suite 1100, New York, New
York 10019, Attention: Investor Relations, or calling 212-582-0900.
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS
On February 26, 2002, our Audit Committee approved the dismissal of
Arthur Andersen LLP as our independent public accountants effective upon
completion of the December 31, 2001 audit, and appointed
PricewaterhouseCoopers LLP to serve as our independent public accountants for
the year ending December 31, 2002. The appointment of PricewaterhouseCoopers
LLP was ratified at our 2002 annual meeting of stockholders held on October
15, 2002.
Arthur Andersen LLP's reports on our consolidated financial
statements for the year ended December 31, 2001 did not contain an adverse
opinion or disclaimer of opinion, nor were they qualified or modified as to
uncertainty, audit scope or accounting principles.
During the year ended December 31, 2001, there were no disagreements
with Arthur Andersen LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure which, if not
resolved to Arthur Andersen LLP's satisfaction, would have caused them to make
reference to the subject matter in connection with their report on our
consolidated financial statements for those years; and there were no
reportable events as defined in Item 304(a) (1) (v) of Regulation S-K.
FURTHER INFORMATION
We are subject to the informational requirements of the 1934 Act and
in accordance therewith file reports, proxy statements and other information
with the SEC. The reports, proxy statements and other information filed by us
can be inspected and copied at public reference facilities maintained by the
SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, its Northeast Regional
Office, 233 Broadway, New York, New York 10279 and its Chicago Regional
Office, Suite 900, 175 West Jackson Boulevard, Chicago, Illinois 60604. You
can obtain information on the operation of the Public Reference room by
calling the SEC at (800) SEC-0330. The SEC also maintains a website that
contains reports, proxy statements, and other information. The address of the
SEC's website is http://www.sec.gov. Copies of this material may also be
obtained from the Public Reference Branch, Office of Consumer Affairs and
Information Services of the SEC at 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. Our Common Stock is listed on the Nasdaq National
Market and our reports, proxy statements and other information concerning us
can be inspected and copied at the library of the National Association of
Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
PRIVACY PRINCIPLES OF THE COMPANY
We are committed to maintaining the privacy of our shareholders and
to safeguarding their non-public personal information. The following
information is provided to help you understand what personal information we
collect, how we protect that information and why, in some cases, we may share
information with select other parties.
Generally, we do not receive any non-public personal information
relating to our shareholders, although some non-public personal information of
our shareholders may become available to us. We do not disclose any non-public
personal information about our shareholders or former shareholders to anyone,
except as permitted by law or as is necessary in order to service shareholder
accounts (for example, to a transfer agent or third party administrator).
We restrict access to non-public personal information about our
shareholders to our employees and to employees of our service providers and
their affiliates with a legitimate business need for the information. We
maintain physical, electronic and procedural safeguards designed to protect
the non-public personal information of our shareholders.
[This Page Intentionally Left Blank]
HARRIS & HARRIS GROUP, INC.
7,000,000 Shares
Common Stock
The date of the Prospectus is June 2, 2004
------------------
This Prospectus constitutes a part of a registration statement on
Form N-2 (together with all the exhibits and the appendix thereto, the
"Registration Statement") filed by us with the SEC under the Securities Act.
This Prospectus does not contain all of the information set forth in the
Registration Statement. Reference is hereby made to the Registration Statement
and related exhibits for further information with respect to us and the shares
offered hereby. Statements contained herein concerning the provisions of
documents are necessarily summaries of the material terms of such documents.
No dealer, salesperson or other person has been authorized to give
any information or to make any representations not contained in this
Prospectus. If given or made, any information or representation must not be
relied upon as having been authorized by us. This Prospectus does not
constitute an offer to sell or the solicitation of an offer to buy any
security other than the shares of Common Stock offered by this Prospectus, nor
does it constitute an offer to sell or the solicitation of an offer to buy
shares of Common Stock by anyone in any jurisdiction in which such offer or
solicitation would be unlawful.
APPENDIX A
Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC. - 2003
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
The following reports and consolidated financial schedules of Harris
& Harris Group, Inc. are filed herewith and included in response to Item 8.
Documents Page
- --------- ----
Report of Independent Auditors........................................ A-2
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 2003 and 2002.................................... A-3
Consolidated Statements of Operations for the
years ended December 31, 2003, 2002 and 2001........................ A-4
Consolidated Statements of Cash Flows for the
years ended December 31, 2003, 2002 and 2001........................ A-5
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2003, 2002 and 2001........................ A-6
Consolidated Schedule of Investments as of December 31, 2003.......... A-7
Footnote to Consolidated Schedule of Investments...................... A-11
Notes to Consolidated Financial Statements............................ A-15
Financial Highlights for the years ended December 31, 2003, 2002,
2001, 2000, and 1999................................................ A-25
Schedules other than those listed above have been omitted because
they are not applicable or the required information is presented in the
consolidated financial statements and/or related notes.
[This Page Intentionally Left Blank]
- -------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
- -------------------------------------------------------------------------------
Report of Independent Auditors
To the Board of Directors and Shareholders of
Harris & Harris Group, Inc.
In our opinion, the accompanying consolidated statements of assets and
liabilities, including the consolidated schedule of investments, and the
related consolidated statements of operations, of cash flows and of changes in
net assets present fairly, in all material respects, the financial position of
Harris & Harris Group, Inc. (the "Company") at December 31, 2003 and December
31, 2002, and the results of its operations, its cash flows and the changes in
its net assets for each of the two years in the period then ended, in
conformity with accounting principles generally accepted in the United States
of America. 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 of these financial
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at December 31, 2003 by
correspondence with the custodian, provide a reasonable basis for our opinion.
The financial statements of the Company as of December 31, 2001 and for the
year then ended were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements
in their report dated March 21, 2002.
As more fully disclosed in Note 2, the financial statements include
investments valued at $15,106,576 (37.13% of net assets) at December 31, 2003,
the fair values of which have been estimated by the Board of Directors in the
absence of readily ascertainable market values. Those estimated values may
differ significantly from the values that would have been used had a ready
market for the investments existed, and the differences could be material.
/s/ PricewaterhouseCoopers, LLP
March 10, 2004
New York, N.Y.
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
- -------------------------------------------------------------------------------
ASSETS
------
December 31, 2003 December 31, 2002
Investments, at value (Cost: $44,603,778 at 12/31/03,
$30,206,935 at 12/31/02)........................................ $ 42,227,062 $ 27,486,822
Cash and cash equivalents........................................... 425,574 5,967,356
Restricted funds (Note 5)........................................... 1,212,078 756,944
Funds in escrow..................................................... 0 750,000
Receivable from portfolio company................................... 0 786,492
Interest receivable................................................. 450 189
Income tax receivable............................................... 17,375 0
Prepaid expenses.................................................... 6,841 96,631
Other assets........................................................ 225,748 107,535
-------------- ----------------
Total assets........................................................ $ 44,115,128 $ 35,951,969
============== ================
LIABILITIES & NET ASSETS
------------------------
Accounts payable and accrued liabilities............................ $ 2,723,398 $ 1,451,568
Payable to broker for unsettled trade............................... 0 5,696,725
Accrued profit sharing (Note 3)..................................... 0 15,233
Deferred rent....................................................... 39,648 5,397
Current income tax liability........................................ 0 857,656
Deferred income tax liability (Note 6).............................. 669,344 669,344
-------------- ----------------
Total liabilities................................................... 3,432,390 8,695,923
Commitments and contingencies (Note 7).............................. -------------- ----------------
Net assets.......................................................... $ 40,682,738 $ 27,256,046
============== ================
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued........................ $ 0 0
Common stock, $0.01 par value, 25,000,000 shares authorized;
15,627,585 issued at 12/31/03 and 13,327,585 issued at 12/31/02. 156,276 133,276
Additional paid in capital (Note 4)................................. 49,564,475 32,845,872
Additional paid in capital - common stock warrants (Note 4)......... 0 109,641
Accumulated net realized gain (loss)................................ (2,410,847) 1,137,820
Accumulated unrealized depreciation of investments, including deferred
tax liability of $844,918 at 12/31/03 and 12/31/02 ............. (3,221,635) (3,565,032)
Treasury stock, at cost (1,828,740 shares at 12/31/03 and 12/31/02). (3,405,531) (3,405,531)
-------------- ----------------
Net assets.......................................................... $ 40,682,738 $ 27,256,046
============== ================
Shares outstanding.................................................. 13,798,845 11,498,845
============== ================
Net asset value per outstanding share............................... $ 2.95 $ 2.37
============== ================
The accompanying notes are an integral part of these consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
Investment income:
Interest from:
Fixed-income securities................... $ 125,173 $ 184,050 $ 422,196
Portfolio companies....................... 450 0 9,616
Dividend income.............................. 0 0 1,000
Other income................................. 42,162 69,411 77,849
--------------- --------------- --------------
Total investment income................... 167,785 253,461 510,661
Expenses:
Profit-sharing (reversal) (Note 3)........... 0 (163,049) (984,021)
Salaries and benefits........................ 1,540,692 1,130,352 1,045,063
Professional fees............................ 303,795 344,717 261,582
Administration and operations................ 446,185 433,569 406,488
Rent......................................... 200,711 173,291 166,312
Directors' fees and expenses................. 162,014 154,682 90,047
Depreciation................................. 51,073 30,607 26,901
Custodian fees............................... 10,178 9,604 14,518
Interest expense (Note 4).................... 16,879 10,776 8,331
--------------- --------------- --------------
Total expenses............................ 2,731,527 2,124,549 1,035,221
--------------- --------------- --------------
Operating loss before income taxes........... (2,563,742) (1,871,088) (524,560)
Income tax benefit (Note 6).................. 0 0 0
--------------- --------------- --------------
Net operating loss............................... (2,563,742) (1,871,088) (524,560)
Net realized (loss) from investments:
Realized (loss) income from investments...... (971,164) 3,284,737 1,394,781
--------------- --------------- --------------
Total realized (loss) income.............. (971,164) 3,284,737 1,394,781
Income tax expense (Note 6).................. (13,761) (894,435) (118,415)
--------------- --------------- --------------
Net realized (loss) income from investments.. (984,925) 2,390,302 1,276,366
--------------- --------------- --------------
Net realized (loss) income....................... (3,548,667) 519,214 751,806
Net decrease (increase) in unrealized depreciation
on investments:
Increase as a result of investment sales..... 1,000,001 1,602,048 4,802,738
Decrease as a result of investment sales..... 0 (322,208) (854,467)
Increase on investments held................. 764,616 285 3,232,919
Decrease on investments held................. (1,421,220) (5,216,659) (14,912,698)
--------------- --------------- --------------
Change in unrealized depreciation
on investments............................ 343,397 (3,936,534) (7,731,508)
Income tax benefit (Note 6).................. 0 695,126 90,464
--------------- --------------- --------------
Net decrease (increase) in unrealized
depreciation on investments............... 343,397 (3,241,408) (7,641,044)
--------------- --------------- --------------
Net decrease in net assets resulting from operations:
Total........................................ $ (3,205,270) $ (2,722,194) $ (6,889,238)
=============== =============== ==============
Per outstanding share........................ $ (0.28) $ (0.24) $ (0.78)
=============== =============== ==============
The accompanying notes are an integral part of these consolidated financial statements.
---------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------------------------------------
Year Ended December Year Ended December Year Ended December
31, 2003 31, 2002 31, 2001
Cash flows used in operating activities:
Net decrease in net assets
resulting from operations............................... $ (3,205,270) $ (2,722,194) $ (6,889,238)
Adjustments to reconcile net
decrease in net assets resulting
from operations to net cash used in
operating activities:
Net realized and unrealized loss on investments......... 627,767 651,797 5,950,398
Deferred income taxes................................... 0 (695,126) 90,464
Depreciation............................................ 51,073 30,607 26,901
Other................................................... 0 0 2,010
Changes in assets and liabilities:
Restricted funds........................................ (455,134) (274,924) (216,837)
Receivable from broker for unsettled trades............. 786,492 (786,492) 0
Funds in escrow......................................... 750,000 (750,000) 0
Interest receivable..................................... (261) (107) 30,000
Income tax receivable................................... (17,375) 0 0
Prepaid expenses........................................ 89,790 (81,798) 67,782
Notes receivable........................................ 0 10,487 401
Other assets............................................ 44,130 1,570 23,667
Accounts payable and accrued liabilities................ 1,271,830 412,217 267,587
Payable to broker for unsettled trade................... (5,696,725) 5,696,725 (115,005)
Accrued profit sharing.................................. (15,233) (163,049) (3,304,959)
Deferred rent........................................... 34,251 (9,253) (9,253)
Current income tax liability............................ (857,656) 602,588 (5,496,498)
-------------- ------------------ -----------------
Net cash (used in) provided by operating activities..... (6,592,321) 1,923,048 (9,572,580)
Cash provided by investing activities:
Net (purchase) sale of short-term investments and
marketable securities................................ (11,669,430) 10,358,006 (10,263,667)
Investment in private placements and loans.............. (3,727,718) (7,195,988) (1,818,826)
Proceeds from sale of investments....................... 27,641 7,631,100 9,385,615
Purchase of fixed assets................................ (213,416) (41,138) (6,508)
-------------- ------------------ -----------------
Net cash (used in) provided by investing activities..... (15,582,923) 10,751,980 (2,703,386)
Cash flows used in financing activities:
Purchase of treasury stock (Note 4)..................... 0 0 (338,000)
Proceeds from note payable.............................. 0 0 12,495,777
Payment of note payable (Note 4)........................ 0 (12,495,777) 0
Proceeds from public offering, net (Note 4)............. 16,631,962 5,643,470 0
Collection on notes receivable.......................... 1,500 9,500 0
-------------- ------------------ -----------------
Net cash provided by (used in) financing activities..... 16,633,462 (6,842,807) 12,157,777
-------------- ------------------ -----------------
Net (decrease) increase in cash and cash equivalents:
Cash and cash equivalents at beginning of the year...... 5,967,356 135,135 253,324
Cash and cash equivalents at end of the year............ 425,574 5,967,356 135,135
-------------- ------------------ -----------------
Net (decrease) increase in cash and cash equivalents.... $(5,541,782) $ 5,832,221 $ (118,189)
============== ================= =================
Supplemental disclosures of cash flow information:
Income taxes paid....................................... $ 575,100 $ 307,585 $ 5,795,916
Interest paid........................................... $ 16,879 $ 19,106 $ 0
The accompanying notes are an integral part of these consolidated financial statements.
- ------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December Year Ended December Year Ended December
31, 2003 31, 2002 31, 2001
Changes in net assets from operations:
Net operating loss................................... $ (2,563,742) $ (1,871,088) $ (524,560)
Net realized (loss) on investments................... (984,925) 2,390,302 1,276,366
Net increase in unrealized appreciation
on investments as a result of sales............... 1,000,001 1,279,840 4,038,735
Net decrease in unrealized appreciation on
investments held.................................. (656,604) (4,521,248) (11,679,779)
----------------- ------------------- -----------------
Net decrease in net assets resulting
from operations..................................... (3,205,270) (2,722,194) (6,889,238)
Changes in net assets from
capital stock transactions:
Purchase of treasury stock........................... 0 0 (338,000)
Proceeds from sale of stock.......................... 23,000 26,346 0
Additional paid in capital on common
stock issued...................................... 16,608,962 5,617,124 0
Deemed dividend shareholder tax credit .............. 0 0 (271,467)
----------------- ------------------- -----------------
Net increase (decrease) in net assets resulting from
capital stock transactions.......................... 16,631,962 5,643,470 (609,467)
----------------- ------------------- -----------------
Net increase (decrease) in net assets.................... 16,631,962 2,921,276 (7,498,705)
----------------- ------------------- -----------------
Net Assets:
Beginning of the year................................ 27,256,692 24,334,770 31,833,475
----------------- ------------------- -----------------
End of the year...................................... $ 40,682,738 $ 27,256,046 $ 24,334,770
================= =================== ==================
The accompanying notes are an integral part of these consolidated financial statements.
- -----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Investments in Unaffiliated Companies (8)(9)(10) - 11.3% of total investments
Private Placement Portfolio (Illiquid) - 11.3% of total investments
AlphaSimplex Group, LLC (2)(12) -- Investment advisory firm
headed by Dr. Andrew W. Lo, holder of the Harris & Harris
Group Chair at MIT Limited Liability Company interest........................ (B) -- $ 118,750
Continuum Photonics, Inc. (1)(2)(6) -- Develops optical
networking components by merging cutting-edge materials,
MEMS and electronics technologies -- 3.70% of fully diluted equity
Series B Convertible Preferred Stock......................................... (D) 2,000,000 745,035
Exponential Business Development Company (1)(2)(5) (12) --
Venture capital partnership focused on early stage companies
Limited partnership interest................................................. (A) - 25,000
Heartware, Inc. (1)(2)(6)(15) -- Develops ventricular assist
devices -- 0% percent of fully diluted equity
Series A-2 Non-Voting Preferred Stock....................................... (D) 47,620 0
NanoGram Corporation (1)(2)(4)(6)(13) -- Develops a broad
suite of intellectual property utilizing nanotechnology --
1.81% of fully diluted equity
Series 1 Convertible Preferred Stock......................................... (A) 63,210 21,672
NanoOpto Corporation (1)(2)(6) -- Develops high performance,
integrated optical communications sub-components on a chip
by utilizing patented nano-manufacturing technology -- 2.60%
of fully diluted equity
Series A-1 Convertible Preferred Stock....................................... (B) 267,857
Series B Convertible Preferred Stock......................................... (B) 293,842 172,567
Nanosys, Inc. (1)(2)(4)(6) -- Develops nanotechnology-enabled
systems incorporating novel and patent-protected zero and
one-dimensional nanometer-scale materials -- 1.65% of fully
diluted equity
Series C Convertible Preferred Stock......................................... (A) 803,428 1,500,000
Nantero, Inc. (1)(2)(6) -- Develops a high density nonvolatile
random access memory chip using nanotechnology -- 3.35% of
fully diluted equity Series A Convertible Preferred Stock.................... (B) 345,070
Series B Convertible Preferred Stock......................................... (B) 207,051 861,309
NeoPhotonics Corporation (1)(2)(6)(13)(14) -- Develops and
manufactures planar optical devices and components using
nanomaterials deposition technology -- 1.53% of fully diluted
equity Series D Convertible Preferred Stock.................................. (D) 1,498,802
Secured Convertible Note........................................................ (D) $75,000 75,000
Optiva, Inc. (1)(2)(5)(6) -- Develops and commercializes
nanomaterials for advanced applications -- 1.96% of
fully diluted equity Series C Convertible Preferred Stock.................... (B) 1,249,999 1,250,000
-------------
Total Private Placement Portfolio (cost: $6,354,651).................................................. $ 4,769,333
=============
Total Investments in Unaffiliated Companies (cost: $6,354,651)........................................ $ 4,769,333
=============
The accompanying notes are an integral part of this consolidated schedule.
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Method of Shares/ Value
Valuation (3) Principal
------------- --------- -----
Investments in Non-Controlled Affiliated Companies (8)(9)(11) -- 24.5% of
total investments
Private Placement Portfolio (Illiquid) - 24.5% of total investments
Agile Materials & Technologies, Inc. (1)(2)(6) - Develops and sells
variable integrated passive RF electronic equipment components --
8.15% of fully diluted equity
Series A Convertible Preferred Stock.............................................. (D) 3,732,736 $ 250,000
Chlorogen, Inc. (1)(2)(4)(6) -- Develops patented chloroplast
technology to produce plant-made proteins -- 9.76% of fully
diluted equity
Series A Convertible Preferred Stock.............................................. (A) 4,478,038 785,000
Experion Systems, Inc. (1)(2)(5)(7) -- Develops and sells software to
credit unions -- 12.44% of fully diluted equity
Series A Convertible Preferred Stock.............................................. (B) 294,118
Series B Convertible Preferred Stock.............................................. (B) 35,294
Series C Convertible Preferred Stock.............................................. (B) 222,184 711,338
NanoGram Devices Corporation (1)(2)(4)(6)(14) -- Develops power components for
biomedical applications by utilizing a patented nanomaterial synthesis process --
5.00% of fully diluted equity
Series A-1 Convertible Preferred Stock............................................ (A) 63,210
Series A-2 Convertible Preferred Stock............................................ (A) 750,000 813,210
Nanopharma Corp. (1)(2)(5)(6) -- Develops advanced nanoscopic drug delivery vehicles
and systems -- 14.39% of fully diluted equity
Series A Convertible Preferred Stock.............................................. (A) 684,516 700,000
Nanotechnologies, Inc. (1)(2)(6) -- Develops high-performance nanoscale materials
for industry -- 6.48% of fully diluted equity
Series B Convertible Preferred Stock.............................................. (B) 1,538,837
Series C Convertible Preferred Stock.............................................. (B) 235,720 1,277,681
NeuroMetrix, Inc. (1)(2)(5) -- Develops and sells medical devices for monitoring
neuromuscular disorders -- 12.08% of fully diluted equity
Series A Convertible Preferred Stock.............................................. (B) 875,000
Series B Convertible Preferred Stock.............................................. (B) 625,000
Series C-2 Convertible Preferred Stock............................................ (B) 1,148,100
Series E Convertible Preferred Stock.............................................. (B) 499,996
Series E-1 Convertible Preferred Stock............................................ (B) 235,521 5,075,426
Questech Corporation (1)(2)(5) -- Manufactures and markets proprietary metal
decorative tiles -- 6.73% of fully diluted equity
Common Stock...................................................................... (B) 646,954
Warrants at $5.00 expiring 10/25/04............................................... (B) 1,966
Warrants at $1.50 expiring 11/16/05............................................... (B) 1,250
Warrants at $1.50 expiring 08/03/06............................................... (B) 8,500
Warrants at $1.50 expiring 11/21/07............................................... (B) 3,750
Warrants at $1.50 expiring 11/19/08............................................... (B) 5,000 724,588
------------
Total Private Placement Portfolio (cost: $11,127,228)..................................................... $ 10,337,243
============
Total Investments in Non-Controlled Affiliated Companies (cost: $11,127,228).............................. $ 10,337,243
============
The accompanying notes are an integral part of this consolidated schedule.
- --------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
- --------------------------------------------------------------------------------------------------------------
Method of Shares/ Value
Valuation (3) Principal
------------- --------- -----
U.S. Government and Agency Obligations - 64.2% of total investments
U.S. Treasury Bills -- due date 01/08/04................... (J) $4,264,000 $ 4,263,275
U.S. Treasury Bills -- due date 01/15/04................... (J) 900,000 899,658
U.S. Treasury Bills -- due date 02/05/04................... (J) 17,308,000 17,293,634
U.S. Treasury Bills -- due date 02/12/04................... (J) 1,670,000 1,668,347
U.S. Treasury Bills -- due date 02/19/04................... (J) 1,600,000 1,598,176
U.S. Treasury Bills -- due date 03/18/04................... (J) 1,400,000 1,397,396
----------------
Total Investments in U.S. Government (cost: $27,121,899).................................................. $ 27,120,486
================
Total Investments - 100% (cost: $44,603,778).............................................................. $ 42,227,062
================
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
- -------------------------------------------------------------------------------
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last 12 months are considered to be
non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the Asset
Valuation Policy Guidelines.
(4) Initial investment was made during 2003.
(5) No changes in valuation occurred in these investments during the 12
months ended December 31, 2003.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of
its efforts to establishing a new business, and either it has not yet
commenced its planned principal operations or it has commenced such
operations but has not realized significant revenue from them.
(7) Previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in which
we own less than five percent of the portfolio company. Investments in
non-controlled affiliated companies consist of investments in which we
own more than five percent but less than 25 percent of the portfolio
company. Investments in controlled affiliated companies consist of
investments in which we own more than 25 percent of the portfolio
company.
(9) The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential equity
interest in each such portfolio company. The calculated percentage
represents the amount of the issuer's equity securities we own or can
acquire as a percentage of the issuer's total outstanding equity
securities plus equity securities reserved for issued and outstanding
warrants, convertible securities and all authorized stock options,
both granted and ungranted.
(10) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $6,354,651. The gross unrealized
appreciation based on the tax cost for these securities is $162,198.
The gross unrealized depreciation based on the tax cost for these
securities is $1,747,516.
(11) The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $11,127,228. The gross
unrealized appreciation based on the tax cost for these securities is
$2,772,007. The gross unrealized depreciation based on the tax cost
for these securities is $3,561,992.
(12) Non-registered investment company.
(13) On April 30, 2003, NeoPhotonics Corporation distributed its shares in
NanoGram Corporation to shareholders of record on November 14, 2002.
We received 63,210 shares of Series 1 Preferred Stock.
(14) On April 30, 2003, NeoPhotonics Corporation distributed its shares in
NanoGram Devices Corporation to shareholders of record on November 14,
2002. We received 63,210 shares of Series A-1 Convertible Preferred
Stock.
(15) On July 10, 2003, we received 47,620 shares of Series A-2 Non-Voting
Preferred stock of Heartware, Inc., a new company formed to acquire
the assets and assume certain liabilities of Kriton Medical, Inc. as
part of Kriton's bankruptcy.
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
- -------------------------------------------------------------------------------
ASSET VALUATION POLICY GUIDELINES
Our investments can be classified into five broad categories for
valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in our portfolio to determine net asset value.
Under the 1940 Act, unrestricted securities with readily available market
quotations are to be valued at the current market value; all other assets must
be valued at "fair value" as determined in good faith by or under the direction
of the Board of Directors.
Our Board of Directors is responsible for (1) determining overall
valuation guidelines and (2) ensuring the valuation of investments within the
prescribed guidelines.
Our Valuation Committee, comprised of at least three or more
independent Board members, is responsible for reviewing and approving the
valuation of our assets within the guidelines established by the Board of
Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing our assets, external measures of value, such as
public markets or third-party transactions, are utilized whenever possible.
Valuation is not based on long-term work-out value, nor immediate liquidation
value, nor incremental value for potential changes that may take place in the
future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as such amounts depend on future circumstances and cannot reasonably
be determined until the individual investments are actually liquidated.
Our valuation policy with respect to the five broad investment
categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
A. Cost: The cost method is based on our original cost. This method is
generally used in the early stages of a company's development until significant
positive or negative events occur subsequent to the date of the original
investment that dictate a change to another valuation method. Some examples of
these events are: (1) a major recapitalization; (2) a major refinancing; (3) a
significant third-party transaction; (4) the development of a meaningful public
market for the company's common stock; and (5) significant positive or negative
changes in a company's business.
B. Private Market: The private market method uses actual, executed,
historical transactions in a company's securities by responsible third parties
as a basis for valuation. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by us.
We discount market value for securities that are subject to significant legal
and contractual restrictions. Other securities, for which market quotations are
readily available, are carried at market value as of the time of valuation.
Market value for securities traded on securities exchanges or on the Nasdaq
National Market is the last reported sales price on the day of valuation. For
other securities traded in the over-the-counter market and listed securities
for which no sale was reported on that day, market value is the mean of the
closing bid price and asked price on that day. This method is the preferred
method of valuation when there is an established public market for a company's
securities, as that market provides the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market in
the company's securities or when the factual information available to us
dictates that an investment should no longer be valued under either the cost or
private market method. This valuation method is inherently imprecise and
ultimately the result of reconciling the judgments of our Valuation Committee
members, based on the data available to them. The resulting valuation, although
stated as a precise number, is necessarily within a range of values that vary
depending upon the significance attributed to the various factors being
considered. Some of the factors considered may include the financial condition
and operating results of the company, the long-term potential of the business
of the company, the values of similar securities issued by companies in similar
businesses, the proportion of the company's securities we owned and the nature
of any rights to require the company to register restricted securities under
applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT IN
TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on our original cost. This method is
generally used in the early stages of commercializing or developing
intellectual property or patents or research and development in technology or
product development until significant positive or adverse events occur
subsequent to the date of the original investment that dictate a change to
another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to us dictates that an investment should no
longer be valued under either the cost or private market method. This valuation
method is inherently imprecise and ultimately the result of reconciling the
judgments of our Valuation Committee members. The resulting valuation, although
stated as a precise number, is necessarily within a range of values that vary
depending upon the significance attributed to the various factors being
considered. Some of the factors considered may include the results of research
and development, product development progress, commercial prospects, term of
patent, projected markets, and other subjective factors.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
I. Fixed-Income Securities for which market quotations are not readily
available are carried at fair value using one or more of the following basic
methods of valuation:
Independent pricing services that provide quotations based primarily
on quotations from dealers and brokers, market transactions, and other sources.
Fair value as determined in good faith by the Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
J. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days or
less is valued at amortized cost.
ALL OTHER INVESTMENTS
K. All Other Investments are reported at fair value as determined in
good faith by the Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Valuation Committee's
judgment of fair values as of the valuation date using the outlined basic
methods of valuation. They do not necessarily represent an amount of money that
would be realized if we had to sell the securities in an immediate liquidation.
Thus, valuations as of any particular date are not necessarily indicative of
amounts that we may ultimately realize as a result of future sales or other
dispositions of investments we hold.
- -------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company," "us," "our" and "we") is a
venture capital company operating as a business development company ("BDC")
under the Investment Company Act of 1940, which we refer to as the 1940 Act. A
BDC is a specialized type of company under the 1940 Act. We operate as an
internally managed investment company whereby our officers and employees, under
the general supervision of our Board of Directors, conduct our operations.
We elected to become a BDC on July 26, 1995, after receiving the
necessary approvals. From September 30, 1992, until the election of BDC status,
we operated as a closed-end, non-diversified investment company under the 1940
Act. Upon commencement of operations as an investment company, we revalued all
of our assets and liabilities at fair value as defined in the 1940 Act. Prior
to such time, we were registered and filed under the reporting requirements of
the Securities and Exchange Act of 1934 as an operating company and, while an
operating company, operated directly and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent
wholly owned subsidiary of the Company. Enterprises held the lease for the
office space until it expired on July 31, 2003, which it sublet to the Company
and an unaffiliated party; is a partner in Harris Partners I, L.P. and is taxed
as a C corporation. Harris Partners I, L.P. is a limited partnership and owned,
until December 31, 2002, a 20 percent limited partnership interest in PHZ
Capital Partners L.P. Currently, Harris Partners I, L.P. owns our interest in
AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P. are
Enterprises (sole general partner) and Harris & Harris Group, Inc. (sole
limited partner).
We filed for the 1999 tax year to elect treatment as a Regulated
Investment Company ("RIC") under Sub-Chapter M of the Internal Revenue Code of
1986 (the "Code") and qualified for the same treatment for 2000-2002. There can
be no assurance that we will qualify as a RIC for 2003 and subsequent years or
that if we do qualify, we will continue to qualify for subsequent years. In
addition, even if we were to qualify as a RIC for a given year, we might take
action in a subsequent year to ensure that we would be taxed in that subsequent
year as a C Corporation, rather than as a RIC. As a RIC, we must, among other
factors, distribute at least 90 percent of our investment company taxable
income and may either distribute or retain our realized net capital gains on
investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies followed
in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for investment companies and include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "value" as
defined in the 1940 Act and in the applicable regulations of the Securities and
Exchange Commission. Value, as defined in Section 2(a)(41) of the 1940 Act, is
(i) the market price for those securities for which a market quotation is
readily available and (ii) for all other assets is as determined in good faith
by, or under the direction of, the Board of Directors. (See "Asset Valuation
Policy Guidelines" in the "Footnote to Consolidated Schedule of Investments.")
Securities Transactions. Securities transactions are accounted for on
the date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined on specific
identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, we recorded income taxes using
the liability method in accordance with the provision of Statement of Financial
Accounting Standards No. 109. Accordingly, deferred tax liabilities had been
established to reflect temporary differences between the recognition of income
and expenses for financial reporting and tax purposes, the most significant
difference of which relates to our unrealized appreciation on investments.
The December 31, 2003 consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of December
31, 1998, net of the unutilized operating and capital loss carryforwards
incurred by us through December 31, 1998.
We pay federal, state and local income taxes on behalf of our wholly
owned subsidiary, Harris & Harris Enterprises, which is a C corporation. (See
"Note 6. Income Taxes.")
Estimates by Management. The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of December 31, 2003, and
December 31, 2002, and the reported amounts of revenues and expenses for the
three years ended December 31, 2003. The most significant estimates relate to
the fair valuations of investments for the years ended December 31, 2003, and
2002. Actual results could differ from these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- ------------------------------------
As of January 1, 2003, we implemented the Amended and Restated Harris
& Harris Group, Inc. Employee Profit-Sharing Plan, which we refer to as the
2002 Plan.
The Plan (and its predecessor) provides for profiting sharing by our
officers and employees equal to 20% of our "qualifying income" for that plan
year. For the purposes of the Plan, qualifying income is defined as net
realized income as reflected on our consolidated statements of operations for
that year, less nonqualifying gains, if any.
For purposes of the Plan, our net realized income includes investment
income, realized gains and losses, and operating expenses (including taxes paid
or payable by us), but is calculated without including dividends paid or
distributions made to shareholders, payments under the Plan, unrealized gains
and losses, and loss carry-overs from other years. The proportion of net
after-tax realized gains attributable to asset values as of September 30, 1997
is considered nonqualifying gain, which reduces qualifying income.
On October 15, 2002, our shareholders approved the performance goals
under the 2002 Plan in accordance with Section 162(m) of the Code, effective as
of January 1, 2003. The Code generally provides that a public company such as
we are may not deduct compensation paid to its chief executive officer or to
any of its four most highly compensated officers to the extent that the
compensation paid to the officer/employee exceeds $1,000,000 in any tax year,
unless payment is made upon the attainment of objective performance goals that
are approved by our shareholders.
Under the 2002 Plan, our net realized income includes investment
income, realized qualifying gains and losses, and operating expenses (including
taxes paid or payable by us), but is calculated without including dividends
paid or loss carry-overs from other years, which we refer to as qualifying
income. As soon as practicable following the year-end audit, the Audit
Committee will determine whether, and if so how much, qualifying income exists
for a plan year. Once determined, 90% of the qualifying income will be paid out
to Plan participants pursuant to the distribution percentages set forth in the
Plan. The remaining 10% will be paid out after we have filed our federal tax
return for that plan year.
Under the 2002 Plan, awards previously granted to the four current
Participants (Messrs. Harris and Melsheimer and Ms. Shavin and Matthews, herein
referred to as the "grandfathered participants") will be reduced by 10% with
respect to "Non-Tiny Technology Investments" (as defined in the 2002 Plan) and
by 25% with respect to "Tiny Technology Investments" (as defined in the 2002
Plan) and will become permanent. These reduced awards are herein referred to as
"grandfathered participations." The amount by which the awards are reduced will
be allocable and reallocable each year by the Compensation Committee among
current and new participants as awards under the 2002 Plan. The grandfathered
participations will be honored by us whether or not the grandfathered
participant is still employed by us or is still alive (in the event of death,
the grandfathered participations will be paid to the grandfathered
participant's estate), unless the grandfathered participant is dismissed for
cause, in which case all awards, including the grandfathered participations,
will be immediately cancelled and forfeited. With regard to new investments and
follow-on investments made after the date on which the first new employee
begins participating in the 2002 Plan, both current and new participants will
be required to be employed by us at the end of a plan year in order to
participate in profit-sharing on our investments with respect to that year.
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which we remain
a "business development company" within the meaning of the 1940 Act be greater
than 20% of our "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards as calculated exceed that
amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the
Compensation Committee at any time. Notwithstanding the foregoing, the
grandfathered participations may not be further modified. Nothing in the 2002
Plan will preclude the Compensation Committee from naming additional
participants in the 2002 Plan or, except for grandfathered participations,
changing the Award Percentage of any Participant (subject to the overall
percentage limitations contained in the 2002 Plan). Currently, under the 2002
Plan, the distribution amounts for non-grandfathered investments for each
officer and employee are: Charles E. Harris, 7.790%; Mel P. Melsheimer, 3.733%;
Douglas W. Jamison, 3.5%; Daniel V. Leff, 3.0%; Helene B. Shavin, 1.524%; and
Jacqueline M. Matthews, 0.453%, which together equal 20%. In one case, for a
former employee who left other than due to termination for cause, any amount
earned will be accrued and may subsequently be paid to the participant.
The grandfathered participations are set forth below:
Grandfathered Participations
--------------------------------------------------------
Name of Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
- ------------------------- -------------------------- ---------------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews 0.40770 0.33975
TOTAL 18.00000 15.00000
Accordingly, an additional 2% of Qualifying Income with respect to
grandfathered Non-Tiny Technology Investments, 5% of Qualifying Income with
respect to grandfathered Tiny Technology Investments and the full 20% of
Qualifying Income with respect to new investments are available for allocation
and reallocation from year to year. Currently, Douglas W. Jamison and Daniel V.
Leff are each allocated 0.80% of the Non-Tiny Technology Grandfathered
Participations and 2% of the Tiny Technology Grandfathered Participations.
We calculate the profit-sharing accrual based on the terms of the plan
in effect. During the first quarter of 2003, we paid out 90 percent of the 2002
profit sharing in the amount of $13,710. The remaining 10 percent of the 2002
profit sharing, $1,523, was paid out upon the completion and filing of our 2002
federal tax return. During 2003, we made no accrual for profit sharing.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that effective January 1,
1998, 50 percent of all Directors' fees be used to purchase our common stock
from us. However, effective March 1, 1999, the Board of Directors approved that
Directors may purchase our common stock in the open market, rather than from
us.
Since 1998, we have repurchased a total of 1,859,047 of our shares for
a total of $3,496,388, including commissions and expenses, at an average price
of $1.88 per share. These treasury shares were reduced by the purchases made by
the Directors. On July 23, 2002, because of our strategic decision to invest in
tiny technology, the Board of Directors reaffirmed its commitment not to
authorize the purchase of additional shares of stock in the foreseeable future.
On July 8, 2002, we filed a final prospectus under Rule 497 of the
Securities Act of 1933 with the SEC for the issuance of transferable rights to
our shareholders. The rights allowed the shareholders to subscribe for a
maximum of 2,954,743 new shares of our common stock, of which 2,634,614 new
shares were subscribed for pursuant to the rights offering. The actual amount
of gross proceeds raised upon completion of the offer was $5,927,882; net
proceeds were $5,643,470, after expenses of $284,412. From the completion of
the offering through December 31, 2003, we have invested $5,477,718 in
accordance with our investment objectives and policies.
On December 24, 2003, we filed a final prospectus under Rule 497 of
the Securities Act of 1933 with the SEC for issuance of 2,000,000 shares of our
common stock plus 300,000 additional shares if the underwriter exercised its
over-allotment option. All of the 2,300,000 shares were sold. The actual amount
of net proceeds raised upon completion of the offering was $17,296,000; net
proceeds of the offering, less offering costs of $664,038, were $16,631,962. We
intend to use the net proceeds of the offering, less offering costs, to make
new investments in tiny technology as well as follow-on investments in our
existing venture capital investments, and for working capital.
As of December 31, 2003, there are no distributable earnings. The
difference between the book basis and tax basis components of distributable
earnings is primarily attributed to Built-In Gains generated at the time of our
qualification as a RIC (see Note 6. "Income Taxes"), nondeductible deferred
compensation and net operating losses.
Beginning with the Consolidated Statements of Assets and Liabilities
at December 31, 2003, additional paid in capital common stock warrants and
additional paid in capital have been combined and are reported as additional
paid in capital.
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with us (disclosed in a Form 8-K filed on October 27, 1999) (the "Employment
Agreement"), which superseded an employment agreement that was about to expire
on December 31, 1999. The Employment Agreement shall terminate on December 31,
2004 ("Term") subject to either an earlier termination or an extension in
accordance with the terms; on January 1, 2000 and on each day thereafter, the
Term extends automatically by one day unless at any time we or Mr. Harris, by
written notice, decides not to extend the Term, in which case the Term will
expire five years from the date of the written notice.
During the period of employment, Mr. Harris shall serve as our
Chairman and Chief Executive Officer; be responsible for the general management
of our affairs and all our subsidiaries, reporting directly to our Board of
Directors; serve as a member of the Board for the period of which he is and
shall from time to time be elected or reelected; and serve, if elected, as our
President and as an officer and director of any subsidiary or affiliate of us.
Mr. Harris is to receive compensation under his Employment Agreement
in the form of base salary of $208,315 for 2000, with automatic yearly
adjustments to reflect inflation. In addition, the Board may increase such
salary, and consequently decrease it, but not below the level provided for by
the automatic adjustments described above. Mr. Harris is also entitled to
participate in our Profit-Sharing Plan as well as in all compensation or
employee benefit plans or programs, and to receive all benefits, perquisites,
and emoluments for which salaried employees are eligible. Under the Employment
Agreement, we will furnish Mr. Harris with certain perquisites which include a
company car, membership in certain clubs and up to a $5,000 annual
reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of $2,000,000;
provides reimbursement for uninsured medical expenses, not to exceed $10,000
per annum, adjusted for inflation, over the period of the contract; provides
Mr. Harris and his spouse with long-term care insurance; and disability
insurance in the amount of 100 percent of his base salary. These benefits are
for the term of the Employment Agreement.
The Employment Agreement provides for us to adopt a supplemental
executive retirement plan (the "SERP") for the benefit of Mr. Harris. Under the
SERP, we will cause an amount equal to one-twelfth of Mr. Harris's current
annual salary to be credited each month (a "Monthly Credit") to a special
account maintained for this purpose on our books for the benefit of Mr. Harris
(the "SERP Account"). The amounts credited to the SERP Account will be deemed
invested or reinvested in such mutual funds or U.S. Government securities as
determined by Mr. Harris. The SERP Account will be credited and debited to
reflect the deemed investment returns, losses and expenses attributed to such
deemed investments and reinvestments. Mr. Harris's benefit under the SERP will
equal the balance in the SERP Account and such benefit will always be 100
percent vested (i.e., not forfeitable). Mr. Harris will determine the form and
timing of the distribution of the balance in the SERP Account; provided,
however, in the event of the termination of his employment, the balance in the
SERP Account will be distributed to Mr. Harris or his beneficiary, as the case
may be, in a lump-sum payment within 30 days of such termination. We will
establish a rabbi trust for the purpose of accumulating funds to satisfy the
obligations incurred by us under the SERP. The restricted funds for the SERP
Plan total $1,212,078 as December 31, 2003. Mr. Harris' rights to benefits
pursuant to this SERP will be no greater than those of a general creditor of
us.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the executive's
base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with us, effective
August 15, 1990. The severance compensation agreement provides that if,
following a change in our control, as defined in the agreement, such
individual's employment is terminated by us without cause or by the executive
within one year of such change in control, the individual shall be entitled to
receive compensation in a lump sum payment equal to 2.99 times the individual's
average annualized compensation and payment of other welfare benefits. If Mr.
Harris's termination is without cause or is a constructive discharge, the
amount payable under the Employment Agreement will be reduced by the amounts
paid pursuant to the severance compensation agreement.
As of January 1, 1989, we adopted an employee benefits program
covering substantially all of our employees under a 401(k) Plan and Trust
Agreement. As of January 1, 1999, we adopted the Harris & Harris Pension Plan
and Trust, a money purchase plan which would allow us to stay compliant with
the 401(k) top-heavy regulations and deduction limitation regulations. In 2001,
Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001
which has increased the deduction limits for plans such as the 401(k) Plan.
This Act eliminates the need for us to maintain two separate plans. Effective
December 31, 2001, the Pension Plan merged into the 401(k) Plan, with the
401(k) Plan being the surviving plan. Contributions to the plan are at our
discretion.
On June 30, 1994, we adopted a plan to provide medical and dental
insurance for retirees, their spouses and dependents who, at the time of their
retirement, have ten years of service with us and have attained 50 years of age
or have attained 45 years of age and have 15 years of service with us. On
February 10, 1997, we amended this plan to include employees who "have seven
full years of service and have attained 58 years of age." The coverage is
secondary to any government provided or subsequent employer provided health
insurance plans. The annual premium cost to us with respect to the entitled
retiree shall not exceed $12,000, subject to an index for inflation. Based upon
actuarial estimates, we provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of December 31,
2003, we had a reserve of $531,293 for the plan. Recent changes to the Medicare
program may affect our costs under this plan. In accordance with FASB Staff
Position 106-1, our estimates of the obligation under this standard do not
reflect these changes. Specific authoritative guidance regarding these changes
is pending and when issued, could require us to change previously reported
information.
We are making the following disclosures about our plan to provide
medical and dental insurance for retirees.
Reconciliation of Accumulated
Postretirement Benefit Obligations 2003 2002
- ----------------------------------- ---- ----
Projected accumulated postretirement benefit
obligation at beginning of year $404,912 $324,100
Service cost 58,710 38,772
Interest cost 26,281 22,347
Actual (gain)/loss 35,385 19,693
-------- --------
Projected accumulated postretirement benefit
obligation at end of year $525,288 $404,912
======== ========
In accounting for the plan, the assumption made in 2003 for the
discount rate was 6%. The assumed health care cost trend rates in 2003 were 12%
grading to 6% over six years for medical and 3% per year for dental. The effect
on disclosure information of a one percentage point change in the assumed
health care cost trend rate for each future year is shown below.
1% Decrease Assumed 1% Increase
in Rates Rates in Rates
----------- ------- -----------
Aggregated service and interest cost $ 76,271 $ 84,991 $ 93,241
Accumulated postretirement benefit obligation $477,410 $525,288 $578,459
On March 20, 2003, in order to begin planning for eventual management
succession, the Board of Directors voted to establish a mandatory retirement
plan for individuals who are employed by us in a bona fide executive or high
policy making position. There are currently two such individuals, the Chairman
and CEO, and the President and COO. Under this plan, mandatory retirement will
take place effective December 31 of the year in which the eligible individuals
attain the age of 65. On an annual basis beginning in the year in which the
designated individual attains the age of 65, a committee of the Board
consisting of non-interested directors may determine to postpone the mandatory
retirement date for that individual for one additional year for our benefit.
Under applicable law prohibiting discrimination in employment on the
basis of age, we can impose a mandatory retirement age of 65 for our executives
or employees in high policy-making positions only if each employee subject to
the mandatory retirement age is entitled to an immediate retirement benefit at
retirement age of at least $44,000 per year. The benefits payable at retirement
to Charles E. Harris, our Chairman and Chief Executive Officer, and Mel P.
Melsheimer, our President, Chief Operating Officer and Chief Financial Officer,
under our existing retirement plans do not equal this threshold. Mr. Harris has
offered, for our benefit, to waive his right to exclude certain other benefits
from this calculation, which makes it unlikely that any provision will have to
be made for him in order for us to comply with this threshold requirement. For
Mr. Melsheimer, however, a new plan must be established to provide him with the
difference between the benefit required under the age discrimination laws and
that provided under our existing plans. The expense to us of providing the
benefit under this new plan is currently estimated to be $450,000. This benefit
will be unfunded, and the expense is being amortized over the fiscal periods
through the year ended December 31, 2004.
NOTE 6. INCOME TAXES
- ---------------------
Provided that a proper election is made, a corporation taxable under
Subchapter C of the Internal Revenue Code (a "C Corporation") that elects to
qualify as a RIC continues to be taxable as a C Corporation on any gains
realized within 10 years of its qualification as a RIC (the "Inclusion Period")
from sales of assets that were held by the corporation on the effective date of
the RIC election ("C Corporation Assets") to the extent of any gain built into
the assets on such date ("Built-In Gain"). (If the corporation fails to make a
proper election, it is taxable on its Built-In Gain as of the effective date of
its RIC election.) We had Built-In Gains at the time of our qualification as a
RIC and made the election to be taxed on any Built-In Gain realized during the
Inclusion Period. Prior to 1999, we incurred ordinary and capital losses from
operations. After our election of RIC status, those losses remained available
to be carried forward to subsequent taxable years. We have previously used loss
carryforwards to offset Built-In Gains. As of January 1, 2004, we had $501,640
of pre-1999 loss carryforwards remaining and $4,663,457 of unrealized Built-In
Gains remaining.
Continued qualification as a RIC requires us to satisfy certain
investment asset diversification requirements in future years. Our ability to
satisfy those requirements may not be controllable by us. There can be no
assurance that we will qualify as a RIC in subsequent years.
To the extent that we retain capital gains and declare a deemed
dividend to shareholders, the dividend is taxable to the shareholders. We would
pay tax, at the corporate rate, on the distribution, and the shareholders would
receive a tax credit equal to their proportionate share of the tax paid. We
took advantage of this rule for 2001. Our financial statements for 2001 include
a tax liability of $290,748. The taxes paid by our shareholders as a result of
our deemed dividend declaration 2001 ($271,467) are reflected as a deduction to
the additional paid-in capital in our Consolidated Statement of Assets and
Liabilities rather than an expense in the Consolidated Statement of Operations.
We pay federal, state and local taxes on behalf of our wholly owned
subsidiary, Harris & Harris Enterprises, Inc., which is taxed as a C
Corporation.
In 2003, we realized long-term capital losses of $1,000,001 from the
tax write-off of Kriton Medical, Inc. We also had net realized short-term gains
of $17,590 from the sale of U.S. Government and Agency obligations. We offset
our net realized short-term capital gains with our long-term capital losses and
neither owed federal income on the gain nor were required to distribute any
portion of this gain to shareholders. As of December 31, 2003, we have a
capital loss carryforward of $914,225 which will expire in 2011. To the extent
that these carryover losses are used to offset future capital gains, it is
probable that the gains so offset will not be distributed to shareholders.
In 2002, we realized long-term capital losses of $470,622 primarily
from long-term capital gains of $1,008,653 from the liquidation of our
partnership interest in PHZ Capital Partners L.P. offset by losses on the sale
of Schwoo, Inc. of $1,248,825 and on the liquidation of Informio, Inc. of
$350,583. We also realized short-term capital gains of $732,936 primarily from
the liquidation of our partnership interest in PHZ Capital Partners L.P.
Realized short-term capital gains were reduced by realized long-term capital
losses resulting in net realized short-term capital gains. We offset the net
realized short-term gains with 2002 expenses and neither owed federal income
taxes on the gain nor were required to distribute any portion of this gain to
shareholders.
For the years ended December 31, 2003, 2002 and 2001, the Company's
income tax (benefit) expense was allocated as follows:
2003 2002 2001
Investment operations $ 0 $ 0 $ 0
Realized income on investments 13,761 894,435 118,415
Decrease in unrealized appreciation on
investments 0 (695,126) (90,464)
Total income tax expense $ 13,761 $ 199,309 $ 27,951
The above tax expense consists of the following:
2003 2002 2001
Current $ 13,761 $ 894,435 $ 118,415
Deferred -- Federal 0 (695,126) (90,464)
Total income tax expense $ 13,761 $ 199,309 $ 27,951
The Company's net deferred tax liability at December 31, 2003 and 2002
consists of the following:
2003 2002
Unrealized appreciation on investments $ 844,918 $ 844,918
Net operating and capital loss carryforward (175,574) (175,574)
Net deferred income tax liability $ 669,344 $ 669,344
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
During 1993, we signed a 10-year lease for office space which expired
on July 31, 2003. On April 17, 2003, we signed a seven-year sublease for office
space at 111 West 57th Street in New York City to replace the expired lease.
Total rent expense was $200,711 for 2003. Future minimum sublease payments in
each of the following years are: 2004 -- $134,816; 2005 -- $138,187; 2006 --
$141,641; 2007 -- $145,182; 2008 -- $148,811; and thereafter for the remaining
term -- $203,571.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, we established an asset account line of credit.
The asset account line of credit is secured by government and government agency
securities. Under the asset account line of credit, we may borrow up to 95
percent of the current value of the government and government agency securities
with which we secure the line. Our available line of credit at December 31,
2003, was $23,572,275. Our outstanding balance under the asset account line of
credit at both December 31, 2002, and December 31, 2003, was $0. The asset
account line of credit bears interest at a rate of the Broker Call Rate plus 50
basis points.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
During 2004, we have made three follow-on investments totaling
$688,401 and one new investment of $150,000 in privately held tiny technology
companies.
In January 2004, we sold our investment in the preferred stock of
NeoPhotonics, Inc., which had been valued at $0, for $10. We realized a loss of
$915,108 on the transaction.
On February 17, 2004, we filed a registration statement with the
Securities and Exchange Commission on Form N-2 with respect to 3,000,000 shares
of our Common Stock. After the effective date, the Common Stock may be sold at
prices and on terms to be set forth in one or more supplements to the
prospectus from time to time.
NOTE 10. SELECTED QUARTERLY DATA (UNAUDITED)
- ---------------------------------------------
2003
-------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 64,676 $ 50,564 $ 30,612 $ 21,933
Net operating loss $ 584,460 $ 726,989 $ 572,346 $ 679,947
Net (decrease) in net assets resulting from
operations $(1,215,127) $(544,709) $(1,270,298) $(175,136)
Net (decrease) in net assets resulting from
operations per outstanding share $ (0.11) $ (0.05) $ (0.11) $ (0.01)
2002
-------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 59,462 $ 60,368 $ 77,413 $ 56,218
Net operating loss $ 556,233 $ 654,718 $ 479,433 $ 180,704
Net (decrease) increase in net assets resulting
from operations $(1,036,934) $ 434,289 $ 660,988 $ (2,780,537)
Net (decrease) increase in net assets resulting
from operations per outstanding share $ (0.12) $ 0.05 $ 0.06 $ (0.24)
- ---------------------------------------------------------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- ---------------------------------------------------------------------------------------------------------------------------------
Per share operating performance
for a share outstanding throughout the year:*
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000 December 31, 1999
------------------ ----------------- ------------------ ------------------ -----------------
Net asset value, beginning of year $ 2.37 $ 2.75 $ 3.51 $ 5.80 $ 2.13
Net operating (loss) income (0.22) (0.19) (0.06) 0.37 (1.04)
Net realized (loss) gain on
investments (0.09) 0.24 0.14 2.09 0.93
Net increase (decrease) in
unrealized appreciation
(depreciation) as a result
of sales 0.09 0.13 0.45 (2.35) (0.46)
Net (decrease) increase in
unrealized appreciation
(depreciation) on
investments held (0.06) (0.46) (1.30) (1.82) 4.58
Total from investment -------------- -------------- -------------- -------------- -------------
operations (0.28) (0.28) (0.77) (1.71) 4.01
Net decrease as a result of
cash dividend 0.00 0.00 0.00 (0.02) (0.35)
Net decrease as a result of
deemed dividend 0.00 0.00 (0.03) (0.62) 0.00
-------------- -------------- ------------- -------------- -------------
Total distributions 0.00 0.00 (0.03) (0.64) (0.35)
Net increase (decrease) from
capital stock transactions 0.86 (0.10) 0.04 0.06 0.01
-------------- -------------- -------------- -------------- --------------
Net asset value, end of year** $ 2.95 $ 2.37 $ 2.75 $ 3.51 $ 5.80
============== ============== ============== ============== ==============
Cash dividends paid per share $ 0.00 $ 0.00 $ 0.00 $ 0.02 $ 0.35
Deemed dividend per share $ 0.00 $ 0.00 $ 0.0875 $ 1.78 $ 0.00
Market value per share, end of
year $ 11.53 $ 2.46 $ 1.90 $ 2.4375 $ 11.50
Total income tax liability per
share $ 0.06 $ 0.15 $ 0.18 $ 0.78 $ 0.16
Ratio of expenses to average net
assets 9.5% 8.3% 3.45% (6.21)% 34.08%
Ratio of net operating (loss)
gain to average net assets (8.9)% (7.3)% (1.75)% 52.7% (3.50)%
Investment return based on:
Stock price 368.7% 40.5% (22.1)% (78.8)% 666.7%
Net asset value 24.5% (13.8)% (21.7)% (39.5)% 188.7%
Portfolio turnover 0% 46.00% 9.00% 20.56% 53.54%
Net assets, end of year $ 40,682,738 $ 27,256,046 $ 24,334,770 $ 31,833,475 $ 53,634,805
Number of shares outstanding 13,798,845 11,498,845 8,864,231 9,064,231 9,240,831
* Based on average shares outstanding.
** Reflects the decline in net asset value as a result of the $0.02 dividend paid in 2000.
The accompanying notes are an integral part of this schedule.
Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC. - 2002
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
The following reports and consolidated financial schedules of Harris &
Harris Group, Inc. are filed herewith and included in response to Item 8.
Documents Page
Report of Independent Accountants............................. A-27
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 2002 and 2001.......................... A-28
Consolidated Statements of Operations for the
years ended December 31, 2002, 2001, 2000................. A-29
Consolidated Statements of Cash Flows for the
years ended December 31, 2002, 2001 and 2000.............. A-30
Consolidated Statements of Changes in Net Assets for
the years ended December 31, 2002, 2001 and 2000.......... A-31
Consolidated Schedule of Investments as of
December 31, 2002......................................... A-32
Footnote to Consolidated Schedule of Investments.............. A-36
Notes to Consolidated Financial Statements.................... A-40
Financial Highlights for the years ended December 31,
2002, 2001, 2000, 1999 and 1998........................... A-51
Schedules other than those listed above have been omitted because they
are not applicable or the required information is presented in the consolidated
financial statements and/or related notes.
----------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
----------------------------------------------------------------------------
Report of Independent Accountants
To the Board of Directors and Shareholders of
Harris & Harris Group, Inc.
In our opinion, the accompanying consolidated statement of assets and
liabilities, including the consolidated schedule of investments, and the
related consolidated statements of operations, of cash flows, of changes in net
assets and of financial highlights present fairly, in all material respects,
the financial position of Harris & Harris Group, Inc. (the "Company") at
December 31, 2002, and the results of its operations, its cash flows, the
changes in its net assets and the financial highlights for the year then ended,
in conformity with accounting principles generally accepted in the United
States of America. 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 audit. We conducted our audit of these
financial statements in accordance with auditing standards generally accepted
in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit, which included confirmation of securities at December
31, 2002 by correspondence with the custodian, provides a reasonable basis for
our opinion. The financial statements of the Company as of December 31, 2001
and 2000, and for the years then ended were audited by other auditors who have
ceased operations. Those auditors expressed an unqualified opinion on those
financial statements in their report dated March 21, 2002.
As more fully disclosed in Note 2, the financial statements include investments
valued at $12,036,077 (44.16% of net assets) at December 31, 2002, the fair
values of which have been estimated by the Board of Directors in the absence of
readily ascertainable market values. Those estimated values may differ
significantly from the values that would have been used had a ready market for
the investments existed, and the differences could be material.
/s/ PricewaterhouseCoopers, LLP
March 18, 2003
New York, N.Y.
--------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
--------------------------------------------------------------------------------------------------------------------
ASSETS
December 31, 2002 December 31, 2001
Investments, at value (Cost: $30,206,935 at 12/31/02, $37,714,285 at
12/31/01........................................................ $ 27,496,822 $ 38,930,705
Cash and cash equivalents........................................... 5,967,356 135,135
Restricted funds (Note 5)........................................... 756,944 482,020
Funds in escrow..................................................... 750,000 0
Receivable from portfolio company................................... 786,492 0
Interest receivable................................................. 189 82
Prepaid expenses.................................................... 96,631 14,833
Note receivable ($987, net of reserve of $987 at 12/31/02).......... 0 10,487
Other assets........................................................ 107,535 109,105
Total assets........................................................ 35,951,969 $ 39,682,367
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities............................ $ 1,451,568 $ 1,039,350
Payable to broker for unsettled trade............................... 5,696,725 0
Bank loan payable (Note 8).......................................... 0 12,495,777
Accrued profit sharing (Note 3)..................................... 15,233 178,282
Deferred rent....................................................... 5,397 14,650
Current income tax liability........................................ 857,656 255,068
Deferred income tax liability (Note 6).............................. 669,344 1,364,470
Total liabilities................................................... 8,695,923 15,347,597
Commitments and contingencies (Note 7)..............................
Net assets.......................................................... $ 27,256,046 $ 24,334,770
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued........................ $ 0 0
Common stock, $0.01 par value, 25,000,000 shares
authorized; 13,327,585 issued at 12/31/02 and
10,692,971 issued at 12/31/00................................... 133,276 106,930
Additional paid in capital (Note 4)................................. 32,845,872 27,228,748
Additional paid in capital - common stock warrants.................. 109,641 109,641
Accumulated net realized gain (loss)................................ 1,137,820 618,606
Accumulated unrealized appreciation of investments,
net of deferred tax liability of $844,918 at 12/31/02 and
$1,540,044 at 12/31/01.......................................... (3,565,032) (323,624)
Treasury stock, at cost (1,828,740 shares at
12/31/01 and 1,628,740 at 12/31/00)............................. (3,405,531) (3,405,531)
Net assets.......................................................... $ 27,256,046 $ 24,334,770
Shares outstanding.................................................. $ 11,498,835 8,864,231
Net asset value per outstanding share............................... $ 2.37 $ 2.75
The accompanying notes are an integral part of these consolidated financial statements
=================================================================================================================================
--------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Investment income:
Interest from:
Fixed-income securities............................ $ 184,050 $ 422,196 $ 554,233
Portfolio companies................................ 0 9,616 64,950
Dividend income....................................... 0 1,000 2,000
Other income.......................................... 69,411 77,849 65,867
Total investment income............................ 253,461 510,661 687,050
Expenses:
Profit-sharing (reversal) accrual (Note 3)............ (163,049) (984,021) (4,812,675)
Salaries and benefits................................. 1,130,352 1,045,063 1,036,737
Professional fees..................................... 344,717 261,582 310,601
Administration and operations......................... 433,569 406,488 385,608
Rent.................................................. 173,291 166,312 166,816
Directors' fees and expenses.......................... 154,682 90,047 100,469
Depreciation.......................................... 30,607 26,901 28,748
Custodian fees........................................ 9,604 14,518 14,355
Interest expense (Note 4)............................. 10,776 8,331 146,141
Total expenses..................................... 2,124,549 1,035,221 (2,623,200)
Operating income (loss) before income taxes........... (1,871,088) (524,560) 3,310,250
Income tax benefit (Note 6)........................... 0 0 0
Net operating (loss) income............................... (1,871,088) (524,560) 3,310,250
Net realized income (loss) from investments:
Realized income from investments...................... 3,284,737 1,394,781 19,065,267
Total realized income.............................. 3,284,737 1,394,781 19,065,267
Income tax expense (Note 6)........................... (894,435) (118,415) (101,435)
Net realized income from investments.................. 2,390,302 1,276,366 18,963,832
Net realized income....................................... 519,214 751,806 22,274,082
Net decrease increase in unrealized appreciation on
investments:
Increase as a result of investment sales............. 1,602,048 4,802,738 0
Decrease as a result of investment sales............. (322,208) (854,467) (21,400,036)
Increase on investments held.......................... 285 3,232,919 26,741,283
Decrease on investments held.......................... (5,216,659) (14,912,698) (43,275,840)
Change in unrealized appreciation on
investments........................................ (3,936,534) (7,731,508) (37,934,593)
Income tax benefit (Note 6)........................... 695,126 90,464 153,304
Net decrease in unrealized appreciation on investments (3,241,408) (7,641,044) (37,781,289)
Net decrease in net assets resulting from
operations:
Total................................................. $ 2,722,194) $ 6,889,238) $ 15,507,207)
Per outstanding share................................. $ (0.24) $ (0.78) $ (1.71)
=============================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
--------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Cash flows used in operating activities:
Net (decrease) increase in net assets
resulting from operations.............................. $ (2,722,194) $ (6,889,238) $ (15,507,207)
Adjustments to reconcile net (decrease) increase
in net assets resulting from operations to
net cash used in operating activities:
Net realized and unrealized loss (gain) on invest-
ments ............................................... 651,797 5,950,398 18,896,326
Deferred income taxes.................................. (695,126) 90,464 (153,304)
Depreciation........................................... 30,607 26,901 28,748
Other.................................................. 0 2,010 109,641
Interest received in stock............................. 0 0 (27,009)
Changes in assets and liabilities:
Restricted funds....................................... (274,924) (216,837) (265,183)
Receivable from investment company..................... (786,492) 0 0
Funds in escrow........................................ (750,000) 0 1,327,748
Interest receivable.................................... (107) 30,000 14,107
Prepaid expenses....................................... (81,798) 67,782 (8,287)
Notes receivable....................................... 10,487 401 0
Other assets........................................... 1,570 23,667 18,384
Accounts payable and accrued liabilities............... 412,217 267,587 71,197
Payable to broker for unsettled trade.................. 5,696,725 (115,005) 115,005
Accrued profit sharing................................. (163,049) (3,304,959) (5,951,226)
Deferred rent.......................................... (9,253) (9,253) (9,253)
Current income tax liability........................... 602,588 (5,496,498) 62,670
--------------- --------------- ---------------
Net cash used in operating activities.................. 1,923,048 (9,572,580) (1,304,643)
Cash provided by investing activities:
Net (purchase) sale of short-term investments and
marketable securities................................. 10,358,006 (10,263,667) (14,480,590)
Investment in private placements and loans............. (7,195,988) (1,818,826) (6,417,500)
Proceeds from sale of investments...................... 7,631,100 9,385,615 23,033,868
Purchase of fixed assets............................... (41,138) (6,508) (6,974)
--------------- --------------- ---------------
Net cash (used in) provided by investing activities.... 10,751,980 (2,703,386) 2,117,804
Cash flows used in financing activities:
Payment of dividend.................................... 0 0 (184,817)
Purchase of treasury stock (Note 4).................... 0 (338,000) (530,051)
Proceeds from note payable............................. 0 12,495,777 3,000,000
Payment of note payable (Note 4)....................... (12,495,777) 0 (3,000,000)
Proceeds from rights offering, net (Note 4)............ 5,643,470 0 0
Collection on notes receivable......................... 9,500 0 21,775
--------------- --------------- ---------------
Net cash provided by (used in) financing activities.... (6,842,807) 12,157,777 (693,093)
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents:
Cash and cash equivalents at beginning of the year..... 135,135 253,324 133,356
Cash and cash equivalents at end of the year........... 5,967,356 135,135 253,324
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents... $ 5,832,221 $ (118,189) $ 120,068
=============== =============== ===============
Supplemental disclosures of cash flow information:
Income taxes paid...................................... $ 307,585 $ 5,795,916 $ 117,134
Interest paid.......................................... $ 19,106 $ 0 $ 36,500
The accompanying notes are an integral part of these consolidated financial statements
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Changes in net assets from operations:
Net operating income (loss)............................... $ (1,871,088) $ (524,560) $ 3,310,250
Net realized gain (loss) on investments................... 2,390,302 1,276,366 18,963,832
Net (decrease) increase in unrealized appreciation
on investments as a result of sales.................. 1,279,840 4,038,735 (21,246,732)
Net (decrease) increase in unrealized appreciation on
investments held (4,521,248) (11,679,779) (16,534,557)
--------------- --------------- ---------------
Net (decrease) increase in net assets resulting from operations (2,722,194) (6,889,238) (15,507,207)
Changes in net assets from
capital stock transactions:
Payment of dividend....................................... 0 0 (184,817)
Purchase of treasury stock................................ 0 (338,000) (530,051)
Proceeds from sale of stock .............................. 26,346 0 0
Additional paid in capital on common stock issued......... 5,617,124 0 0
Deemed dividend shareholder tax credit.................... 0 (271,467) (5,688,896)
Additional paid in capital warrants....................... 0 0 109,641
--------------- --------------- ---------------
Net decrease in net assets resulting from capital stock
transactions............................................. 5,643,470 (609,467) (6,294,123)
--------------- --------------- ---------------
Net increase (decrease) in net assets 2,921,276 (7,498,705) (21,801,330)
--------------- --------------- ---------------
Net Assets
24,334,770 31,833,475 53,634,805
--------------- --------------- ---------------
Beginning of the year.....................................
End of the year........................................... $ 27,256,046 $ 24,334,770 $ 31,833,475
=============== =============== ===============
The accompanying notes are an integral part of these consolidated financial statements.
-----------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
-----------------------------------------------------------------------------------------------------------------
(Audited)
Method of Valuation Shares/Principal Value
(3)
------------------- ---------------- -------------
Investments in Unaffiliated Companies (8)(9)(10)
- 10.0% of total investments
Private Placement Portfolio (Illiquid)
- 10.0% of total investments
AlphaSimplex Group, LLC (2) -- Investment advisory firm headed
by Dr. Andrew W. Lo, holder of the Harris & Harris Group
Chair at MIT Limited Liability Company interest.......... (D) -- $ 6,235
Continuum Photonics, Inc. (1)(2)(4)(6) -- Develops optical
networking components by merging
cutting-edge materials, MEMS and electronics technologies
3.73% of fully diluted equity
Series B Convertible Preferred Stock..................... (D) 2,000,000 518,989
Exponential Business Development Company (1)(2)(5) -- Venture
capital partnership focused on early stage companies
Limited partnership interest............................. (A) -- 25,000
Kriton Medical, Inc. (1)(2)(6) -- Develops ventricular assist
devices -- 1.73% of fully diluted equity
Series B Convertible Preferred Stock..................... (D) 476,191 0
NanoOpto Corporation (1)(2)(4)(6) -- Develops high performance,
integrated optical communications sub-components on a chip
by utilizing patented nano-manufacturing technology --
1.45% of fully diluted equity Series A-1 Convertible
Preferred Stock.......................................... (D) 267,857 28,400
Nantero, Inc. (1)(2)(5)(6) -- Develops a high density
nonvolatile random access memory chip using nano-
technology -- 4.15% of fully diluted equity Series A
Convertible Preferred Stock.............................. (A) 345,070 489,999
NeoPhotonics Corporation (1)(2)(4)(6) -- Develops and
manufactures planar optical devices and components using
nanomaterials deposition technology -- 1.76% of fully
diluted equity Series D Convertible Preferred Stock...... (D) 1,498,802 430,440
Optiva, Inc. (1)(2)(4)(5)(6) -- Develops and commercializes
nanomaterials for advanced applications -- 1.99% of fully
diluted equity Series C Convertible Preferred Stock...... (B) 1,249,999 1,250,000
---------------
Total Private Placement Portfolio (cost: $5,395,166)...................................................... $ 2,749,063
---------------
Total Investments in Unaffiliated Companies (cost: $5,395,166)............................................ $ 2,749,063
---------------
The accompanying notes are an integral part of this consolidated schedule.
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
- ----------------------------------------------------------------------------------------------------------------------------
(Audited)
Method of
Valuation (3) Shares/Principal Value
------------- ---------------- ------
Investments in Non-Controlled
Affiliated Companies (8)(9)(11)
- 33.8% of total investments
Private Placement Portfolio
(Illiquid)
- 33.8% of total investments
Agile Materials & Technologies, Inc.
(1)(2)(4)(5)(6) --
Develops and sells variable integrated passive
electronic equipment components- 8.21% of fully
diluted equity Series A Convertible Preferred
Stock.................................................. (A) 3,732,736 $ 1,000,000
Experion Systems, Inc. (1)(2)(7) -- Develops and sells
software to credit unions - 12.45% of fully diluted equity
Series A Convertible Preferred Stock................... (B) 294,118
Series B Convertible Preferred Stock................... (B) 35,294
Series C Convertible Preferred Stock................... (B) 222,184 $ 1,037,000
Nanopharma Corp. (1)(2)(4)(5)(6) -- Develops advanced
nanoscopic drug delivery vehicles and systems -- 14.69% of
fully diluted equity
Series A Convertible Preferred Stock................... (A) 684,516 700,000
Nanotechnologies, Inc. (1)(2)(4)(5)(6) -- Develops
high-performance nanoscale materials for industry -- 6.48%
of fully diluted equity
Series B Convertible Preferred Stock .................. (A) 1,538,837 750,000
NeuroMetrix, Inc. (1)(2) -- Develops and sells medical devices
for monitoring neuromuscular disorders - 12.10% of fully
diluted equity
Series A Convertible Preferred Stock................... (B) 875,000
Series B Convertible Preferred Stock................... (B) 625,000
Series C-2 Convertible Preferred Stock................. (B) 1,148,100
Series E Convertible Preferred Stock................... (B) 499,996
Series E-1 Convertible Preferred Stock................. (B) 235,521 5,075,426
Questech Corporation (1)(2)(5) --
Manufactures and markets
proprietary metal decorative
tiles -- 6.68% of fully diluted
equity
Common Stock........................................... (B) 646,954
Warrants at $5.00 expiring 11/15/04.................... (B) 1,966
Warrants at $1.50 expiring 11/16/05.................... (B) 1,250
Warrants at $1.50 expiring 12/14/06.................... (B) 8,500
Warrants at $1.50 expiring 11/21/07.................... (B) 3,750 724,588
---------------
Total Private Placement Portfolio (cost: $9,359,300)................................................... $ 9,287,014
===============
Total Investments in Non-Controlled Affiliated Companies (cost: $9,359,300)............................ $ 9,287,014
===============
- ------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this consolidated schedule.
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
- ----------------------------------------------------------------------------------------------------------------------------
(Audited)
Method of
Valuation (3) Shares/Principal Value
------------- ---------------- ------
U.S. Government and Agency Obligations - 56.2% of total investments
U.S. Treasury Bills -- due date 01/16/03................ (K) $1,045,000 $ 1,044,488
U.S. Treasury Bills -- due date 01/23/03................ (K) 9,470,000 9,463,237
U.S. Treasury Bills -- due date 02/13/03................ (K) 4,950,000 4,943,020
---------------
Total Investments in U.S. Government (cost: $15,452,469).............................................. $15,450,745
===============
Total Investments -- 100% (cost: $30,206,935)......................................................... $27,486,822
===============
The accompanying notes are an integral part of this consolidated schedule.
- -----------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
- -----------------------------------------------------------------------------
(Audited)
- -----------------------------------------------------------------------------
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last 12 months are considered to be
non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the Asset
Valuation Policy Guidelines.
(4) Initial investment was made during 2002.
(5) No changes in valuation occurred in these investments during the 12
months ended December 31, 2002.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of
its efforts to establishing a new business, and either it has not yet
commenced its planned principal operations or it has commenced such
operations but has not realized significant revenue from them.
(7) Previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in which
the Company owns less than five percent of the portfolio company.
Investments in non-controlled affiliated companies consist of
investments in which the Company owns more than five percent but less
than 25 percent of the portfolio company. Investments in controlled
affiliated companies consist of investments in which the Company owns
more than 25 percent of the portfolio company.
(9) The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential equity
interest in each such portfolio company. The calculated percentage
represents the amount of the issuer's equity securities the Company
owns or can acquire as a percentage of the issuer's total outstanding
equity securities plus equity securities reserved for issued and
outstanding warrants, convertible securities and all authorized stock
options, both granted and ungranted.
(10) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $5,395,166. The gross unrealized
appreciation based on the tax cost for these securities is $1,069. The
gross unrealized depreciation based on the tax cost for these
securities is $2,647,172.
(11) The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $9,359,300. The gross
unrealized appreciation based on the tax cost for these securities is
$2,414,044. The gross unrealized depreciation based on the tax cost
for these securities is $2,486,330.
The accompanying notes are an integral part of this consolidated
schedule.
- -----------------------------------------------------------------------------
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
- -----------------------------------------------------------------------------
ASSET VALUATION POLICY GUIDELINES
The Company's investments
can be classified into five broad
categories for valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH
AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in the Company's portfolio to determine net asset
value. Under the 1940 Act, unrestricted securities with readily available
market quotations are to be valued at the current market value; all other
assets must be valued at "fair value" as determined in good faith by or under
the direction of the Board of Directors.
The Company's Board of Directors is responsible for (1) determining
overall valuation guidelines and (2) ensuring the valuation of investments
within the prescribed guidelines.
The Company's Investment and Valuation Committee, comprised of at
least three or more independent Board members, is responsible for reviewing and
approving the valuation of the Company's assets within the guidelines
established by the Board of Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing the assets of the Company, external measures of
value, such as public markets or third-party transactions, are utilized
whenever possible. Valuation is not based on long-term work-out value, nor
immediate liquidation value, nor incremental value for potential changes that
may take place in the future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as such amounts depend on future circumstances and cannot reasonably
be determined until the individual investments are actually liquidated.
The Company's valuation policy with respect to the five broad
investment categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
A. Cost: The cost method is based on the original cost to the Company.
This method is generally used in the early stages of a company's development
until significant positive or negative events occur subsequent to the date of
the original investment that dictate a change to another valuation method.
Some examples of such events are: (1) a major recapitalization; (2) a
major refinancing; (3) a significant third-party transaction; (4) the
development of a meaningful public market for the company's common stock; and
(5) significant positive or negative changes in the company's business.
B. Private Market: The private market method uses actual third-party
transactions in the company's securities as a basis for valuation, using
actual, executed, historical transactions in the company's securities by
responsible third parties. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by the
Company. The Company discounts market value for securities that are subject to
significant legal and contractual restrictions. Other securities, for which
market quotations are readily available, are carried at market value as of the
time of valuation.
Market value for securities traded on securities exchanges or on the
Nasdaq National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter market and
listed securities for which no sale was reported on that day, market value is
the mean of the closing bid price and asked price on that day.
This method is the preferred method of valuation when there is an
established public market for a company's securities, as that market provides
the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market in
the company's securities or when the factual information available to the
Company dictates that an investment should no longer be valued under either the
cost or private market method. This valuation method is inherently imprecise
and ultimately the result of reconciling the judgments of the Company's
Investment and Valuation Committee members, based on the data available to
them. The resulting valuation, although stated as a precise number, is
necessarily within a range of values that vary depending upon the significance
attributed to the various factors being considered. Some of the factors
considered may include the financial condition and operating results of the
company, the long-term potential of the business of the company, the values of
similar securities issued by companies in similar businesses, the proportion of
the company's securities owned by the Company and the nature of any rights to
require the company to register restricted securities under applicable
securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT
IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on the original cost to the Company.
Such method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and development in
technology or product development until significant positive or adverse events
occur subsequent to the date of the original investment that dictate a change
to another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to the Company dictates that an investment should
no longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of the Company's Investment and Valuation Committee
members. The resulting valuation, although stated as a precise number, is
necessarily within a range of values that vary depending upon the significance
attributed to the various factors being considered. Some of the factors
considered may include the results of research and development, product
development progress, commercial prospects, term of patent and projected
markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services
that provide market quotations based primarily on quotations from dealers and
brokers, market transactions, and other sources.
J. Other Fixed-Income Securities that are not readily marketable are
valued at fair value by the Investment and Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
K. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days or
less is valued at amortized cost.
ALL OTHER INVESTMENTS
L. All Other Investments are reported at fair value as determined in
good faith by the Investment and Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Investment and Valuation
Committee's judgment of fair values as of the valuation date using the outlined
basic methods of valuation. They do not necessarily represent an amount of
money that would be realized if the securities had to be sold in an immediate
liquidation. Thus valuations as of any particular date are not necessarily
indicative of amounts that may ultimately be realized as a result of future
sales or other dispositions of investments held.
- -----------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company") is a venture capital
investment company operating as a business development company ("BDC") under
the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type of
investment company under the 1940 Act. The Company operates as an internally
managed investment company whereby its officers and employees, under the
general supervision of its Board of Directors, conduct its operations.
The Company elected to become a BDC on July 26, 1995, after receiving
the necessary approvals. From September 30, 1992 until the election of BDC
status, the Company operated as a closed-end, non-diversified, investment
company under the 1940 Act. Upon commencement of operations as an investment
company, the Company revalued all of its assets and liabilities at fair value
as defined in the 1940 Act. Prior to such time, the Company was registered and
filed under the reporting requirements of the Securities and Exchange Act of
1934 as an operating company and, while an operating company, operated directly
and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent
wholly owned subsidiary of the Company. Enterprises holds the lease for the
office space, which it subleases to the Company and an unaffiliated party;
operates a financial relations and consulting firm; is a partner in Harris
Partners I, L.P. and is taxed as a C corporation. Harris Partners I, L.P. is a
limited partnership and owned, until December 31, 2002, a 20 percent limited
partnership interest in PHZ Capital Partners L.P. The partners of Harris
Partners I, L.P. are Enterprises (sole general partner) and Harris & Harris
Group, Inc. (sole limited partner).
The Company filed for 1999 to elect treatment as a Regulated
Investment Company ("RIC") under Sub-Chapter M of the Internal Revenue Code of
1986 (the "Code") and qualified for the same treatment for 2000 and 2001. There
can be no assurance that the Company will qualify as a RIC for 2002 and
subsequent years or that if it does qualify, it will continue to qualify for
subsequent years. In addition, even if the Company were to qualify as a RIC for
a given year, the Company might take action in a subsequent year to ensure that
it would be taxed in that subsequent year as a C Corporation, rather than as a
RIC. As a RIC, the Company must, among other factors, distribute at least 90
percent of its investment company taxable income and may either distribute or
retain its realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies followed
in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for investment companies and include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "fair
value" as defined in the 1940 Act and in the applicable regulations of the
Securities and Exchange Commission. All assets are valued at fair value as
determined in good faith by, or under the direction of, the Board of Directors.
(See "Asset Valuation Policy Guidelines" in the "Footnote to Consolidated
Schedule of Investments.")
Securities Transactions. Securities transactions are accounted for on
the date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined on specific
identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, the Company recorded income
taxes using the liability method in accordance with the provision of Statement
of Financial Accounting Standards No. 109. Accordingly, deferred tax
liabilities had been established to reflect temporary differences between the
recognition of income and expenses for financial reporting and tax purposes,
the most significant difference of which relates to the Company's unrealized
appreciation on investments.
The December 31, 2002 consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of December
31, 1998, net of the unutilized operating and capital loss carryforwards
incurred by the Company through December 31, 1998.
The Company pays federal, state and local income taxes on behalf of
its wholly owned subsidiary, Harris & Harris Enterprises, which is a C
corporation. (See "Note 6 Income Taxes.")
Estimates by Management. The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of December 31, 2002 and
2001, and the reported amounts of revenues and expenses for the three years
ended December 31, 2002. The most significant estimate relates to the fair
valuations of investments for the years ended December 31, 2002 and 2001.
Actual results could differ from these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- ------------------------------------
On August 3, 1989, the shareholders of the Company approved the 1988
Long Term Incentive Compensation Plan (the "1988 Plan"). The Company's 1988
Plan was cancelled as of December 31, 1997, canceling all outstanding stock
options and eliminating all potential stock option grants. As a substitution
for the 1988 Plan, the Company adopted an employee profit-sharing plan.
As of January 1, 1998, the Company implemented the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan (the "1998 Plan") that provided for
profit sharing equal to 20 percent of the net realized income of the Company as
reflected on the Consolidated Statements of Operations for such year, less the
nonqualifying gain, if any. The 1998 Plan was terminated by the Company as of
December 31, 1999, subject to the payment of any amounts owed on the 1999
realized gains under the 1998 Plan.
In March 2000, the Company paid out 90 percent of the profit sharing
in the amount of $1,024,696 on the 1999 realized gains; the remaining 10
percent or $113,855 was paid out in September 2000, upon the completion and
filing of the Company's 1999 federal tax return.
As of January 1, 2000, the Company implemented the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan (the "Plan") that provides for profit
sharing by its officers and employees equal to 20 percent of the net realized
income of the Company as reflected on the consolidated statements of operations
of the Company for such year, less the nonqualifying gain, if any.
On April 26, 2000 the shareholders of the Company approved the
performance goals under the Plan in accordance with Section 162(m) of the
Internal Revenue Code of 1986 ("Code"), effective as of January 1, 2000. The
Code generally provides that a public company such as the Company may not
deduct compensation paid to its chief executive officer or to any of its four
most highly compensated officers to the extent that the compensation paid to
any such officer/employee exceeds $1 million in any tax year, unless the
payment is made upon the attainment of objective performance goals that are
approved by the Company's shareholders.
Under the Plan, net realized income of the Company includes investment
income, realized gains and losses, and operating expenses (including taxes paid
or payable by the Company), but is calculated without regard to dividends paid
or distributions made to shareholders, payments under the Plan, unrealized
gains and losses, and loss carry-overs from other years ("Qualifying Income").
The portion of net after-tax realized gains attributable to asset values as of
September 30, 1997 is considered nonqualifying gain, which reduces Qualifying
Income.
As soon as practicable following the year-end audit, the Committee
will determine whether, and if so how much, Qualifying Income exists for a plan
year, and 90 percent of the Qualifying Income will be paid out to Plan
participants pursuant to the distribution percentages set forth in the Plan.
The remaining 10 percent will be paid out after the Company has filed its
federal tax return for that year in which Qualifying Income exists. At December
31, 2002, the distribution amounts for each officer and employee were as
follows: Charles E. Harris, 13.790 percent; Mel P. Melsheimer, 4.233 percent;
Helene B. Shavin, 1.524 percent; and Jacqueline M. Matthews, 0.453 percent. In
one case, for a former employee, who left the Company other than due to
termination for cause, any amount earned will be accrued and may subsequently
be paid to such participant.
On October 15, 2002 the shareholders of the Company approved the
performance goals under the 2002 Plan in accordance with Section 162(m) of the
Internal Revenue Code of 1986 ("Code"), effective as of January 1, 2003. The
Code generally provides that a public company such as the Company may not
deduct compensation paid to its chief executive officer or to any of its four
most highly compensated officers to the extent that the compensation paid to
any such officer/employee exceeds $1 million in any tax year, unless the
payment is made upon the attainment of objective performance goals that are
approved by the Company's shareholders.
As of January 1, 2003, the Company implemented the Amended and
Restated Harris & Harris Group, Inc. Employee Profit-Sharing Plan (the "2002"
Plan").
Under the 2002 Plan, net realized income of the Company includes
investment income, realized qualifying gains and losses, and operating expenses
(including taxes paid or payable by the Company), but is calculated without
regard to dividends paid or loss carry-overs from other years ("Qualifying
Income").
Under the 2002 Plan, awards previously granted to the Plan's four
current Participants (Messrs. Harris and Melsheimer and Mss. Shavin and
Matthews, herein referred to as the "grandfathered participants") will be
reduced by 10% with respect to "Non-Tiny Technology Investments" (as defined in
the 2002 Plan) and by 25% with respect to "Tiny Technology Investments" (as
defined in the 2002 Plan) and will become permanent. These reduced awards are
herein referred to as "grandfathered participations." The amount by which such
awards are reduced will be allocable and reallocable each year by the
Compensation Committee ("Committee") among current and new participants as
awards under the 2002 Plan. The grandfathered participations will be honored by
the Company whether or not the grandfathered participant is still employed by
the Company or is still alive (in the event of death, the grandfathered
participations will be paid to the grandfathered participant's estate), unless
the grandfathered participant is dismissed for cause, in which case all awards,
including the grandfathered participations, will be immediately cancelled and
forfeited. With regard to new investments and follow-on investments made after
the date on which the first new employee begins participating in the 2002 Plan,
both current and new participants will be required to be employed by the
Company at the end of a plan year in order to participate in profit sharing on
such investments with respect to such year.
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which the
Company remains a "business development company" within the meaning of 1940 Act
be greater than 20 percent of the Company's "net income after taxes" within the
meaning of Section 57(n)(1)(B) of the 1940 Act. In the event the awards as
calculated exceed such amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the Committee
at any time. Notwithstanding the foregoing, the grandfathered participations
may not be modified further. Nothing in the 2002 Plan will preclude the
Committee from naming additional participants in the 2002 Plan or, except for
grandfathered participations, changing the Award Percentage of any Participant
(subject to the overall percentage limitations contained in the 2002 Plan).
Under the 2002 Plan, the distribution amounts for non-grandfathered investments
for each officer and employee currently are as follows: Charles E. Harris,
10.790 percent; Mel P. Melsheimer, 4.233 percent; Douglas W. Jamison, 3.0
percent; Helene B. Shavin, 1.524 percent; and Jacqueline M. Matthews, 0.453
percent.
The grandfathered participations are set forth below:
Grandfathered Participations
Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews .40770 .33975
Total 18.00000 15.00000
Accordingly, an additional 2.00% of Qualifying Income with respect to
grandfathered Non-Tiny Technology Investments, 5.00% of Qualifying Income with
respect to grandfathered Tiny Technology Investments and the full 20.00% of
Qualifying Income with respect to new investments are available for allocation
and reallocation from year to year. Currently Douglas W. Jamison is allocated
..80% of the Non-Tiny Technology Grandfathered Participations and 2.00 % of the
Tiny Technology Grandfathered Participations.
During 2002, the Company decreased the profit-sharing accrual by
$163,049, bringing the cumulative accrual under the Plan to $15,233 at December
31, 2002. The amounts payable under the Plan for net realized income during the
year ended December 31, 2002 are $15,233. The Company will pay out 90 percent
in March 2003 and the remaining 10 percent upon the completion and filing of
the Company's 2002 federal tax return.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that, effective January 1,
1998, 50 percent of all Directors' fees be used to purchase Company common
stock from the Company. However, effective March 1, 1999, the directors may
purchase the Company's common stock in the open market, rather than from the
Company. During 1999, the Directors bought directly from the Company 5,816
shares.
On July 14, 1999, the Board of Directors announced a tender offer to
purchase up to 1,100,000 shares of its common stock for cash at a price equal
to $1.63 per share. A total of 1,080,569 shares were tendered for a total cost,
including related expenses of approximately $71,500, of $1,832,831. Of these
shares, 1,075,269 were tendered by one shareholder, which tendered all of its
holdings.
On January 27, 2000, the Company placed privately, with an
unaffiliated investor, for $3 million in cash, a one-year, 12 percent note with
one-year warrants to purchase 25,263 shares of the Company's common stock at
$11.8750 per share. Unless the note was prepaid, six months after its issuance,
the investor would have received additional one-year warrants to purchase an
additional $300,000 worth of the Company's common stock at the then-current
market price. During March 2000, with part of the proceeds from the sale of
SciQuest.com stock, the Company prepaid the Note. The Company incurred total
interest costs of $146,141: $36,500 in interest paid on the note and $109,641
on warrants. The warrants expired unexercised.
On July 8, 2002, the Company filed a final prospectus under Rule 497
of the Securities Act of 1933 with the SEC for the issuance of transferable
rights to its shareholders. The rights allowed the shareholders to subscribe
for a maximum of 2,954,743 new shares of the Company's common stock, of which
2,634,614 new shares were subscribed for pursuant to the rights offering. The
actual amount of gross proceeds raised upon completion of the offer was
$5,927,882; net proceeds were $5,643,470, after expenses of $284,412. The
Company intends to invest, under normal circumstances, directly or indirectly,
the net proceeds of the offer in accordance with its investment objectives and
policies, within the 12 months following the receipt of such proceeds,
depending on the available investment opportunities for the types of
investments in which the Company principally invests.
Since 1998, the Company has repurchased a total of 1,859,047 of its
shares for a total of $3,496,388, including commissions and expenses, at an
average price of $1.88 per share. These treasury shares were reduced by the
purchases made by the Directors. On July 23, 2002, because of the Company's
strategic decision to invest in tiny technology, the Board of Directors
reaffirmed its commitment not be authorize the purchase of additional shares of
stock in the foreseeable future.
On December 14, 2000, the Company declared a deemed dividend of $1.78
per share for a total of $16,253,987, and in 2001, the Company paid federal
income taxes on behalf of shareholders of $0.62 per share for a total of
$5,688,896. The Company paid the tax at the corporate rate on the distribution,
and the shareholders received a tax credit equal to their proportionate share
of the tax paid.
On January 22, 2002, the Company announced a deemed dividend of
$0.0875 per share for a total of $775,620, and in 2002 the Company paid federal
income taxes on behalf of shareholders of $0.030625 per share for a total of
$271,467. The Company paid the tax at the corporate rate on the distribution,
and the shareholders received a tax credit equal to their proportionate share
of the tax paid.
The net of the total deemed dividends declared in 2000 ($16,253,987)
and 2001 ($775,620) and the taxes paid on behalf of shareholders in 2000
($5,688,896) and 2001 ($271,467) is considered to be reinvested by the
shareholders; therefore, during 2000 and 2001, additional paid in capital has
increased by $10,565,091 and $504,153, respectively.
The tax character of the 2000 and 2001 deemed dividends was long-term
capital gain.
As of December 31, 2002, there are no distributable earnings. The
difference between the book basis and tax basis components of distributable
earnings is attributed to Built-In Gains generated at the time of the Company's
qualification as a RIC (see Note 6. "Income Taxes") and after tax earnings that
are not required to be distributed.
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with the Company (disclosed in a Form 8-K filed on October 27, 1999) (the
"Employment Agreement"), which superseded an employment agreement that was
about to expire on December 31, 1999. The Employment Agreement shall terminate
on December 31, 2004 ("Term") subject to either an earlier termination or an
extension in accordance with the terms; on January 1, 2000 and on each day
thereafter, the Term extends automatically by one day unless at any time the
Company or Mr. Harris, by written notice, decides not to extend the Term, in
which case the Term will expire five years from the date of the written notice.
During the period of employment, Mr. Harris shall serve as the
Chairman and Chief Executive Officer of the Company; be responsible for the
general management of the affairs of the Company and all its subsidiaries,
reporting directly to the Board of Directors of the Company; serve as a member
of the Board for the period of which he is and shall from time to time be
elected or reelected; and serve, if elected, as President of the Company and as
an officer and director of any subsidiary or affiliate of the Company.
Mr. Harris is to receive compensation under his Employment Agreement
in the form of base salary of $208,315 for 2000, with automatic yearly
adjustments to reflect inflation. In addition, the Board may increase such
salary, and consequently decrease it, but not below the level provided for by
the automatic adjustments described above. Mr. Harris is also entitled to
participate in the Company's Profit-Sharing Plan as well as in all compensation
or employee benefit plans or programs, and to receive all benefits,
perquisites, and emoluments for which salaried employees are eligible. Under
the Employment Agreement, the Company is to furnish Mr. Harris with certain
perquisites which include a company car, membership in certain clubs and up to
a $5,000 annual reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of $2,000,000;
provides reimbursement for uninsured medical expenses, not to exceed $10,000
per annum, adjusted for inflation, over the period of the contract; provides
Mr. Harris and his spouse with long-term care insurance; and disability
insurance in the amount of 100 percent of his base salary. These benefits are
for the term of the Employment Agreement.
The Employment Agreement provides for the Company to adopt a
supplemental executive retirement plan (the "SERP") for the benefit of Mr.
Harris. Under the SERP, the Company will cause an amount equal to one-twelfth
of Mr. Harris's current annual salary to be credited each month (a "Monthly
Credit") to a special account maintained for this purpose on the books of the
Company for the benefit of Mr. Harris (the "SERP Account"). The amounts
credited to the SERP Account will be deemed invested or reinvested in such
mutual funds or U.S. Government securities as determined by Mr. Harris. The
SERP Account will be credited and debited to reflect the deemed investment
returns, losses and expenses attributed to such deemed investments and
reinvestments. Mr. Harris' benefit under the SERP will equal the balance in the
SERP Account and such benefit will always be 100 percent vested (i.e., not
forfeitable). Mr. Harris will determine the form and timing of the distribution
of the balance in the SERP Account; provided, however, in the event of the
termination, the balance in the SERP Account will be distributed to Mr. Harris
or his beneficiary, as the case may be, in a lump-sum payment within 30 days of
such termination. The Company will establish a rabbi trust for the purpose of
accumulating funds to satisfy the obligations incurred by the Company under the
SERP. The restricted funds for the SERP Plan total $756,944 as of December 31,
2002. Mr. Harris' rights to benefits pursuant to this SERP will be no greater
than those of a general creditor of the Company.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the executive's
base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with the Company,
effective August 15, 1990. The severance compensation agreement provides that
if, following a change in control of the Company, as defined in the agreement,
such individual's employment is terminated by the Company without cause or by
the executive within one year of such change in control, the individual shall
be entitled to receive compensation in a lump sum payment equal to 2.99 times
the individual's average annualized compensation and payment of other welfare
benefits. If Mr. Harris' termination is without cause or is a constructive
discharge, the amount payable under the Employment Agreement will be reduced by
the amounts paid pursuant to the severance compensation agreement.
As of January 1, 1989, the Company adopted an employee benefits
program covering substantially all employees of the Company under a 401(k) Plan
and Trust Agreement. As of January 1, 1999, the Company adopted the Harris &
Harris Pension Plan and Trust, a money purchase plan which would allow the
Company to stay compliant with the 401(k) top-heavy regulations and deduction
limitation regulations. In 2001, Congress enacted the Economic Growth and Tax
Relief Reconciliation Act of 2001 which has increased the deduction limits for
plans such as the 401(k) Plan. This Act eliminates the need for the Company to
maintain two separate plans. Effective December 31, 2001, the Pension Plan
merged into the 401(k) Plan, with the 401(k) Plan being the surviving plan.
Contributions to the plan are at the discretion of the Company. During 2002,
contributions to the plan that have been charged to salaries and benefits
totaled approximately $51,500.
On June 30, 1994, the Company adopted a plan to provide medical and
health insurance for retirees, their spouses and dependents who, at the time of
their retirement, have ten years of service with the Company and have attained
50 years of age or have attained 45 years of age and have 15 years of service
with the Company. On February 10, 1997, the Company amended this plan to
include employees who "have seven full years of service and have attained 58
years of age." The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of December 31,
2002 the Company had a reserve of $446,302 for the plan.
NOTE 6. INCOME TAXES
- ---------------------
The Company elected Sub-Chapter M status for the year ended December
31, 1999. On February 23, 1999, the Company declared a cash dividend of $0.35
per share (for a total of $3,647,017), thereby distributing part of the
long-term capital gain generated in 1999 by the sale of NBX Corporation to 3Com
Corporation. Approximately $143,261 of the long-term capital gain for 1999 was
not distributed during 1999. Accordingly, on September 20, 2000, the Company
declared a $0.02 dividend (for a total of $184,817). For the year ended
December 31, 1999, the Company incurred approximately $20,000 in excise taxes.
Provided that a proper election is made, a corporation taxable under
Sub-Chapter C of the Internal Revenue Code (a "C Corporation") that elects to
qualify as a RIC continues to be taxable as a C Corporation on any gains
realized within 10 years of its qualification as a RIC (the "Inclusion Period")
from sales of assets that were held by the corporation on the effective date of
the RIC election ("C Corporation Assets") to the extent of any gain built into
the assets on such date ("Built-In Gain"). (If the corporation fails to make a
proper election, it is taxable on its Built-In Gain as of the effective date of
its RIC election.) The Company had Built-In Gains at the time of its
qualification as a RIC and made the election to be taxed on any Built-In Gain
realized during the Inclusion Period. Prior to 1999, the Company incurred
ordinary and capital losses from its operations. After the Company's election
of RIC status, those losses remained available to be carried forward to
subsequent taxable years. The Company has previously used loss carryforwards to
offset Built-In Gains. As of January 1, 2003, the Company had $501,640 of loss
carryforwards remaining and $4,663,457 of unrealized Built-In Gains.
Continued qualification as a RIC requires the Company to satisfy
certain investment asset diversification requirements in future years. The
Company's ability to satisfy those requirements may not be controllable by the
Company. (See "Sub-Chapter M Status" contained in Item 1. "Business.") There
can be no assurance that the Company will qualify as a RIC in subsequent years.
To the extent that the Company retains capital gains, and declares a
deemed dividend to shareholders, the dividend is taxable to the shareholders.
The Company would pay tax, at the corporate rate, on the distribution, and the
shareholders would receive a tax credit equal to their proportionate share of
the tax paid. The Company took advantage of this rule for 2000 and 2001. The
Company's financial statements for 2000 and 2001 include a tax liability of
$5,709,884 and $290,748, respectively. The taxes paid by the Company's
shareholders as a result of its deemed dividend declaration for 2000
($5,688,896) and 2001 ($271,467) are reflected as a deduction to the additional
paid-in capital in the Company's Consolidated Statement of Assets and
Liabilities rather than an expense in the Consolidated Statement of Operations.
The Company also realized short-term capital gains of approximately
$2,111,865 in 2000, primarily on sales of shares of Alliance Pharmaceutical
Corp. The Company offset the realized short-term gain with 2000 expenses and
neither owed federal income taxes on the gain nor was required to distribute
any portion of this gain to shareholders.
In 2002, the Company realized long-term capital losses of $470,622
primarily from long-term capital gains of $1,008,653 from the Company's
liquidation of its partnership interest in PHZ Capital Partners L.P. offset by
losses on the sale of Schwoo, Inc. of $1,248,825 and on the liquidation of
Informio, Inc. of $350,583. The Company also realized short-term capital gains
of $732,936 primarily from the liquidation of its partnership interest in PHZ
Capital Partners L.P. Realized short-term capital gains were reduced by
realized long-term capital losses resulting in net realized short-term capital
gains. The Company offset the net realized short-term gains with 2002 expenses
and neither owed federal income taxes on the gain nor was required to
distribute any portion of this gain to shareholders.
For the years ended December 31, 2002, 2001 and 2000, the Company's
income tax (benefit) expense was allocated as follows:
2002 2001 2000
Investment operations $ 0 $ 0 $ 0
Realized income on investments 894,435 118,415 101,435
Decrease in unrealized appreciation on
investments (695,126) (90,464) (153,304)
--------------- --------------- ---------------
Total income tax (benefit) expense $ 199,309 27,951 (51,869)
=============== =============== ===============
The above tax (benefit) expense consists of the following:
2002 2001 2000
Current $ 894,435 $ 118,415 $ 101,435
Deferred -- Federal (695,126) (90,464) (153,304)
--------------- --------------- ---------------
Total income tax (benefit) expense $ 199,309 $ 27,951 $ (51,869)
=============== =============== ===============
The Company's net deferred tax liability at December 31, 2002 and 2001 consists of the following:
2002 2001
Unrealized appreciation on investments $ $844,918 $ 1,540,044
Net operating and capital loss carryforward (175,574) (175,574)
--------------- ---------------
Net deferred income tax liability $ 669,344 $ 1,364,470
=============== ===============
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
During 1993, the Company signed a ten-year lease with sublet
provisions for office space. In 1995, this lease was amended to include
additional office space. During 1999, the Company sublet this additional space
to an unaffiliated party. Rent expense under this lease for the year ended
December 31, 2002 was $178,561. Future minimum lease payments in 2003 are
$101,946.
The Company had $750,000 of funds in escrow as of December 31, 2002,
in anticipation of closing an investment in NanoGram Devices Corporation. On
February 3, 2003, the Company announced that it had invested in a convertible
preferred security of Nanogram Devices Corporation.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, the Company established an asset account line of
credit of up to $12,700,000. The asset account line of credit is secured by the
Company's government agency securities. Under the asset account line of credit,
the Company may borrow up to 95 percent of the current value of its government
agency securities. The Company's outstanding balance under the asset line of
credit at December 31, 2001 and December 31, 2002 was $12,495,777 and $0,
respectively. The asset line of credit bears interest at a rate of the Broker
Call Rate plus 50 basis points.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
On January 16, 2003, the Company received $786,492 as final payment in
the liquidation of the Company's investment in PHZ Capital Partners L.P.
On February 3, 2003, the Company announced that it had invested
$750,000 in a convertible preferred security of Nanogram Devices Corporation.
Nanogram Devices has developed and is commercializing specialized power sources
for medical devices and other medical equipment based on its patented,
laser-based nanomaterials synthesis technology.
On March 20, 2003, in order to begin planning for eventual management
succession, the Board of Directors voted to establish a mandatory retirement
plan for individuals who are employed by the Company in a bona fide executive
or high policy making position. There are currently two such individuals, the
Chairman and CEO, and the President and COO. Under this plan, mandatory
retirement will take place effective December 31 of the year in which the
eligible individuals attain the age of 65. On an annual basis beginning in the
year in which the designated individual attains the age of 65, a committee of
the Board consisting of non-interested directors may determine to postpone the
mandatory retirement date for that individual for one additional year for the
benefit of the Company.
Pursuant to applicable age discrimination laws, the Company is
required to establish a pension benefit plan (the "Plan") for such individuals.
The Company's Chairman and CEO has offered, for the benefit of the Company in
connection with its establishment of the Plan, to waive certain of his existing
benefit rights, which is expected to relieve the Company from having to provide
for Plan expense for him. Plan expense to cover the President and COO's
anticipated benefit under the Plan will total approximately a currently
estimated $450,000, which will be unfunded and will be amortized over the
fiscal periods through the year ended December 31, 2004.
- ----------------------------------------------------------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- ----------------------------------------------------------------------------------------------------------------------------------
Per share operating performance:
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Net asset value, beginning of period $ 2.75 $ 3.51 $ 5.80 $ 2.13 $ 3.15
Net operating income (loss) (0.19) (0.06) 0.37 (1.04) (0.26)
Net realized gain (loss) on investments 0.24 0.14 2.09 0.93 (0.16)
Net (decrease) increase in unrealized
appreciation as a result of sales 0.13 0.45 (2.35) (0.46) 0.11
Net decrease (increase) in unrealized
appreciation on investments held (0.46) (1.30) (1.82) 4.58 0.05
Net decrease as a result of cash dividend 0.00 0.00 (0.02) (0.35) (0.75)
Net decrease as a result of deemed
dividend 0.00 (0.03) (0.62) 0.00 0.00
Net increase (decrease) from capital
stock transactions (0.10) 0.04 0.06 0.01 (0.01)
Net asset value, end of period* $ 2.37 $ 2.75 $ 3.51 $ 5.80 $ 2.13
Cash dividends paid per share $ 0.00 $ 0.00 $ 0.02 $ 0.35 $ 0.75
Deemed dividend per share $ 0.00 $ 0.0875 $ 1.78 $ 0.00 $ 0.00
Market value per share, end of period $ 2.46 $ 1.90 $2.4375 $ 11.50 $ 1.50
Total income tax liability per share $ 0.15 $ 0.18 $ 0.78 $ 0.16 $ 0.09
Ratio of expenses to average net assets 8.3% 3.45% (6.21)% 34.08% 10.9%
Ratio of net operating gain (loss) to
average net assets (7.3)% (1.75)% 52.7% (3.50)% (10.4)%
Investment return based on:
Stock price 40.5% (22.1)% (78.8)% 666.7% (45.5)%
Net asset value (13.8)% (21.7)% (39.5)% 188.7% (8.3)%
Portfolio turnover 46.00% 9.00 % 20.56 % 53.54% 19.71%
Net assets, end of period $ 27,256,046 $ 24,334,770 $31,833,475 $53,634,805 $22,556,709
Number of shares outstanding 11,498,845 8,864,231 9,064,231 9,240,831 10,591,232
*Reflects the decline in net asset value as a result of the $0.02 dividend paid in 2000.
The accompanying notes are an integral part of this schedule.
Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC. - 2001
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
The following reports and consolidated financial schedules of Harris &
Harris Group, Inc. are filed herewith and included in response to Item 8.
Documents Page
Report of Independent Public Accountants........................ A-53
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 2001 and 2000........................... A-54
Consolidated Statements of Operations for the
years ended December 31, 2001, 2000 and 1999............... A-55
Consolidated Statements of Cash Flows for the
years ended December 31, 2001, 2000 and 1999............... A-56
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2001, 2000 and 1999............... A-57
Consolidated Schedule of Investments as of December 31, 2001.... A-58
Footnote to Consolidated Schedule of Investments................ A-62
Notes to Consolidated Financial Statements...................... A-66
Selected Per Share Data and Ratios for the
years ended December 31, 2001, 2000, 1999, 1998 and 1997... A-76
Schedules other than those listed above have been omitted because they
are not applicable or the required information is presented in the consolidated
financial statements and/or related notes.
- ------------------------------------------------------------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
- ------------------------------------------------------------------------------
To Harris & Harris Group, Inc.:
We have audited the accompanying consolidated statements of assets and
liabilities of Harris & Harris Group, Inc. (a New York corporation) as of
December 31, 2001 and 2000, including the consolidated schedule of investments
as of December 31, 2001, and the related consolidated statements of operations,
cash flows and changes in net assets for each of the three years ended December
31, 2001, and the selected per share data and ratios for each of the five years
ended December 31, 2001. These consolidated financial statements and selected
per share data and ratios are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and selected per share data and ratios based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements and selected per share data and ratios are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned as of December 31,
2001 and 2000, by correspondence with the custodian and brokers. 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.
As explained in Note 2, the consolidated financial statements include
securities valued at $13,120,978 (53.92 percent of net assets), whose values
have been estimated by the Board of Directors in the absence of readily
ascertainable market values. However, because of the inherent uncertainty of
valuation, those estimated values may differ significantly from the values that
would have been used had a ready market for the securities existed, and the
differences could be material.
In our opinion, the consolidated financial statements and selected per
share data and ratios referred to above present fairly, in all material
respects, the financial position of Harris & Harris Group, Inc. as of December
31, 2001 and 2000, the results of their operations, their cash flows and the
changes in their net assets for the three years ended December 31, 2001, and
the selected per share data and ratios for each of the five years ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States.
/s/ Arthur Andersen LLP
New York, New York
March 21, 2002
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
December 31, 2001 December 31, 2000
Investments, at value (See accompanying
consolidated schedule of investments and notes)................. $ 38,930,705 $ 42,568,559
Cash and cash equivalents........................................... 135,135 253,324
Restricted funds (Note 5)........................................... 482,020 265,183
Interest receivable................................................. 82 30,082
Prepaid expenses.................................................... 14,833 82,615
Note receivable..................................................... 10,487 10,888
Other assets........................................................ 109,105 132,772
Total assets........................................................ $39,682,367 $ 43,343,423
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities............................ $ 1,039,350 $ 771,763
Payable to broker for unsettled trade............................... 0 115,005
Bank loan payable (Note 8).......................................... 12,495,777 0
Accrued profit sharing (Note 3)..................................... 178,282 3,483,241
Deferred rent....................................................... 14,650 23,903
Current income tax liability (Note 6)............................... 255,068 5,751,566
Deferred income tax liability (Note 6).............................. 1,364,470 1,364,470
Total liabilities................................................... 15,347,597 11,509,948
Commitments and contingencies (Note 7)..............................
Net assets.......................................................... $ 24,334,770 $ 31,833,475
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued........................ $ 0 0
Common stock, $0.01 par value, 25,000,000 shares authorized;
10,692,971 issued at 12/31/01
and at 12/31/00................................................. 106,930 106,930
Additional paid in capital (Note 4)................................. 27,228,748 26,724,595
Additional paid in capital - common stock warrants.................. 109,641 109,641
Accumulated net realized gain (loss)................................ 618,606 642,418
Accumulated unrealized appreciation of investments,
net of deferred tax liability of $1,540,044
at 12/31/01 and $1,630,506 at 12/31/00.......................... (323,624) 7,317,422
Treasury stock, at cost (1,828,740 shares at
12/31/01 and 1,628,740 at 12/31/00)............................. (3,405,531) (3,067,531)
Net assets.......................................................... $ 24,334,770 $ 31,833,475
Shares outstanding.................................................. 8,864,231 9,064,231
Net asset value per outstanding share............................... $ 2.75 $ 3.51
=================================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------
Year Ended December Year Ended December Year Ended December
31, 2001 31, 2000 31, 1999
Investment income:
Interest from:
Fixed-income securities................... $ 422,196 $ 554,233 $ 234,347
Portfolio companies....................... 9,616 64,950 48,526
Dividend income.............................. 1,000 2,000 900
Other income................................. 77,849 65,867 3,911
Total investment income................... 510,661 687,050 287,684
Expenses:
Profit-sharing (reversal) accrual
(Note 3).................................... (984,021) (4,812,675) 8,110,908
Salaries and benefits........................ 1,045,063 1,036,737 834,700
Professional fees............................ 261,582 310,601 331,889
Administration and operations................ 406,488 385,608 319,167
Rent......................................... 166,312 166,816 162,987
Directors' fees and expenses................. 90,047 100,469 120,328
Depreciation................................. 26,901 28,748 35,455
Custodian fees............................... 14,518 14,355 8,586
Interest expense (Note 4).................... 8,331 146,141 0
Total expenses............................ 1,035,221 (2,623,200) 9,924,020
Operating income (loss)
before income taxes......................... (524,560) 3,310,250 (9,636,336)
Income tax benefit (Note 6).................. 0 0 0
Net operating income (loss)...................... (524,560) 3,310,250 (9,636,336)
Net realized gain (loss) from investments:
Realized gain (loss) from investments........ 1,394,781 19,065,267 10,976,714
Total realized gain (loss)................ 1,394,781 19,065,267 10,976,714
Income tax expense (Note 6).................. (118,415) (101,435) (2,361,044)
Net realized gain (loss) from investments.... 1,276,366 18,963,832 8,615,670
--------------- --------------- ---------------
Net realized income (loss)....................... 751,806 22,274,082 (1,020,666)
Net (decrease) increase in unrealized appreciation
on investments:
Increase as a result of
investment sales............................ 4,802,738 0 704,801
Decrease as a result of
investment sales............................ (854,467) (21,400,036) (4,939,595)
Increase on investments held................. 3,232,919 26,741,283 43,186,960
Decrease on investments held................. (14,912,698) (43,275,840) (2,477,193)
Change in unrealized --------------- --------------- ---------------
appreciation on investments............... (7,731,508) (37,934,593) 36,474,973
Income tax benefit (Note 6).................. 90,464 153,304 1,627,074
Net (decrease) increase in unrealized --------------- --------------- ---------------
appreciation on investments................. (7,641,044) (37,781,289) 38,102,047
--------------- --------------- ---------------
Net (decrease) increase in net assets
resulting from operations:
Total........................................ $ (6,889,238) $ (15,507,207) $ 37,081,381
=============== =============== ===============
Per outstanding share........................ $ (0.78) $ (1.71) $ 4.01
=============== =============== ===============
The accompanying notes are an integral part of these consolidated financial statements.
=================================================================================================================================
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------------
Year Ended December Year Ended December Year Ended December
31, 2001 31, 2000 31, 1999
Cash flows used in operating activities:
Net (decrease) increase in net assets
resulting from operations............................... $ (6,889,238) $ (15,507,207) $ 37,081,381
Adjustments to reconcile net (decrease) increase
in net assets resulting from operations to
net cash used in operating activities:
Net realized and unrealized loss (gain)
on investments.......................................... 5,950,398 18,869,326 (47,451,687)
Deferred income taxes................................... 90,464 (153,304) 586,710
Depreciation............................................ 26,901 28,748 35,455
Other................................................... 2,010 109,641 0
Interest received in stock.............................. 0 (27,009) 0
Changes in assets and liabilities:........................
Restricted funds........................................ (216,837) (265,183) 0
Receivable from broker for unsettled trades............. 0 0 380,707
Funds in escrow......................................... 0 1,327,748 (1,327,748)
Interest receivable..................................... 30,000 14,107 (43,523)
Prepaid expenses........................................ 67,782 (8,287) 16,321
Notes receivable........................................ 401 0 0
Other assets............................................ 23,667 18,384 (41,281)
Accounts payable and accrued liabilities................ 267,587 71,197 195,448
Payable to broker for unsettled trade................... (115,005) 115,005 0
Accrued profit sharing.................................. (3,304,959) (5,951,226) 8,110,908
Deferred rent........................................... (9,253) (9,253) (9,253)
Current income tax liability............................ (5,496,498) 62,670 0
--------------- --------------- ---------------
Net cash used in operating activities................... (9,572,580) (1,304,643) (2,466,562)
Cash provided by investing activities:
Net (purchase) sale of short-term investments
and marketable securities............................ (10,263,667) (14,480,590) 240,590
Investment in private placements and loans.............. (1,818,826) (6,417,500) (4,077,001)
Proceeds from sale of investments....................... 9,385,615 23,022,868 12,274,632
Purchase of fixed assets................................ (6,508) (6,974) (9,261)
--------------- --------------- ---------------
Net cash (used in) provided by investing activities..... (2,703,386) 2,117,804 8,428,960
Cash flows used in financing activities:
Payment of dividend..................................... 0 (184,817) (3,647,017)
Purchase of treasury stock (Note 4)..................... (338,000) (530,051) (2,373,551)
Proceeds from note payable.............................. 12,495,777 3,000,000 0
Payment of note payable (Note 4)........................ 0 (3,000,000) 0
Proceeds from sale of stock (Note 4).................... 0 0 17,283
Collection on notes receivable.......................... 0 21,775 10,000
--------------- --------------- ---------------
Net cash provided by (used in) financing activities..... 12,157,777 (693,093) (5,993,285)
Net increase (decrease) in cash and cash equivalents: --------------- --------------- ---------------
Cash and cash equivalents at beginning of the year...... 253,324 133,256 164,143
Cash and cash equivalents at end of the year............ 135,135 253,324 133,256
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents $ (118,189) $ 120,068 $ (30,887)
Supplemental disclosures of cash flow information: =============== =============== ===============
Income taxes paid....................................... $ 5,795,916 $ 117,134 $ 122,560
Interest paid........................................... $ 0 $ 36,500 $ 0
The accompanying notes are an integral part of these consolidated financial statements.
----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
----------------------------------------------------------------------------------------------------------------------------
Year Ended December Year Ended December Year Ended December
31, 2001 31, 2000 31, 1999
Changes in net assets from operations:
Net operating income (loss)`....................... $ (524,560) $ 3,310,250 $ (9,636,336)
Net realized gain (loss) on investments............ 1,276,366 18,963,832 8,615,670
Net (decrease) increase in unrealized appreciation
on investments as a result of sales............. 4,038,735 (21,246,732) (2,607,720)
Net (decrease) increase in unrealized appreciation on
investments held.................................. (11,679,779) (16,534,557) 40,709,767
--------------- --------------- ---------------
Net (decrease) increase in net assets resulting from
operations........................................ (6,889,238) (15,507,207) 37,081,381
Changes in net assets from capital stock transactions:
Payment of dividend................................ 0 (184,817) (3,647,017)
Purchase of treasury stock......................... (338,000) (530,051) (2,373,551)
Proceeds from sale of stock ....................... 0 0 17,283
Deemed dividend shareholder tax credit............. (271,467) (5,688,896) 0
Additional paid in capital warrants................ 0 109,641 0
--------------- --------------- ---------------
Net decrease in net assets resulting from capital stock
transactions...................................... (609,467) (6,294,123) (6,003,285)
--------------- --------------- ---------------
Net (decrease) increase in net assets.................. (7,498,705) (21,801,330) 31,078,096
--------------- --------------- ---------------
Net Assets:
Beginning of the year.............................. 31,833,475 53,634,805 22,556,709
--------------- --------------- ---------------
End of the year.................................... $ 24,334,770 $ 31,833,475 $ 53,634,805
=============== =============== ===============
The accompanying notes are an integral part of these consolidated financial statements.
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INVESTMENTS AS OF DECEMBER 31, 2001
- -------------------------------------------------------------------------------------------------------------------------
Method of Valuation Shares/ Value
(3) Principal
Investments in Unaffiliated Companies (10)(11)(12)
-- 4.3% of total investments
Private Placement Portfolio (Illiquid)
-- 4.3% of total investments
AlphaSimplex Group, LLC (1)(2) -- Investment advisory firm
headed by Dr. Andrew W. Lo, holder
of the Harris & Harris Group Chair at MIT.................. (D) -- $ 784
Exponential Business Development
Company (1)(2)(5) Venture capital
partnership focused on early
stage companies
Limited partnership interest............................... (A) - 25,000
Informio, Inc. (1)(2)(6)(7) -- Develops audio web portal
technology -- 0.86% of fully diluted equity
Series A Convertible Preferred Stock ...................... (D) 229,364 151,380
Kriton Medical, Inc. (1)(2)(5)(6) -- Develops ventricular
assist devices -- 1.83% of fully diluted equity
Series B Convertible Preferred Stock.......................... (A) 476,191 1,000,001
Nantero, Inc. (1)(2)(4)(6) -- Develops a high density
nonvolatile random access memory chip using nanotechnology
-- 4.18% of fully diluted equity
Series A Convertible Preferred Stock.......................... (A) 345,000 489,999
Total Private Placement Portfolio (cost: $2,019,601)....................................................... $ 1,667,164
Total Investments in Unaffiliated Companies (cost: $2,019,601)............................................. $ 1,667,164
- ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this consolidated schedule.
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Method of Valuation Shares/
(3) Principal Value
------------------- --------- -----------------
Investments in Non-Controlled Affiliated Companies (16)(19)
-- 29.4% of total investments
Private Placement Portfolio (Illiquid)
-- 29.4% of total investments
Experion Systems, Inc. (1)(2)(6)(8)
-- Develops and sells
software to credit unions
-- 10.77% of fully diluted equity
Convertible Preferred Stock................................ (D) 197,500 $ 1,100,000
NeuroMetrix, Inc. (1)(2)(5)(6)
-- Develops and sells medical devices for monitoring
neuromuscular disorders
-- 13.40% of fully diluted equity
Series A Convertible Preferred Stock....................... (D) 875,000
Series B Convertible Preferred Stock....................... (D) 625,000
Series C-2 Convertible Preferred Stock..................... (D) 1,148,100
Series E Convertible Preferred Stock....................... (D) 266,665 6,708,225
PHZCapital Partners Limited
Partnership (2)(9) -- Organizes
and manages investment
partnerships utilizing its
proprietary algorithms -- 20.0%
of fully diluted equity
Limited partnership interest............................... (D) - 2,921,001
Questech Corporation (1)(2)(6) --
Manufactures and markets
proprietary metal decorative
tiles -- 7.35% of fully diluted
equity
Common Stock............................................... (B) 646,954
Warrants at $5.00 expiring 11/15/04........................ (B) 1,965
Warrants at $1.50 expiring 11/16/05........................ (B) 1,250 724,588
Schwoo, Inc. (1)(2)(4) -- Develops software that automatically
manages e-commerce security
infrastructure -- 14.88% of fully diluted equity
Series B Convertible Stock................................. (D) 2,306,194
Convertible Bridge Loans................................... (D) $ 360,250
Series B Convertible Preferred Warrants.................... (D) 934,985 0
Total Private Placement Portfolio (cost: $9,885,933)....................................................... $ 11,453,814
Total Investments in Non-Controlled Affiliated Companies (cost: $9,885,933)................................ $ 11,453,814
- ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this consolidated schedule.
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Method of Valuation Shares/
(3) Principal Value
------------------- --------- -----------------
U.S. Government and Agency
Obligations -- 66.3% of total
investments
U.S. Treasury Bills -- due date 01/10/02................... (K) $ 12,615,000 $ 12,614,495
U.S. Treasury Bills -- due date 01/10/02................... (K) $ 2,000,000 $ 1,999,260
U.S. Treasury Bills -- due date 01/17/02................... (K) $ 894,000 $ 893,374
U.S. Treasury Bills -- due date 02/07/02................... (K) $ 3,150,000 $ 3,144,897
U.S. Treasury Bills -- due date 02/14/02................... (K) $ 1,700,000 $ 1,696,651
U.S. Treasury Bills -- due date 02/28/02................... (K) $ 580,000 $ 578,422
U.S. Treasury Bills -- due date 03/07/02................... (K) $ 1,030,000 $ 1,026,869
U.S. Treasury Bills -- due date 03/21/02................... (K) $ 3,870,000 $ 3,855,759
Total Investments in U.S. Government (cost: $25,808,751).................................................. $ 25,809,727
Total Investments -- 100% (cost: $37,714,285)............................................................ $ 38,930,705
=================================================================================================================================
The accompanying notes are an integral part of this consolidated schedule.
----------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2001
----------------------------------------------------------------------------
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last 12 months are considered to be
non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the
Methods of Valuation A to L.
(4) Initial investment was made during 2001. The amounts shown on the
schedule as cost represent the gross additions in 2001.
(5) No changes in valuation occurred in these investments during the 12
months ended December 31, 2001.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of
its efforts to establishing a new business, and either it has not yet
commenced its planned principal operations or it has commenced such
operations but has not realized significant revenue from them.
(7) Previously named iPacer Corporation.
(8) Previously named MyPersonalAdvocate.com, Inc.
(9) Harris Partners I, L.P. owns a 20 percent limited partnership interest
in PHZ Capital Partners L.P. The partners of Harris Partners I, L.P.
are Harris & Harris Enterprises, Inc. (sole general partner) and
Harris & Harris Group, Inc. (sole limited partner). Harris & Harris
Enterprises, Inc. is a 100 percent owned subsidiary of Harris & Harris
Group, Inc.
(10) Investments in unaffiliated companies consist of investments in which
the Company owns less than five percent of the portfolio company.
Investments in non-controlled affiliated companies consist of
investments in which the Company owns more than five percent but less
than 25 percent of the portfolio company. Investments in controlled
affiliated companies consist of investments in which the Company owns
more than 25 percent of the portfolio company.
(11) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $2,019,601. The gross unrealized
depreciation based on the tax cost for these securities is $353,221.
The gross unrealized appreciation based on the tax cost for these
securities is $784.
(12) The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential common
equity interest in each such portfolio. The calculated percentage
represents the amount of the issuer's common stock the Company owns or
can acquire as a percentage of the issuer's total outstanding common
stock plus common shares reserved for issued and outstanding warrants,
convertible securities and stock options.
The accompanying notes are an integral part of this consolidated
schedule.
----------------------------------------------------------------------------
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
----------------------------------------------------------------------------
ASSET VALUATION POLICY GUIDELINES
The Company's investments can be classified into five broad categories
for valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH
AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in the Company's portfolio to determine net asset
value of the Company. Under the 1940 Act, unrestricted securities with readily
available market quotations are to be valued at the current market value; all
other assets must be valued at "fair value" as determined in good faith by or
under the direction of the Board of Directors.
The Company's Board of Directors is responsible for 1) determining
overall valuation guidelines and 2) ensuring the valuation of investments
within the prescribed guidelines.
The Company's Investment and Valuation Committee is responsible for
reviewing and approving the valuation of the Company's assets within the
guidelines established by the Board of Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing the assets of the Company, external measures of
value, such as public markets or third-party transactions, are utilized
whenever possible. Valuation is not based on long-term work-out value, nor
immediate liquidation value, nor incremental value for potential changes that
may take place in the future.
Valuation assumes that, in the ordinary course of its business, the
Company will eventually sell its investment.
The Company's valuation policy with respect to the five broad
investment categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
A. Cost: The cost method is based on the original cost to the Company.
This method is generally used in the early stages of a company's development
until significant positive or negative events occur subsequent to the date of
the original investment that dictate a change to another valuation method. Some
examples of such events are: (1) a major recapitalization; (2) a major
refinancing; (3) a significant third-party transaction; (4) the development of
a meaningful public market for the company's common stock; (5) significant
positive or negative changes in the company's business.
B. Private Market: The private market method uses actual third-party
transactions in the company's securities as a basis for valuation, using
actual, executed, historical transactions in the company's securities by
responsible third parties. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by the
Company. The Company discounts market value for securities that are subject to
significant legal, contractual or practical restrictions. Other securities, for
which market quotations are readily available, are carried at market value as
of the time of valuation.
Market value for securities traded on securities exchanges or on the
Nasdaq National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter market and
listed securities for which no sale was reported on that day, market value is
the mean of the closing bid price and asked price on that day.
This method is the preferred method of valuation when there is an
established public market for a company's securities, as that market provides
the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market in
the company's securities or when the factual information available to the
Company dictates that an investment should no longer be valued under either the
cost or private market method. This valuation method is inherently imprecise
and ultimately the result of reconciling the judgments of the Company's
Investment and Valuation Committee members, based on the data available to
them. The resulting valuation, although stated as a precise number, is
necessarily within a range of values that vary depending upon the significance
attributed to the various factors being considered. Some of the factors
considered may include the financial condition and operating results of the
company, the long-term potential of the business of the company, the values of
similar securities issued by companies in similar businesses, the proportion of
the company's securities owned by the Company and the nature of any rights to
require the company to register restricted securities under applicable
securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on the original cost to the Company.
Such method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and development in
technology or product development until significant positive or adverse events
occur subsequent to the date of the original investment that dictate a change
to another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to the Company dictates that an investment should
no longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of the Company's Investment and Valuation Committee
members. The resulting valuation, although stated as a precise number, is
necessarily within a range of values that vary depending upon the significance
attributed to the various factors being considered. Some of the factors
considered may include the results of research and development, product
development progress, commercial prospects, term of patent and projected
markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services
that provide market quotations based primarily on quotations from dealers and
brokers, market transactions, and other sources.
J. Other Fixed-Income Securities that are not readily marketable are
valued at fair value by the Investment and Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
K. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days or
less is valued at amortized cost.
ALL OTHER INVESTMENTS
L. All Other Investments are reported at fair value as determined in
good faith by the Investment and Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Investment and Valuation
Committee's judgment of fair values as of the valuation date using the outlined
basic methods of valuation. They do not necessarily represent an amount of
money that would be realized if the securities had to be sold in an immediate
liquidation. The Company makes many of its portfolio investments with the view
of holding them for a number of years, and the reported value of such
investments may be considered in terms of disposition over a period of time.
Thus valuations as of any particular date are not necessarily indicative of
amounts that may ultimately be realized as a result of future sales or other
dispositions of investments held.
- -------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company") is a venture capital
investment company operating as a business development company ("BDC") under
the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type
of investment company under the 1940 Act. The Company operates as an
internally managed investment company whereby its officers and employees,
under the general supervision of its Board of Directors, conduct its
operations.
The Company elected to become a BDC on July 26, 1995, after receiving
the necessary approvals. From September 30, 1992 until the election of BDC
status, the Company operated as a closed-end, non-diversified, investment
company under the 1940 Act. Upon commencement of operations as an investment
company, the Company revalued all of its assets and liabilities at fair value
as defined in the 1940 Act. Prior to such time, the Company was registered and
filed under the reporting requirements of the Securities and Exchange Act of
1934 as an operating company and, while an operating company, operated
directly and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent
wholly owned subsidiary of the Company. Enterprises holds the lease for the
office space, which it subleases to the Company and an unaffiliated party;
operates a financial relations and consulting firm; is a partner in Harris
Partners I, L.P. and is taxed as a C corporation. Harris Partners I, L.P. is a
limited partnership and owns a 20 percent limited partnership interest in PHZ
Capital Partners L.P. The partners of Harris Partners I, L.P. are Enterprises
(sole general partner) and Harris & Harris Group, Inc. (sole limited partner).
The Company filed for 1999 to elect treatment as a Regulated
Investment Company ("RIC") under Sub-Chapter M of the Internal Revenue Code of
1986 (the "Code") and qualified for the same treatment for 2000 and 2001.
There can be no assurance that the Company will qualify as a RIC in subsequent
years or that if it does qualify, it will continue to qualify for subsequent
years. In addition, even if the Company were to qualify as a RIC for a given
year, the Company might take action in a subsequent year to ensure that it
would be taxed in that subsequent year as a C Corporation, rather than as a
RIC. As a RIC, the Company must, among other things, distribute at least 90
percent of its taxable net income and may either distribute or retain its
realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies
followed in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for investment companies and include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "fair
value" as defined in the 1940 Act and in the applicable regulations of the
Securities and Exchange Commission. All assets are valued at fair value as
determined in good faith by, or under the direction of, the Board of
Directors. (See "Asset Valuation Policy Guidelines" in the "Footnote to
Consolidated Schedule of Investments.")
Securities Transactions. Securities transactions are accounted for on
the date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined on
specific identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, the Company recorded income
taxes using the liability method in accordance with the provision of Statement
of Financial Accounting Standards No. 109. Accordingly, deferred tax
liabilities had been established to reflect temporary differences between the
recognition of income and expenses for financial reporting and tax purposes,
the most significant difference of which relates to the Company's unrealized
appreciation on investments.
The December 31, 2001 consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of
December 31, 1998, net of the unutilized operating and capital loss
carryforwards incurred by the Company through December 31, 1998.
These statements also reflect a tax liability on realized net
long-term capital gains which the Company intends to retain for liquidity and
to fund investment opportunities, rather than distribute to shareholders as a
cash distribution. Accordingly, the Company declared a designated
undistributed capital gain dividend for the year. (See "Note 6 Income Taxes"
and Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operation -- Recent Developments -- Sub-Chapter M Status.")The
Company pays federal, state and local income taxes on behalf of its wholly
owned subsidiary, Harris & Harris Enterprises, which is a C corporation. (See
"Note 6 Income Taxes.")
Reclassifications. Certain reclassifications have been made to the
December 31, 1998 and December 31, 1999 financial statements to conform to the
December 31, 2000 presentation.
Estimates by Management. The preparation of the consolidated
financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of
December 31, 2001 and 2000, and the reported amounts of revenues and expenses
for the three years ended December 31, 2001. Actual results could differ from
these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- ------------------------------------
On August 3, 1989, the shareholders of the Company approved the 1988
Long Term Incentive Compensation Plan. The Company's 1988 Plan was cancelled
as of December 31, 1997, canceling all outstanding stock options and
eliminating all potential stock option grants. As a substitution for the 1988
Stock Option Plan, the Company adopted an employee profit-sharing plan.
As of January 1, 1998, the Company began implementing the Harris &
Harris Group, Inc. Employee Profit Sharing Plan (the "1998 Plan") that
provides for profit sharing equal to 20 percent of the net realized income of
the Company as reflected on the Consolidated Statements of Operations for such
year, less the nonqualifying gain, if any. The 1998 Plan was terminated by the
Company as of December 31, 1999, subject to the payment of any amounts owed on
the 1999 realized gains under the 1998 Plan.
In March 2000, the Company paid out, under the 1998 Plan, 90 percent
of the profit sharing in the amount of $1,024,696 on the 1999 realized gains;
the remaining 10 percent or $113,855 was paid out in September 2000, upon the
completion and filing of the Company's 1999 federal tax return.
As of January 1, 2000, the Company implemented the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan (the "Plan") that provides for profit
sharing equal to 20 percent of the net realized income of the Company as
reflected on the Consolidated Statements of Operations of the Company for such
year, less the nonqualifying gain, if any.
Under the Plan, net realized income of the Company includes
investment income, realized gains and losses, and operating expenses
(including taxes paid or payable by the Company), but is calculated without
regard to dividends paid or distributions made to shareholders, payments under
the Plan, unrealized gains and losses, and loss carry-overs from other years
("Qualifying Income"). The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 is considered
non-qualifying gain, which reduces Qualifying Income.
As soon as practicable following the year-end audit, the Board of
Directors will determine whether, and if so how much, Qualifying Income exists
for a plan year, and 90 percent of the Qualifying Income will be paid out to
Plan participants pursuant to the distribution percentages set forth in the
Plan. The remaining 10 percent will be paid out after the Company has filed
its federal tax return for that year in which Qualifying Income exists.
Currently, the distribution amounts for each officer and employee are as
follows: Charles E. Harris, 13.790 percent; Mel P. Melsheimer, 4.233 percent;
Helene B. Shavin, 1.524 percent; and Jacqueline M. Matthews, 0.453 percent. If
a participant leaves the Company for other than cause, the amount earned will
be accrued and may subsequently be paid to such participant.
Notwithstanding any provisions of the Plan, in no event may the
aggregate amount of all awards payable for any Plan year during which the
Company remains a "business development company" within the meaning of 1940
Act be greater than 20 percent of the Company's "net income after taxes"
within the meaning of Section 57(n)(1)(B) of the 1940 Act. In the event the
awards exceed such amount, the awards will be reduced pro rata.
The Plan may be modified, amended or terminated by the Company's
Board of Directors at any time with the stipulation that no such modification,
amendment or termination may adversely affect any participant that has not
consented to such modification, amendment or termination. Nothing in this Plan
shall preclude the Committee from, for any Plan Year subsequent to the current
Plan Year, naming additional Participants in the Plan or changing the Award
Percentage of any Full Participant or New Participant (subject to the overall
percentage limitations contained herein).
The Company calculates the Plan accrual at each quarter end based on
the realized and unrealized gains at that date, net of operating expenses and
income taxes for the year. Any adjustments to the Plan accrual are then
reflected in the Consolidated Statements of Operations for that quarter. The
Plan accrual is not paid out until the gains are realized. During 2000, the
Company, as a result of a net decrease in the unrealized appreciation,
decreased the profit-sharing accrual by $4,812,675 and paid out the 1999
profit sharing in the amount of $1,138,551, which decreased the cumulative
accrual under the Plan to $3,483,241 at December 31, 2000.
The amounts payable under the Plan of $2,320,939 for the gains
realized during the year ended December 31, 2000 were paid out as follows: 90
percent in February 2001; the remaining 10 percent upon the completion and
filing of the Company's 2000 federal tax return. Additionally, during 2001,
the Company decreased the profit-sharing accrual by $984,021, bringing the
cumulative accrual under the Plan to $178,282 at December 31, 2001.
On April 26, 2000, the shareholders of the Company approved the
performance goals under the Plan in accordance with Section 162(m) of the
Code. The Code generally provides that a public company such as the Company
may not deduct compensation paid to its chief executive officer or to any of
its four most highly compensated officers to the extent that the compensation
paid to any such officer/employee exceeds $1 million in any tax year, unless
the payment is made upon the attainment of objective performance goals that
are approved by the Company's shareholders.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that, effective January 1,
1998, 50 percent of all Directors' fees be used to purchase Company common
stock from the Company. However, effective March 1, 1999, the directors may
purchase the Company's common stock in the open market, rather than from the
Company. During 1999, the Directors bought directly from the Company 5,816
shares.
On July 14, 1999, the Board of Directors announced a tender offer to
purchase up to 1,100,000 shares of its common stock for cash at a price equal
to $1.63 per share. A total of 1,080,569 shares were tendered for a total
cost, including related expenses of approximately $71,500, of $1,832,831. Of
these shares, 1,075,269 were tendered by one shareholder, which tendered all
of its holdings.
On January 27, 2000, the Company placed privately, with an
unaffiliated investor, for $3 million in cash, a one-year, 12 percent note
with one-year warrants to purchase 25,263 shares of the Company's common stock
at $11.8750 per share. Unless the note was prepaid, six months after its
issuance, the investor would have received additional one-year warrants to
purchase an additional $300,000 worth of the Company's common stock at the
then-current market price. During March 2000, with part of the proceeds from
the sale of SciQuest.com stock, the Company prepaid the Note. The Company
incurred total interest costs of $146,141: $36,500 in interest paid on the
note and $109,641 on warrants. The warrants expired unexercised.
On October 12, 2000, the Company announced that the Board of
Directors had authorized a repurchase program in the open market of up to $2
million of the Company's stock, at the discretion of management. As of
December 31, 2001, the Company had repurchased a total of 376,600 shares in
the open market, at approximately $2.30 per share, for a total of $868,051.
Since 1998, the Company has repurchased a total of 1,859,047 of its
shares for a total of $3,496,388, including commissions and expenses, at an
average price of $1.88 per share. These treasury shares were reduced by the
purchases made by the Directors.
On December 14, 2000, the Company declared a deemed dividend of $1.78
per share for a total of $16,253,987, and in 2001, the Company paid federal
income taxes on behalf of shareholders of $0.62 per share for a total of
$5,688,896. The Company paid the tax at the corporate rate on the
distribution, and the shareholders received a tax credit equal to their
proportionate share of the tax paid.
On January 22, 2002, the Company declared a deemed dividend of
$0.0875 per share for a total of $775,620, and in 2002 the Company paid
federal income taxes on behalf of shareholders of $0.030625 per share for a
total of $271,467. The Company paid the tax at the corporate rate on the
distribution, and the shareholders received a tax credit equal to their
proportionate share of the tax paid.
The net of the total deemed dividends declared in 2000 ($16,253,987)
and 2001 ($775,620) and the taxes paid on behalf of shareholders in 2000
($5,688,896) and 2001 ($271,467) is considered to be reinvested by the
shareholders; therefore, during 2000 and 2001, additional paid in capital has
increased by $10,565,091 and $504,153, respectively.
The tax character of the 2001 deemed dividend is long-term capital
gain.
As of December 31, 2001, there are no distributable earnings. The
difference between the book basis and tax basis components of distributable
earnings is attributed to Built-In Gains generated at the time of the
Company's qualification as a RIC (see Note 6. "Income Taxes") and after tax
earnings that are not required to be distributed.
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with the Company (disclosed in a Form 8-K filed on October 27, 1999) (the
"Employment Agreement"), which superseded an employment agreement that was
about to expire on December 31, 1999. The Employment Agreement shall terminate
on December 31, 2004 ("Term") subject to either an earlier termination or an
extension in accordance with the terms; on January 1, 2000 and on each day
thereafter, the Term extends automatically by one day unless at any time the
Company or Mr. Harris, by written notice, decides not to extend the Term, in
which case the Term will expire five years from the date of the written
notice.
During the period of employment, Mr. Harris shall serve as the
Chairman and Chief Executive Officer of the Company; be responsible for the
general management of the affairs of the Company and all its subsidiaries,
reporting directly to the Board of Directors of the Company; serve as a member
of the Board for the period of which he is and shall from time to time be
elected or reelected; and serve, if elected, as President of the Company and
as an officer and director of any subsidiary or affiliate of the Company.
Mr. Harris is to receive compensation under his Employment Agreement
in the form of base salary of $208,315 for 2000, with automatic yearly
adjustments to reflect inflation. In addition, the Board may increase such
salary, and consequently decrease it, but not below the level provided for by
the automatic adjustments described above. Mr. Harris is also entitled to
participate in the Company's Profit-Sharing Plan as well as in all
compensation or employee benefit plans or programs, and to receive all
benefits, perquisites, and emoluments for which salaried employees are
eligible. Under the Employment Agreement, the Company is to furnish Mr. Harris
with certain perquisites which include a company car, membership in certain
clubs and up to a $5,000 annual reimbursement for personal, financial or tax
advice.
The Employment Agreement provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of $2,000,000;
provides reimbursement for uninsured medical expenses, not to exceed $10,000
per annum, adjusted for inflation, over the period of the contract; provides
Mr. Harris and his spouse with long-term care insurance; and disability
insurance in the amount of 100 percent of his base salary. These benefits are
for the term of the Employment Agreement.
The Employment Agreement provides for the Company to adopt a
supplemental executive retirement plan (the "SERP") for the benefit of Mr.
Harris. Under the SERP, the Company will cause an amount equal to one-twelfth
of the Mr. Harris's current base salary to be credited each month (a "Monthly
Credit") to a special account maintained for this purpose on the books of the
Company for the benefit of Mr. Harris (the "SERP Account"). The amounts
credited to the SERP Account will be deemed invested or reinvested in such
mutual funds or U.S. Government securities as determined by Mr. Harris. The
SERP Account will be credited and debited to reflect the deemed investment
returns, losses and expenses attributed to such deemed investments and
reinvestments. Mr. Harris' benefit under the SERP will equal the balance in
the SERP Account and such benefit will always be 100 percent vested (i.e., not
forfeitable). Mr. Harris will determine the form and timing of the
distribution of the balance in the SERP Account; provided, however, in the
event of the termination, the balance in the SERP Account will be distributed
to Mr. Harris or his beneficiary, as the case may be, in a lump-sum payment
within 30 days of such termination. The Company will establish a rabbi trust
for the purpose of accumulating funds to satisfy the obligations incurred by
the Company under the SERP. The restricted funds for the SERP Plan total
$482,020 as of December 31, 2001. Mr. Harris' rights to benefits pursuant to
this SERP will be no greater than those of a general creditor of the Company.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the
executive's base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with the Company,
effective August 15, 1990. The severance compensation agreement provides that
if, following a change in control of the Company, as defined in the agreement,
such individual's employment is terminated by the Company without cause or by
the executive within one year of such change in control, the individual shall
be entitled to receive compensation in a lump sum payment equal to 2.99 times
the individual's average annualized compensation and payment of other welfare
benefits. If Mr. Harris' termination is without cause or is a constructive
discharge, the amount payable under the Employment Agreement will be reduced
by the amounts paid pursuant to the severance compensation agreement.
As of January 1, 1989, the Company adopted an employee benefits
program covering substantially all employees of the Company under a 401(k)
Plan and Trust Agreement. As of January 1, 1999, the Company adopted the
Harris & Harris Pension Plan and Trust, a money purchase plan which would
allow the Company to stay compliant with the 401(k) top-heavy regulations and
deduction limitation regulations. In 2001, Congress enacted the Economic
Growth and Tax Relief Reconciliation Act of 2001 which has increased the
deduction limits for plans such as the 401(k) Plan. This Act eliminates the
need for the Company to maintain two separate plans. Effective December 31,
2001, the Pension Plan merged into the 401(k) Plan, with the 401(k) Plan being
the surviving plan. Contributions to the plan are at the discretion of the
Company. During 2001, contributions to the plan that have been charged to
salaries and benefits totaled approximately $40,000.
On June 30, 1994, the Company adopted a plan to provide medical and
health insurance for retirees, their spouses and dependents who, at the time
of their retirement, have ten years of service with the Company and have
attained 50 years of age or have attained 45 years of age and have 15 years of
service with the Company. On February 10, 1997, the Company amended this plan
to include employees who "have seven full years of service and have attained
58 years of age." The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of December 31,
2001 the Company had a reserve of $385,935 for the plan.
NOTE 6. INCOME TAXES
- ---------------------
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification as a RIC under Sub-Chapter M of the Code. As a
RIC, the Company annually must distribute at least 90 percent of its
investment company taxable income as a dividend and may either distribute or
retain its realized net capital gains from investments. To initially qualify
as a RIC, among other requirements, the Company had to pay a dividend to
shareholders equal to the Company's cumulative realized earnings and profits
("E&P"). On April 9, 1998, the Company declared a one-time cash dividend of
$0.75 per share to meet this requirement (for a total of $8,019,728). The cash
dividend was paid on May 12, 1998.
The Company elected Sub-Chapter M status for the year ended December
31, 1999. On February 23, 1999, the Company declared a cash dividend of $0.35
per share (for a total of $3,647,017), thereby distributing part of the
long-term capital gain generated in 1999 by the sale of NBX Corporation to
3Com Corporation. Approximately $143,261 of the long-term capital gain for
1999 was not distributed during 1999. Accordingly, on September 20, 2000, the
Company declared a $0.02 dividend (for a total of $184,817). For the year
ended December 31, 1999, the Company incurred approximately $20,000 in excise
taxes.
A corporation that elects to qualify as a RIC continues to be taxable
as a C Corporation on any gains realized within 10 years of its qualification
as a RIC from sales of assets that were held by the corporation on the
effective date of the election ("C Corporation Assets") to the extent of any
gain built into the assets on such date ("Built-In Gain"). The Company had
Built-In Gains at the time of its qualification as a RIC. Prior to 1999, the
Company incurred ordinary and capital losses from its operations. After the
Company's election of RIC status, those losses remained available to be
carried forward to subsequent taxable years. Recently issued Internal Revenue
Service regulations (issued in temporary and proposed form) confirm that such
losses may be used to offset realized Built-In Gains and, to the extent so
used, to eliminate C Corporation taxation of such gains. Notwithstanding any
such offset, however, the new regulations also provide that all realized
Built-In Gains (calculated without regard to the offset, but net of any C
Corporation tax imposed on the Built-In Gains after application of the offset)
must be included in calculating a RIC's investment company taxable income or
net capital gains, as the case may be, and therefore appear to require that
such Built-In Gains must be distributed to avoid Sub-Chapter M taxation of
such investment company taxable income or net capital gains (and, in the case
of any Built-In Gains that are includible in investment company taxable
income, possible loss of RIC status). The Company has previously used loss
carryforwards to offset Built-In Gains. As of January 1, 2002, the Company had
$501,640 of loss carryforwards remaining and $4,663,457 of unrealized Built-In
Gains.
Continued qualification as a RIC requires the Company to satisfy
certain portfolio diversification requirements in future years. The Company's
ability to satisfy those requirements may not be controllable by the Company.
(See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operation -- Sub-Chapter M Status.") There can be no assurance that
the Company will qualify as a RIC in subsequent years.
To the extent that the Company retains capital gains, and declares a
deemed dividend to shareholders, the dividend is taxable to the shareholders.
The Company would pay tax, at the corporate rate, on the distribution, and the
shareholders would receive a tax credit equal to their proportionate share of
the tax paid. The Company took advantage of this rule for 2000 and 2001.
Accordingly, the Company's financial statements for 2000 and 2001 include a
tax liability of $5,709,884 and $290,748, respectively. The taxes paid by the
Company's shareholders as a result of its deemed dividend declaration for 2000
($5,688,896) and 2001 ($271,467) are reflected as a deduction to the
additional paid-in capital in the Company's Consolidated Statement of Assets
and Liabilities rather than an expense in the Consolidated Statement of
Operations.
The Company also realized short-term capital gains of approximately
$2,111,865 in 2000, primarily on sales of shares of Alliance Pharmaceutical
Corp. The Company offset the realized short-term gain with 2000 expenses and
neither owed federal income taxes on the gain nor was required to distribute
any portion of this gain to shareholders.
For the years ended December 31, 2001, 2000 and 1999, the Company's
income tax (benefit) expense was allocated as follows:
2001 2000 1999
Investment operations $ 0 $ 0 $ 0
Realized loss on investments 118,415 101,435 2,361,044
Decrease in unrealized
appreciation on investments (90,464) (153,304) (1,627,074)
---------- ---------- ------------
Total income tax (benefit) expense $ 27,951 $ (51,869) $ 733,970
========== ========== ============
The above tax (benefit) expense consists of the following:
2001 2000 1999
Current $ 118,415 $ 101,435 $ 2,361,044
Deferred -- Federal (90,464) (153,304) (1,627,074)
---------- ---------- ------------
Total income tax (benefit) expense $ 27,951 $ (51,869) $ 733,970
========== ========== ============
The Company's net deferred tax liability at December 31, 2001 and
2000 consists of the following:
2001 2000
Unrealized appreciation on investments $ 1,540,044 $ 1,630,506
Net operating and capital loss carryforward (175,574) (266,036)
-------------- -------------
Net deferred income tax liability $ 1,364,470 $ 1,364,470
============== =============
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
During 1993, the Company signed a ten-year lease with sublet
provisions for office space. In 1995, this lease was amended to include
additional office space. During 1999, the Company sublet this additional space
to an unaffiliated party. Rent expense under this lease for the year ended
December 31, 2001 was $178,561. Future minimum lease payments in each of the
following years are: 2002 -- $178,561; 2003 -- $101,946.
The Company had a total of $1,475,276 of funds in escrow as of
December 31, 1999 as a result of the sale of NBX Corporation to 3Com
Corporation. These funds were in a one-year interest-bearing escrow account
for the benefit of the Company, subject to any 3Com Corporation warranty
claims associated with its acquisition of NBX Corporation. The Company set up
a reserve of 10 percent for any potential claims, therefore the funds in
escrow reflected $1,327,748 net of the reserve of $147,528. The Company
received the full escrow monies including interest of $65,860 for a total of
$1,541,136 on March 6, 2000, and accordingly realized the $147,528 in 2000.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, the Company established an asset account line
of credit of up to $12,700,000. The asset account line of credit is secured by
the Company's government agency securities. Under the asset account line of
credit, the Company may borrow up to 95 percent of the current value of its
government agency securities. The Company's outstanding balance under the
asset line of credit at December 31, 2001 was $12,495,777. The asset line of
credit bears interest at a rate of the Broker Call Rate plus 50 basis points.
On January 3, 2002, the Company repaid the entire outstanding balance under
the asset line of credit.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
On January 3, 2002, the Company paid the balance due on the credit
line of $12,495,777.
On January 29, 2002, the Company invested an additional $100,000 in
Series B preferred stock of Experion Systems, Inc.
On February 12, 2002, the Company announced that it had purchased for
$700,000 a Series A preferred stock which represented an approximate 15
percent fully diluted equity interest in Nanopharma Corp. Nanopharma is a
privately held company spun off from Massachusetts General Hospital.
Nanopharma, which is based in Massachusetts, is a research company founded to
develop advanced drug delivery systems based on patented technology.
On February 20, 2002, Schwoo, Inc. filed for Chapter 7 bankruptcy.
The Company wrote off its investment in Schwoo in 2001.
On March 7, 2002, the Company invested approximately $625,000 in
Series A-1 preferred stock of a privately held company engaged in the
production of nanoscale components based on patented technology. Under certain
conditions, the Company will be obligated to invest an additional $375,000 in
the Series A-1 preferred.
On March 8, 2002, the Company invested $1,000,000 in Series D
preferred stock of privately held NEO Photonics Corporation. NEO Photonics has
developed patented technology that enables the manufacture of unique nanoscale
optical compositions for the telecommunications industry.
On March 8, 2002, the Company announced that its Board of Directors
has expanded its size from eight to nine and has elected Kelly S. Kirkpatrick,
a consulting materials scientist, as a member of its board of directors.
On March 22, 2002, the Company announced that its Board of Directors
has expanded its size from nine to ten and has elected Lori D. Pressman, a
business consultant, as a member of its board of directors.
- ------------------------------------------------------------------------------
SELECTED PER SHARE DATA AND RATIOS
- ------------------------------------------------------------------------------
Per share operating performance:
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
2001 2000 1999 1998 1997
------------ ----------- ------------ ----------- ------------
Net asset value, beginning of period $ 3.51 $ 5.80 $ 2.13 $ 3.15 $ 3.44
Net operating income (loss) (0.06) 0.37 (1.04) (0.26) (0.14)
Net realized gain (loss) on investments 0.14 2.09 0.93 (0.16) (0.19)
Net (decrease) increase in unrealized
appreciation as a result of sales 0.45 (2.35) (0.46) 0.11 (0.17)
Net decrease (increase) in unrealized
appreciation on investments held (1.30) (1.82) 4.58 0.05 0.26
Net decrease as a result of cash
dividend 0.00 (0.02) (0.35) (0.75) 0.0
Net decrease as a result of deemed
dividend (0.03) (0.62) 0.00 0.00 0.00
Net increase (decrease) from capital
stock transactions 0.04 0.06 0.01 (0.01) (0.05)
----------- ------------ ------------ ------------ ------------
Net asset value, end of period* $ 2.75 $ 3.51 $ 5.80 $ 2.13 $ 3.15
=========== ============ ============ ============ ============
Cash dividends paid per share $ 0.00 $ 0.02 $ 0.35 $ 0.75 $ 0.00
Deemed dividend per share $ 0.0875 $ 1.78 $ 0.00 $ 0.00 $ 0.00
Market value per share, end of period $ 1.90 $ 2.4375 $ 11.50 $ 1.50 $ 3.50
Total income tax liability per share $ 0.18 $ 0.78 $ 0.16 $ 0.09 $ 0.06
Ratio of expenses to average net assets 3.45% (6.21)% 34.08% 10.9% 9.1%
Ratio of net operating gain (loss) to
average net assets (1.75)% 52.7% (3.50)% (10.4)% (4.5)%
Investment return based on:
Stock price (22.1)% (78.8)% 666.7% (45.5)% (6.7)%
Net asset value (21.7)% (39.5)% 188.7% (8.3)% (8.4)%
Portfolio turnover 9.00% 20.56% 53.54% 19.71% 77.2%
Net assets, end of period $ 24,334,770 $ 31,833,475 $ 53,634,805 $ 22,556,709 $ 33,654,934
Number of shares outstanding 8,864,231 9,064,231 9,240,831 10,591,232 10,692,971
* Reflects the decline in net asset value as a result of the $0.02 dividend paid in 2000, the $0.35 dividend paid
in 1999 and the $0.75 dividend paid in 1998.
The accompanying notes are an integral part of this schedule.
- -----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
March 31, 2004 December 31, 2003
(Unaudited) (Audited)
Investments, at value (Cost: $54,634,386 at 3/31/04,
$44,603,778 at 12/31/03)............................................. $ 53,041,457 $ 42,227,062
Cash and cash equivalents................................................. 389,811 425,574
Restricted funds (Note 5)................................................. 1,330,645 1,212,078
Interest receivable....................................................... 20,565 450
Income tax receivable..................................................... 11,035 17,375
Prepaid expenses.......................................................... 79,165 6,841
Other assets, net of reserve of $255,486 at 3/31/04....................... 232,903 225,748
------------- -------------
Total assets.............................................................. $ 55,105,581 $ 44,115,128
============= =============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities.................................. $ 2,311,831 $ 2,723,398
Payable to broker for unsettled trade..................................... 10,583,080 0
Deferred rent............................................................. 38,073 39,648
Deferred income tax liability (Note 6).................................... 669,344 669,344
------------- -------------
Total liabilities......................................................... 13,602,328 3,432,390
------------- -------------
Net assets................................................................ $ 41,503,253 $ 40,682,738
============= =============
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued............................. $ 0 $ 0
Common stock, $0.01 par value, 25,000,000 shares authorized;
15,627,585 issued at 3/31/04 and 12/31/03............................ 156,276 156,276
Additional paid in capital (Note 4)....................................... 49,564,475 49,564,475
Accumulated net realized gain (loss)...................................... (2,374,119) (2,410,847)
Accumulated unrealized appreciation of investments, net of
deferred tax liability of $844,918 at 3/31/04 and 12/31/03........... (2,437,848) (3,221,635)
Treasury stock, at cost (1,828,740 shares at 3/31/04 and
12/31/03)............................................................ (3,405,531) (3,405,531)
-------------- --------------
Net assets................................................................ $ 41,503,253 $ 40,682,738
============= =============
Shares outstanding........................................................ 13,798,845 13,798,845
============= =============
Net asset value per outstanding share..................................... $ 3.01 $ 2.95
============= =============
The accompanying notes are an integral part of this consolidated schedule.
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
Investment income:
Interest from:
Fixed income securities........................................ $ 55,853 $ 46,246
Portfolio companies............................................ 683 0
Other income....................................................... 0 18,430
------------ ------------
Total investment income........................................ 56,536 64,676
Expenses:
Salaries and benefits.............................................. 470,075 362,196
Administration and operations...................................... 159,299 95,112
Professional fees.................................................. 79,061 67,158
Rent............................................................... 33,737 47,877
Directors' fees and expenses....................................... 52,446 56,365
Depreciation....................................................... 9,283 9,980
Custodian fees..................................................... 2,500 2,187
Interest expense (Note 4).......................................... 0 8,261
------------ ------------
Total expenses................................................. 806,401 649,136
------------ ------------
Operating loss before income taxes................................. (749,865) (584,460)
Income tax provision (Note 6)...................................... 0 0
------------ ------------
Net operating loss....................................................... (749,865) (584,460)
Net realized gain on investments:
Realized gain on investments....................................... 793,389 432
------------ ------------
Total realized gain............................................ 793,389 432
Income tax provision (Note 6)...................................... (6,796) (2,973)
------------ ------------
Net realized gain (loss) on investments.................................. 786,593 (2,541)
------------ ------------
Net realized gain (loss)................................................. 36,728 (587,001)
Net decrease in unrealized appreciation on investments:
Decrease as a result of investment sales........................... 0 0
Increase as a result of investment sales........................... 915,118 0
Increase on investments held....................................... 40,258 227,838
Decrease on investments held....................................... (171,589) (855,964)
------------ ------------
Change in unrealized appreciation on investments............... 783,787 (628,126)
Income tax provision (Note 6)...................................... 0 0
------------ ------------
Net increase (decrease) in unrealized
appreciation on investments.................................... 783,787 (628,126)
------------ ------------
Net increase (decrease) in net assets resulting from operations:
Total.............................................................. $ 820,515 $ (1,215,127)
============ ============
Per outstanding share.............................................. $ 0.06 $ (0.11)
============ ============
The accompanying notes are an integral part of this consolidated schedule.
- ------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
Cash flows from operating activities:
Net increase (decrease) in net assets resulting from operations.......... $ 820,515 $ (1,215,127)
Adjustments to reconcile net increase (decrease) in net assets
resulting from operations to net cash used in operating activities:
Net realized and unrealized gain on investments.................... (1,577,176) 627,694
Depreciation....................................................... 9,283 9,980
Changes in assets and liabilities:
Restricted funds................................................... (118,567) (5,588)
Receivable from portfolio company.................................. 0 786,492
Funds in escrow.................................................... 0 750,000
Interest receivable................................................ (20,115) (21,897)
Current income tax receivable...................................... 6,340 (72,546)
Prepaid expenses................................................... (72,324) 20,764
Other assets....................................................... (3,212) (2,072)
Accounts payable and accrued liabilities........................... (411,567) 67,779
Payable to broker for unsettled trade.............................. 10,583,080 (5,696,725)
Accrued profit sharing............................................. 0 (13,710)
Current income tax liability....................................... 0 (857,656)
Deferred rent...................................................... (1,575) (2,313)
-------------- ----------------
Net cash provided by (used in) operating activities................ 9,214,682 (5,624,925)
Cash flows from investing activities:
Net purchase of short-term investments
and marketable securities...................................... (4,520,645) (7,211,448)
Proceeds from investments.......................................... 2,506,588 12,088
Investment in private placements and loans......................... (7,223,662) (750,000)
Purchase of fixed assets........................................... (12,726) (1,330)
-------------- ----------------
Net cash used in investing activities.............................. (9,250,445) (7,950,690)
Cash flows from financing activities:
Proceeds from bank loan payable.................................... 0 7,724,207
Net cash provided by financing activities.......................... 0 7,724,207
-------------- ----------------
Net decrease in cash and cash equivalents:
Cash and cash equivalents at beginning of the period............... 425,574 5,967,356
Cash and cash equivalents at end of the period..................... 389,811 115,948
-------------- ----------------
Net decrease in cash and cash equivalents.......................... $ (35,763) $ (5,851,408)
============== ================
Supplemental disclosures of cash flow information:
Income taxes paid.................................................. $ 0 $ 565,000
The accompanying notes are an integral part of this consolidated schedule.
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
Changes in net assets from operations:
Net operating loss............................................... $ (749,865) $ (584,460)
Net realized gain (loss) on investments.......................... 786,593 (2,541)
Net increase in unrealized appreciation on investments as a
result of sales.................................................. 915,118 0
Net decrease in unrealized appreciation on investments held...... (131,331) (628,126)
------------- -------------
Net increase (decrease) in net assets resulting from operations.. 820,515 (1,215,127)
Net increase (decrease) in net assets.................................... 820,515 (1,215,127)
------------- -------------
Net assets:
Beginning of the period.......................................... 40,682,738 27,256,046
------------- -------------
End of the period................................................ $ 41,503,253 $ 26,040,919
============= =============
The accompanying notes are an integral part of this consolidated schedule.
- ---------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2004
(UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Investments in Unaffiliated Companies (8)(9)(10) - 17.6% of total investments
Private Placement Portfolio (Illiquid) - 17.6% of total investments
AlphaSimplex Group, LLC (2)(12) - Investment advisory firm
headed by Dr. Andrew W. Lo, holder of the Harris & Harris
Group Chair at MIT Limited Liability Company Interest..........................(B) -- $ 125,000
Continuum Photonics, Inc. (1)(2)(6) - Develops optical networking
components by merging cutting-edge materials, MEMS and
electronics technologies - 4.00% of fully diluted equity
Series B Convertible Preferred Stock...........................................(B) 2,000,000 776,119
Series C Convertible Preferred Stock...........................................(B) 2,368,590 739,000
---------
1,515,119
Exponential Business Development
Company (1)(2)(5)(12) -
Venture capital partnership focused on early stage companies
Limited Partnership Interest...................................................(A) -- 25,000
Heartware, Inc. (1)(2)(5)(6) - Develops ventricular assist devices -
0% of fully diluted equity
Series A-2 Non-Voting Preferred Stock..........................................(D) 47,620 0
Molecular Imprints, Inc. (1)(2)(4)(6) - Develops nanoimprint lithography
capital equipment - 2.09% of fully diluted equity
Series B Convertible Preferred Stock...........................................(A) 1,333,333 2,000,000
NanoGram Corporation (1)(2)(5)(6) - Develops a broad suite of
intellectual property utilizing nanotechnology - 1.81%
of fully diluted equity
Series 1 Convertible Preferred Stock...........................................(A) 63,210 21,672
Nanosys, Inc. (1)(2)(5)(6) - Develops nanotechnology-enabled systems
incorporating novel and patent-protected zero and one-dimensional
nanometer-scale materials - 1.55% of fully diluted equity
Series C Convertible Preferred Stock...........................................(A) 803,428 1,500,000
Nantero, Inc. (1)(2)(5)(6) - Develops a high density nonvolatile random
access memory chip using nanotechnology - 3.35% of fully diluted equity
Series A Convertible Preferred Stock...........................................(B) 345,070 538,309
Series B Convertible Preferred Stock...........................................(B) 207,051 323,000
---------
861,309
NeoPhotonics Corporation (1)(2)(6)(13) - Develops and manufactures planar optical
devices and components using nanomaterials deposition technology -
3.66% of fully diluted equity Common Stock.....................................(B) 56,250 8,438
Series 1 Convertible Preferred Stock...........................................(A) 1,821,155 2,003,721
Warrants at $0.15 expiring 3/12/11.............................................(B) 28,636 286
----------
2,012,445
Optiva, Inc. (1)(2)(5)(6) - Develops and commercializes nanomaterials
for advanced applications - 1.96% of fully diluted equity
Series C Convertible Preferred Stock...........................................(B) 1,249,999 1,250,000
---------
Total Unaffiliated Private Placement Portfolio (cost: $9,367,478)........................................... $9,310,545
----------
Total Investments in Unaffiliated Companies (cost: $9,367,478).............................................. $9,310,545
----------
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2004
(UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- ---------- -----
Investments in Non-Controlled Affiliated Companies (8)(9)(11) - 22.8% of total investments
Private Placement Portfolio (Illiquid) - 22.8% of total investments
Agile Materials & Technologies, Inc. (1)(2)(6) - Develops and sells
variable integrated passive RF electronic equipment components -
8.15% of fully diluted equity
Series A Convertible Preferred Stock.............................................(D) 3,732,736 $ 110,700
Convertible Bridge Note....(D) $ 75,901 76,584
----------
187,284
Chlorogen, Inc. (1)(2)(5)(6) - Develops patented chloroplast technology
to produce plant-made proteins - 9.74% of fully diluted equity
Series A Convertible Preferred Stock.............................................(A) 4,478,038 785,000
Experion Systems, Inc. (1)(2)(7) - Develops and sells
software to credit unions - 12.49% of fully diluted equity
Series A Convertible Preferred Stock.............................................(D) 294,118 262,406
Series B Convertible Preferred Stock.............................................(D) 35,294 31,226
Series C Convertible Preferred Stock.............................................(D) 222,184 417,706
Series D Convertible Preferred Stock.............................................(D) 64,501 121,262
---------
832,600
NanoOpto Corporation (1)(2)(6) -
Develops high performance, integrated optical
communications sub-components on a chip by utilizing
patented nano-manufacturing technology - 7.28% of fully
diluted equity
Series A-1 Convertible Preferred Stock...........................................(B) 267,857 47,567
Series B Convertible Preferred Stock.............................................(B) 1,733,664 737,500
-----------
785,067
Nanopharma Corp. (1)(2)(5)(6) - Develops advanced nanoscopic drug
delivery vehicles and systems - 14.39% of fully diluted equity
Series A Convertible Preferred Stock.............................................(A) 684,516 700,000
Nanotechnologies, Inc. (1)(2)(6) - Develops high-performance
nanoscale materials for industry - 6.48% of fully diluted equity
Series B Convertible Preferred Stock.............................................(B) 1,538,837 1,107,963
Series C Convertible Preferred Stock.............................................(B) 235,720 169,718
------------
1,277,681
NeuroMetrix, Inc. (1)(2) - Develops and sells medical devices for
monitoring neuromuscular disorders - 12.42% of fully diluted equity
Series A Convertible Preferred Stock.............................................(B) 875,000 1,312,500
Series B Convertible Preferred Stock.............................................(B) 625,000 937,500
Series C-2 Convertible Preferred Stock...........................................(B) 1,148,100 1,722,150
Series E Convertible Preferred Stock.............................................(B) 499,996 749,994
Series E-1 Convertible Preferred Stock...........................................(B) 1,402,187 2,103,282
------------
6,825,426
Questech Corporation (1)(2)(5) - Manufactures and markets
proprietary metal decorative tiles - 6.73% of fully diluted equity
Common Stock.................................................................... (B) 646,954 724,588
Warrants at $5.00 expiring 10/25/04..............................................(B) 1,966 0
Warrants at $1.50 expiring 11/16/05..............................................(B) 1,250 0
Warrants at $1.50 expiring 08/03/06..............................................(B) 8,500 0
Warrants at $1.50 expiring 11/21/07..............................................(B) 3,750 0
Warrants at $1.50 expiring 11/19/08..............................................(B) 5,000 0
------------
724,588
Total Non-Controlled Private Placement Portfolio (cost: $13,624,364)........................................ $12,117,646
------------
Total Investments in Non-Controlled Affiliated Companies (cost: $13,624,364)................................ $12,117,646
------------
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2004
(UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- ------
U.S. Government and Agency Obligations - 59.6% of total investments
U.S. Treasury Bills - due date 04/01/04 ................................(J) $ 10,875,000 $ 10,875,000
U.S. Treasury Bills - due date 04/08/04 ................................(J) 1,800,000 1,799,640
U.S. Treasury Bills - due date 04/29/04 ................................(J) 10,590,000 10,581,846
U.S. Treasury Bills - due date 05/13/04 ................................(J) 2,090,000 2,087,701
U.S. Treasury Bills - due date 05/20/04 ................................(J) 2,425,000 2,421,896
U.S. Treasury Notes - due date 05/15/08, coupon 2.625% .................(H) 1,850,000 1,861,563
U.S. Treasury Notes - due date 03/15/09, coupon 2.625% .................(H) 2,000,000 1,985,620
------------
Total Investments in U.S. Government and Agency Obligations (cost: $31,642,544)............................ $31,613,266
------------
Total Investments - 100% (cost: $54,634,386)............................................................... $53,041,457
------------
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2004
- -------------------------------------------------------------------------------
Notes to Consolidated Schedule of Investments
1. Represents a non-income producing security. Equity investments that have
not paid dividends within the last 12 months are considered to be
non-income producing.
2. Legal restrictions on sale of investment.
3. See Footnote to Schedule of Investments for a description of the Asset
Valuation Policy Guidelines.
4. Initial investment was made during 2004.
5. No changes in valuation occurred in these investments during the three
months ended March 31, 2004.
6. These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of its
efforts to establishing a new business, and either it has not yet
commenced its planned principal operations, or it has commenced such
operations but has not realized significant revenue from them.
7. Previously named MyPersonalAdvocate.com, Inc.
8. Investments in unaffiliated companies consist of investments in which we
own less than 5% of the portfolio company. Investments in non-controlled
affiliated companies consist of investments in which we own more than 5%
but less than 25% of the portfolio company. Investments in controlled
affiliated companies consist of investments in which we own more than 25%
of the portfolio company.
9. The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential equity
interest in each such portfolio company. The calculated percentage
represents the amount of the issuer's equity securities we own or can
acquire as a percentage of the issuer's total outstanding equity
securities plus equity securities reserved for issued and outstanding
warrants, convertible securities and all authorized stock options, both
granted and ungranted.
10. The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $9,367,478. The gross unrealized appreciation
based on the tax cost for these securities is $166,948. The gross
unrealized depreciation based on the tax cost for these securities is
$223,881.
11. The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $13,624,364. The gross unrealized
appreciation based on the tax cost for these securities is $2,772,007. The
gross unrealized depreciation based on the tax cost for these securities
is $4,278,725.
12. Non-registered investment company.
13. NeoPhotonics filed for bankruptcy on November 17, 2003. We sold our
investment in the Series D Preferred Stock in January 2004. NeoPhotonics
emerged from bankruptcy, as a newly reorganized company, after obtaining
financing from us and other investors.
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
- -------------------------------------------------------------------------------
ASSET VALUATION POLICY GUIDELINES
Our investments can be classified into five broad categories for
valuation purposes:
(a) EQUITY-RELATED SECURITIES
(b) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
(c) LONG-TERM FIXED-INCOME SECURITIES
(d) SHORT-TERM FIXED-INCOME INVESTMENTS
(e) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in our portfolio to determine net asset value.
Under the 1940 Act, unrestricted securities with readily available market
quotations are to be valued at the current market value; all other assets must
be valued at "fair value" as determined in good faith by or under the direction
of the Board of Directors.
Our Board of Directors is responsible for (1) determining overall
valuation guidelines and (2) ensuring the valuation of investments within the
prescribed guidelines.
Our Valuation Committee, comprised of at least three or more
independent Board members, is responsible for reviewing and approving the
valuation of our assets within the guidelines established by the Board of
Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing our assets, external measures of value, such as
public markets or third-party transactions, are utilized whenever possible.
Valuation is not based on long-term work-out value, nor immediate liquidation
value, nor incremental value for potential changes that may take place in the
future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as such amounts depend on future circumstances and cannot reasonably
be determined until the individual investments are actually liquidated.
Our valuation policy with respect to the five broad investment
categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
A. Cost: The cost method is based on our original cost. This method is
generally used in the early stages of a company's development until significant
positive or negative events occur subs110equent to the date of the original
investment that dictate a change to another valuation method. Some examples of
these events are: (1) a major recapitalization; (2) a major refinancing; (3) a
significant third-party transaction; (4) the development of a meaningful public
market for the company's common stock; and (5) significant positive or negative
changes in a company's business.
B. Private Market: The private market method uses actual, executed,
historical transactions in a company's securities by responsible third parties
as a basis for valuation. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by us.
We discount market value for securities that are subject to significant legal
and contractual restrictions. Other securities, for which market quotations are
readily available, are carried at market value as of the time of valuation.
Market value for securities traded on securities exchanges or on the Nasdaq
National Market is the last reported sales price on the day of valuation. For
other securities traded in the over-the-counter market and listed securities
for which no sale was reported on that day, market value is the mean of the
closing bid price and asked price on that day. This method is the preferred
method of valuation when there is an established public market for a company's
securities, as that market provides the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market in
the company's securities or when the factual information available to us
dictates that an investment should no longer be valued under either the cost or
private market method. This valuation method is inherently imprecise and
ultimately the result of reconciling the judgments of our Valuation Committee
members, based on the data available to them. The resulting valuation, although
stated as a precise number, is necessarily within a range of values that vary
depending upon the significance attributed to the various factors being
considered. Some of the factors considered may include the financial condition
and operating results of the company, the long-term potential of the business
of the company, the values of similar securities issued by companies in similar
businesses, the proportion of the company's securities we own and the nature of
any rights to require the company to register restricted securities under
applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT IN
TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on our original cost. This method is
generally used in the early stages of commercializing or developing
intellectual property or patents or research and development in technology or
product development until significant positive or adverse events occur
subsequent to the date of the original investment that dictate a change to
another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to us dictates that an investment should no
longer be valued under either the cost or private market method. This valuation
method is inherently imprecise and ultimately the result of reconciling the
judgments of our Valuation Committee members. The resulting valuation, although
stated as a precise number, is necessarily within a range of values that vary
depending upon the significance attributed to the various factors being
considered. Some of the factors considered may include the results of research
and development, product development progress, commercial prospects, term of
patent, projected markets, and other subjective factors.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
I. Fixed-Income Securities for which market quotations are not readily
available are carried at fair value using one or more of the following basic
methods of valuation:
Independent pricing services that provide quotations based primarily
on quotations from dealers and brokers, market transactions, and other sources.
Fair value as determined in good faith by the Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
J. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days or
less is valued at amortized cost.
ALL OTHER INVESTMENTS
K. All Other Investments are reported at fair value as determined in
good faith by the Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Valuation Committee's
judgment of fair values as of the valuation date using the outlined basic
methods of valuation. They do not necessarily represent an amount of money that
would be realized if we had to sell the securities in an immediate liquidation.
Thus, valuations as of any particular date are not necessarily indicative of
amounts that we may ultimately realize as a result of future sales or other
dispositions of investments we hold.
- -------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- -------------------------------------------------------------------------------
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company," "us," "our" and "we") is a
venture capital company operating as a business development company ("BDC")
under the Investment Company Act of 1940 ("1940 Act"). We operate as an
internally managed company whereby our officers and employees, under the
general supervision of our Board of Directors, conduct our operations.
We elected to become a BDC on July 26, 1995, after receiving the
necessary approvals. From September 30, 1992, until the election of BDC status,
we operated as a closed-end, non-diversified investment company under the 1940
Act. Upon commencement of operations as an investment company, we revalued all
of our assets and liabilities at fair value as defined in the 1940 Act. Prior
to September 30, 1992, we were registered and filed under the reporting
requirements of the Securities and Exchange Act of 1934 as an operating company
and, while an operating company, operated directly and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100% wholly
owned subsidiary of the Company. Enterprises held a lease for office space
until the lease expired on July 31, 2003, which office space it sublet to the
Company and an unaffiliated party; is a partner in Harris Partners I, L.P., and
is taxed as a C corporation. Harris Partners I, L.P., is a limited partnership
and owned, until December 31, 2002, a 20% limited partnership interest in PHZ
Capital Partners L.P. Currently, Harris Partners I, L.P. owns our interest in
AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P. are
Enterprises (sole general partner) and Harris & Harris Group, Inc. (sole
limited partner).
We filed for the 1999 tax year to elect treatment as a Regulated
Investment Company ("RIC") under Subchapter M of the Internal Revenue Code of
1986 (the "Code") and qualified for the same treatment for 2000-2002. There can
be no assurance that we will qualify as a RIC for 2003 and subsequent years or
that if we do qualify, we will continue to qualify for subsequent years. In
addition, even if we were to qualify as a RIC for a given year, we might take
action in a subsequent year to ensure that we would be taxed in that subsequent
year as a C Corporation, rather than as a RIC. As a RIC, we must, among other
factors, distribute at least 90% of our investment company taxable income and
may either distribute or retain our realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies followed
in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for investment companies and include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "value" as
defined in the 1940 Act and in the applicable regulations of the Securities and
Exchange Commission. Value, as defined in Section 2(a)(41) of the 1940 Act, is
(i) the market price for those securities for which a market quotation is
readily available and (ii) for all other assets is as determined in good faith
by, or under the direction of, the Board of Directors. (See "Asset Valuation
Policy Guidelines" in the "Footnote to Consolidated Schedule of Investments.")
Securities Transactions. Securities transactions are accounted for on
the date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined by specific
identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, we recorded income taxes using
the liability method in accordance with the provision of Statement of Financial
Accounting Standards No. 109. Accordingly, deferred tax liabilities had been
established to reflect temporary differences between the recognition of income
and expenses for financial reporting and tax purposes; the most significant
such difference relates to our unrealized appreciation on investments.
The March 31, 2004, consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of December
31, 1998, net of the unutilized operating and capital loss carryforwards
incurred by us through December 31, 1998.
We pay federal, state and local income taxes on behalf of our wholly
owned subsidiary, Harris & Harris Enterprises, which is a C corporation. (See
"Note 6. Income Taxes.")
Estimates by Management. The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of March 31, 2004, and
December 31, 2003, and the reported amounts of revenues and expenses for the
three months ended March 31, 2004, and March 31, 2003. The most significant
estimates relate to the fair valuations of investments. Actual results could
differ from these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- -------------------------------------
As of January 1, 2003, we implemented the Amended and Restated Harris
& Harris Group, Inc. Employee Profit-Sharing Plan, which we refer to as the
2002 Plan.
The 2002 Plan (and its predecessor) provides for profiting sharing by
our officers and employees equal to 20% of our "qualifying income" for that
plan year. For the purposes of the 2002 Plan, qualifying income is defined as
net realized income as reflected on our consolidated statements of operations
for that year, less nonqualifying gains, if any.
For purposes of the 2002 Plan, our net realized income includes
investment income, realized gains and losses, and operating expenses (including
taxes paid or payable by us), but is calculated without including dividends
paid or distributions made to shareholders, payments under the Plan, unrealized
gains and losses, and loss carry-overs from other years. The proportion of net
after-tax realized gains attributable to asset values as of September 30, 1997,
is considered nonqualifying gain, which reduces qualifying income.
On October 15, 2002, our shareholders approved the performance goals
under the 2002 Plan in accordance with Section 162(m) of the Code, effective as
of January 1, 2003. The Code generally provides that a public company such as
we may not deduct compensation paid to its chief executive officer or to any of
its four most highly compensated officers to the extent that the compensation
paid to the officer/employee exceeds $1,000,000 in any tax year, unless payment
is made upon the attainment of objective performance goals that are approved by
our shareholders.
Under the 2002 Plan, our net realized income, which we refer to as
qualifying income, includes investment income, realized qualifying gains and
losses, and operating expenses (including taxes paid or payable by us), but is
calculated without including dividends paid or loss carry-overs from other
years. As soon as practicable following the year-end audit, the Audit Committee
will determine whether, and if so how much, qualifying income exists for a plan
year. Once determined, 90% of the qualifying income will be paid out to 2002
Plan participants pursuant to the distribution percentages set forth in the
2002 Plan. The remaining 10% will be paid out after we have filed our federal
tax return for that plan year.
Under the 2002 Plan, awards previously granted to four current
Participants (Messrs. Harris and Melsheimer and Ms. Shavin and Matthews, herein
referred to as the "grandfathered participants") will be reduced by 10% with
respect to "Non-Tiny Technology Investments" (as defined in the 2002 Plan) and
by 25% with respect to "Tiny Technology Investments" (as defined in the 2002
Plan) and will become permanent. These reduced awards are herein referred to as
"grandfathered participations." The amount by which the awards are reduced will
be allocable and reallocable each year by the Compensation Committee among
current and new participants as awards under the 2002 Plan. The grandfathered
participations will be honored by us whether or not the grandfathered
participant is still employed by us or is still alive (in the event of death,
the grandfathered participations will be paid to the grandfathered
participant's estate), unless the grandfathered participant is dismissed for
cause, in which case all awards, including the grandfathered participations,
will be immediately cancelled and forfeited. With regard to new investments and
follow-on investments made after the date on which the first new employee
begins participating in the 2002 Plan, both current and new participants will
be required to be employed by us at the end of a plan year in order to
participate in profit-sharing on our investments with respect to that year.
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which we remain
a "business development company" within the meaning of the 1940 Act be greater
than 20% of our "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards as calculated exceed that
amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the
Compensation Committee at any time. Notwithstanding the foregoing, the
grandfathered participations may not be further modified. Nothing in the 2002
Plan will preclude the Compensation Committee from naming additional
participants in the 2002 Plan or, except for grandfathered participations,
changing the Award Percentage of any Participant (subject to the overall
percentage limitations contained in the 2002 Plan). Currently, under the 2002
Plan, the distribution amounts for non-grandfathered investments for each
officer and employee are: Charles E. Harris, 7.790%; Mel P. Melsheimer, 3.733%;
Douglas W. Jamison, 3.5%; Daniel V. Leff, 3.0%; Helene B. Shavin, 1.524%; and
Jacqueline M. Matthews, 0.453%, which together equal 20%. In one case, for a
former employee who left other than due to termination for cause, any amount
earned will be accrued and may subsequently be paid to the participant.
The grandfathered participations are set forth below:
Grandfathered Participations
Name of Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
- ------------------------ ----------------------- -------------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews 0.40770 0.33975
TOTAL 18.00000 15.00000
Accordingly, an additional 2% of Qualifying Income with respect to
grandfathered Non-Tiny Technology Investments, 5% of Qualifying Income with
respect to grandfathered Tiny Technology Investments and the full 20% of
Qualifying Income with respect to new investments are available for allocation
and reallocation from year to year. Currently, Douglas W. Jamison and Daniel V.
Leff are each allocated 0.80% of the Non-Tiny Technology Grandfathered
Participations and 2% of the Tiny Technology Grandfathered Participations.
During 2003, we made no accrual for profit sharing. At March 31, 2004,
we have no accrual for profit sharing.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that effective January 1,
1998, 50% of all Directors' fees be used to purchase our common stock from us.
However, effective March 1, 1999, the Board of Directors approved that
Directors may purchase our common stock in the open market, rather than from
us.
Since 1998, we have repurchased a total of 1,859,047 of our shares for
a total of $3,496,388, including commissions and expenses, at an average price
of $1.88 per share. These treasury shares were reduced by the purchases made by
the Directors. On July 23, 2002, because of our strategic decision to invest in
tiny technology, the Board of Directors reaffirmed its commitment not to
authorize the purchase of additional shares of stock in the foreseeable future.
On July 8, 2002, we filed a final prospectus under Rule 497 of the
Securities Act of 1933 with the SEC for the issuance of transferable rights to
our shareholders. The rights allowed the shareholders to subscribe for a
maximum of 2,954,743 new shares of our common stock, of which 2,634,614 new
shares were subscribed for pursuant to the rights offering. The actual amount
of gross proceeds raised upon completion of the offer was $5,927,882; net
proceeds were $5,643,470, after expenses of $284,412. We have invested all of
the net proceeds raised from the offering in accordance with our investment
objectives and policies.
On December 24, 2003, we filed a final prospectus under Rule 497 of
the Securities Act of 1933 with the SEC for issuance of 2,000,000 shares of our
common stock plus 300,000 additional shares if the underwriter exercised its
over-allotment option. All of the 2,300,000 shares were sold. The actual amount
of net proceeds raised upon completion of the offering was $17,296,000; net
proceeds of the offering, less offering costs of $664,038, were $16,631,962. We
intend to use the net proceeds of the offering, less offering costs, to make
new investments in tiny technology as well as follow-on investments in our
existing venture capital investments, and for working capital. From the
completion of the offering through March 31, 2004, we have used $7,951,609 of
the $16,631,962.
On February 17, 2004, we filed a registration statement with the
Securities and Exchange Commission on Form N-2 with respect to 3,000,000 shares
of our Common Stock. After the effective date, the Common Stock may be sold at
prices and on terms to be set forth in one or more supplements to the
prospectus from time to time.
As of December 31, 2003, there are no distributable earnings. The
difference between the book basis and tax basis components of distributable
earnings is primarily attributed to Built-In Gains generated at the time of our
qualification as a RIC (see Note 6. "Income Taxes"), nondeductible deferred
compensation and net operating losses.
Beginning with the Consolidated Statements of Assets and Liabilities
at December 31, 2003, additional paid-in capital and common stock warrants have
been combined and are reported as additional paid-in capital. There have been
no common stock warrants outstanding since March 2000.
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with us (disclosed in a Form 8-K filed on October 27, 1999) (the "Employment
Agreement"), which superseded an employment agreement that was about to expire
on December 31, 1999. The Employment Agreement shall terminate on December 31,
2004 ("Term") subject to either an earlier termination or an extension in
accordance with the terms; on January 1, 2000 and on each day thereafter, the
Term extends automatically by one day unless at any time we or Mr. Harris, by
written notice, decide not to extend the Term, in which case the Term will
expire five years from the date of the written notice.
During the period of employment, Mr. Harris shall serve as our
Chairman and Chief Executive Officer; be responsible for the general management
of our affairs and all our subsidiaries, reporting directly to our Board of
Directors; serve as a member of the Board for the period of which he is and
shall from time to time be elected or reelected; and serve, if elected, as our
President and as an officer and director of any subsidiary or affiliate of us.
Mr. Harris is to receive compensation under his Employment Agreement
in the form of base salary of $208,315 for 2000, with automatic yearly
adjustments to reflect inflation. In addition, the Board may increase such
salary, and consequently decrease it, but not below the level provided for by
the automatic adjustments described above. Mr. Harris is also entitled to
participate in our Profit-Sharing Plan as well as in all compensation or
employee benefit plans or programs, and to receive all benefits, perquisites,
and emoluments for which salaried employees are eligible. Under the Employment
Agreement, we will furnish Mr. Harris with certain perquisites which include a
company car, membership in certain clubs and up to a $5,000 annual
reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of $2,000,000;
provides reimbursement for uninsured medical expenses, not to exceed $10,000
per annum, adjusted for inflation, over the period of the contract; provides
Mr. Harris and his spouse with long-term care insurance; and with disability
insurance in the amount of 100% of his base salary. These benefits are for the
term of the Employment Agreement.
The Employment Agreement provides for us to adopt a supplemental
executive retirement plan (the "SERP") for the benefit of Mr. Harris. Under the
SERP, we will cause an amount equal to one-twelfth of Mr. Harris's current
annual salary to be credited each month (a "Monthly Credit") to a special
account maintained for this purpose on our books for the benefit of Mr. Harris
(the "SERP Account"). The amounts credited to the SERP Account will be deemed
invested or reinvested in such mutual funds or U.S. Government securities as
determined by Mr. Harris. The SERP Account will be credited and debited to
reflect the deemed investment returns, losses and expenses attributed to such
deemed investments and reinvestments. Mr. Harris's benefit under the SERP will
equal the balance in the SERP Account and such benefit will always be 100%
vested (i.e., not forfeitable). Mr. Harris will determine the form and timing
of the distribution of the balance in the SERP Account; provided, however, in
the event of the termination of his employment, the balance in the SERP Account
will be distributed to Mr. Harris or his beneficiary, as the case may be, in a
lump-sum payment within 30 days of such termination. We will establish a rabbi
trust for the purpose of accumulating funds to satisfy the obligations incurred
by us under the SERP. The restricted funds for the SERP Plan total $1,330,645
at March 31, 2004. Mr. Harris's rights to benefits pursuant to this SERP will
be no greater than those of a general creditor of us.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the executive's
base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with us, effective
August 15, 1990. The severance compensation agreement provides that if,
following a change in our control, as defined in the agreement, such
individual's employment is terminated by us without cause or by the executive
within one year of such change in control, the individual shall be entitled to
receive compensation in a lump sum payment equal to 2.99 times the individual's
average annualized compensation and payment of other welfare benefits. If Mr.
Harris's termination is without cause or is a constructive discharge, the
amount payable under the Employment Agreement will be reduced by the amounts
paid pursuant to the severance compensation agreement.
As of January 1, 1989, we adopted an employee benefits program
covering substantially all of our employees under a 401(k) Plan and Trust
Agreement. As of January 1, 1999, we adopted the Harris & Harris Pension Plan
and Trust, a money purchase plan which would allow us to stay compliant with
the 401(k) top-heavy regulations and deduction limitation regulations. In 2001,
Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001
which has increased the deduction limits for plans such as the 401(k) Plan.
This Act eliminates the need for us to maintain two separate plans. Effective
December 31, 2001, the Pension Plan merged into the 401(k) Plan, with the
401(k) Plan being the surviving plan. Contributions to the plan are at our
discretion.
On June 30, 1994, we adopted a plan to provide medical and dental
insurance for retirees, their spouses and dependents who, at the time of their
retirement, have ten years of service with us and have attained 50 years of age
or have attained 45 years of age and have 15 years of service with us. On
February 10, 1997, we amended this plan to include employees who "have seven
full years of service and have attained 58 years of age." The coverage is
secondary to any government provided or subsequent employer provided health
insurance plans. The annual premium cost to us with respect to the entitled
retiree shall not exceed $12,000, subject to an index for inflation. Based upon
actuarial estimates, we provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of March 31,
2004, we had a reserve of $555,129 for the plan. Recent changes to the Medicare
program may affect our costs under this plan. In accordance with FASB Staff
Position 106-1, our estimates of the obligation under this standard do not
reflect these changes. Specific authoritative guidance regarding these changes
is pending and when issued, could require us to change previously reported
information.
We are making the following disclosures about our plan to provide
medical and dental insurance for retirees.
Reconciliation of Accumulated
Postretirement Benefit Obligations
Projected accumulated postretirement
benefit obligation at January 1, 2004............. $525,288
Service cost.................................... 15,988
Interest cost................................... 7,848
Projected accumulated postretirement
benefit obligation at March 31, 2004.............. $549,124
On March 20, 2003, in order to begin planning for eventual management
succession, the Board of Directors voted to establish a mandatory retirement
plan for individuals who are employed by us in a bona fide executive or high
policy-making position. There are currently two such individuals, the Chairman
and CEO, and the President and COO. Under this plan, mandatory retirement will
take place effective December 31 of the year in which the eligible individuals
attain the age of 65. On an annual basis beginning in the year in which the
designated individual attains the age of 65, a committee of the Board
consisting of non-interested directors may determine to postpone the mandatory
retirement date for that individual for one additional year for our benefit.
Under applicable law prohibiting discrimination in employment on the
basis of age, we can impose a mandatory retirement age of 65 for our executives
or employees in high policy-making positions only if each employee subject to
the mandatory retirement age is entitled to an immediate retirement benefit at
retirement age of at least $44,000 per year. The benefits payable at retirement
to Charles E. Harris, our Chairman and Chief Executive Officer, and Mel P.
Melsheimer, our President, Chief Operating Officer and Chief Financial Officer,
under our existing retirement plans do not equal this threshold. Mr. Harris has
offered, for our benefit, to waive his right to exclude certain other benefits
from this calculation, which makes it unlikely that any provision will have to
be made for him in order for us to comply with this threshold requirement. For
Mr. Melsheimer, however, a new plan was established to provide him with the
difference between the benefit required under the age discrimination laws and
that provided under our existing plans. The expense to us of providing the
benefit under this new plan is currently estimated to be $450,000. This benefit
will be unfunded, and the expense is being amortized over the fiscal periods
through the year ended December 31, 2004.
NOTE 6. INCOME TAXES
- ---------------------
Provided that a proper election is made, a corporation taxable under
Subchapter C of the Internal Revenue Code (a "C Corporation") that elects to
qualify as a RIC continues to be taxable as a C Corporation on any gains
realized within 10 years of its qualification as a RIC (the "Inclusion Period")
from sales of assets that were held by the corporation on the effective date of
the RIC election ("C Corporation Assets") to the extent of any gain built into
the assets on such date ("Built-In Gain"). (If the corporation fails to make a
proper election, it is taxable on its Built-In Gain as of the effective date of
its RIC election.) We had Built-In Gains at the time of our qualification as a
RIC and made the election to be taxed on any Built-In Gain realized during the
Inclusion Period. Prior to 1999, we incurred ordinary and capital losses from
operations. After our election of RIC status, those losses remained available
to be carried forward to subsequent taxable years. We have previously used loss
carryforwards to offset Built-In Gains. As of January 1, 2004, we had $501,640
of pre-1999 loss carryforwards remaining and $4,663,457 of unrealized Built-In
Gains remaining.
Continued qualification as a RIC requires us to satisfy certain
investment asset diversification requirements in future years. Our ability to
satisfy those requirements may not be controllable by us. There can be no
assurance that we will qualify as a RIC in subsequent years.
To the extent that we retain capital gains and declare a deemed
dividend to shareholders, the dividend is taxable to the shareholders. We would
pay tax, at the corporate rate, on the distribution, and the shareholders would
receive a tax credit equal to their proportionate share of the tax paid. We
took advantage of this rule for 2001. Our financial statements for 2001 include
a tax liability of $290,748. The taxes paid by our shareholders as a result of
our deemed dividend declaration 2001 ($271,467) are reflected as a deduction to
the additional paid-in capital in our Consolidated Statement of Assets and
Liabilities, rather than an expense in the Consolidated Statement of
Operations.
We pay federal, state and local taxes on behalf of our wholly owned
subsidiary, Harris & Harris Enterprises, Inc., which is taxed as a C
Corporation.
During the three months ended March 31, 2004, we accrued a net tax
provision of $6,796.
For the three months ended March 31, 2004, and 2003, our income tax
provision was allocated as follows:
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
Investment operations $ 0 $ 0
Net realized gain on investments 6,796 2,973
Net decrease in unrealized
appreciation on investments 0 0
------------ -------------
Total income tax provision $ 6,796 $ 2,973
The above tax provision consists of
the following:
Current $ 6,796 $ 2,973
Deferred - Federal 0 0
------------ -------------
Total income tax provision $ 6,796 $ 2,973
=========== ===========
Our net deferred tax liability at March 31, 2004, and December 31,
2003, consists of the following:
March 31, 2004 December 31, 2003
Tax on unrealized appreciation on investments $ 844,918 $ 844,918
Net operating loss and capital carryforward (175,574) (175,574)
--------------- --------------
Net deferred income tax liability $ 669,344 $ 669,344
=============== ==============
NOTE 7. COMMITMENTS
- --------------------
During 1993, we signed a 10-year lease for office space, which lease
expired on July 31, 2003. On April 17, 2003, we signed a seven-year sublease
for office space at 111 West 57th Street in New York City to replace the
expired lease. Total rent expense was $200,711 for 2003. Future minimum
sublease payments in each of the following years are: 2004 - $134,816; 2005 -
$138,187; 2006 - $141,641; 2007 - $145,182; 2008 - $148,811; and thereafter,
for the remaining term - $203,571.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, we established an asset account line of credit.
The asset account line of credit is secured by government and government agency
securities. Under the asset account line of credit, we may borrow up to 95% of
the current value of the government and government agency securities with which
we secure the line. Our available line of credit at March 31, 2004, was
$30,032,603. Our outstanding balance under the asset account line of credit at
March 31, 2004, and March 31, 2003, was $0 and $7,724,207, respectively. The
asset account line of credit bears interest at a rate of the Broker Call Rate
plus 50 basis points.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
On April 13, 2004, we filed an amended registration statement with the
Securities and Exchange Commission on Form N-2 with respect to shares of our
Common Stock. After the effective date, the Common Stock may be sold at prices
and on terms to be set forth in one or more supplements to the prospectus from
time to time.
On April 13, 2004, we wired $150,000 into an escrow account in
anticipation of making a follow-on investment in the form of a Convertible
Bridge Note of a privately held portfolio company.
On April 20, 2004, we made a $75,901 follow-on investment in the form
of a Convertible Bridge Note of a privately held portfolio company.
On May 7, 2004, we made a $50,000 follow-on investment in a privately
held portfolio company and a $250,000 initial investment in a privately held
portfolio company.
On May 10, 2004, we made a $12,091 follow-on investment in a privately
held portfolio company by purchasing shares from selling shareholders.
NOTE 10. OTHER
- ---------------
We have a total of $255,486 of funds in escrow as a result of the
merger of NanoGram Devices Corporation and a wholly owned subsidiary of Wilson
Greatbatch Technologies, Inc. The funds are being held for one year in an
interest-bearing escrow account to secure the indemnification obligations of
the former stockholders of NanoGram Devices Corporation. We set up a reserve of
100% of the $255,486.
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------------------------------------------------
ASSETS
March 31, 2003 December 31, 2002
(Unaudited) (Audited)
Investments, at value (Cost: $38,148,077 at 3/31/03,
$30,206,935 at 12/31/02)................................................ $ 34,799,838 $ 27,486,822
Cash and cash equivalents..................................................... 115,948 5,967,356
Restricted funds (Note 5)..................................................... 762,532 756,944
Funds in escrow............................................................... 0 750,000
Receivable from portfolio company............................................. 0 786,492
Interest receivable........................................................... 22,086 189
Income tax receivable......................................................... 72,546 0
Prepaid expenses.............................................................. 75,867 96,631
Other assets.................................................................. 109,607 107,535
-------------- ---------------
Total assets.................................................................. $ 35,958,424 $ 35,951,969
============== ===============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities...................................... $ 1,519,347 $ 1,451,568
Payable to broker for unsettled trade......................................... 0 5,696,725
Bank loan payable (Note 8).................................................... 7,724,207 0
Accrued profit sharing (Note 3)............................................... 1,523 15,233
Deferred rent................................................................. 3,084 5,397
Current income tax liability.................................................. 0 857,656
Deferred income tax liability (Note 6)........................................ 669,344 669,344
-------------- ---------------
Total liabilities............................................................. 9,917,505 8,695,923
-------------- ---------------
Commitments and contingencies (Note 7)
Net assets.................................................................... $ 26,040,919 $ 27,256,046
============== ===============
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued................................ $ 0 $ 0
Common stock, $0.01 par value, 25,000,000 shares authorized;
13,327,585 issued at 3/31/03 and 12/31/02............................... 133,276 133,276
Additional paid in capital (Note 4)........................................... 32,845,872 32,845,872
Additional paid in capital - common stock warrants............................ 109,641 109,641
Accumulated net realized gain................................................. 550,819 1,137,820
Accumulated unrealized appreciation of investments, net of
deferred tax liability of $844,918 at 3/31/03 and 12/31/02.............. (4,193,158) (3,565,032)
Treasury stock, at cost (1,828,740 shares at 3/31/03 and 12/31/02)............ (3,405,531) (3,405,531)
-------------- ---------------
Net assets.................................................................... $ 26,040,919 $ 27,256,046
============== ===============
Shares outstanding............................................................ 11,498,845 11,498,845
============== ===============
Net asset value per outstanding share......................................... $ 2.26 $ 2.37
============== ===============
The accompanying notes are an integral part of these consolidated financial statements.
- ----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
---------------------------------------------------------------------------------------------------------------------
Three Months Three Months
Ended Ended
March 31, 2003 March 31, 2002
Investment income:
Interest from unaffiliated issuers............................... $ 46,246 $ 54,136
Other income..................................................... 18,430 5,326
------------- --------------
Total investment income....................................... 64,676 59,462
Expenses:
Profit-sharing accrual (Note 3).................................. 0 127,959
Salaries and benefits............................................ 362,196 255,376
Administration and operations.................................... 95,112 87,902
Professional fees................................................ 67,158 43,095
Rent............................................................. 47,877 42,724
Directors' fees and expenses..................................... 56,365 41,076
Depreciation..................................................... 9,980 5,948
Custodian fees................................................... 2,187 3,839
Interest expense (Note 4)........................................ 8,261 7,776
------------- --------------
Total expenses................................................ 649,136 615,695
------------- --------------
Operating loss before income taxes............................... (584,460) (556,233)
Income tax provision (Note 6).................................... 0 0
------------- --------------
Net operating loss................................................... (584,460) (556,233)
Net realized gain on investments:
Realized gain on investments..................................... 432 110,679
------------- --------------
Total realized gain........................................... 432 110,679
Income tax provision (Note 6).................................... (2,973) (34,223)
------------- --------------
Net realized (loss) gain on investments.............................. (2,541) 76,456
------------- --------------
Net realized loss.................................................... (587,001) (479,777)
Net decrease in unrealized appreciation on investments:
Decrease as a result of investment sales......................... 0 0
Increase as a result of investment sales......................... 0 0
Increase on investments held..................................... 227,838 45,006
Decrease on investments held..................................... (855,964) (602,163)
------------- --------------
Change in unrealized appreciation on investments.............. (628,126) (557,157)
Income tax provision (Note 6).................................... 0 0
------------- --------------
Net decrease in unrealized appreciation on investments........... (628,126) (557,157)
------------- --------------
Net decrease in net assets resulting from operations:
Total............................................................ $ (1,215,127) $ (1,036,934)
============== ==============
$ (0.11) $ (0.12)
============== ==============
Per outstanding share................................................
The accompanying notes are an integral part of these consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
Cash flows from operating activities:
Net decrease in net assets resulting from operations................. $ (1,215,127) $ (1,036,934)
Adjustments to reconcile net decrease in net assets resulting from
operations to net cash used in operating activities:
Net realized and unrealized loss on investments.................. 627,694 442,349
Depreciation..................................................... 9,980 5,948
Changes in assets and liabilities:
Restricted funds................................................. (5,588) (72,947)
Receivable from investment company............................... 786,492 0
Funds in escrow.................................................. 750,000 0
Interest receivable.............................................. (21,897) 82
Note receivable.................................................. 0 10,487
Current income tax receivable.................................... (72,546) 0
Prepaid expenses................................................. 20,764 (56,284)
Other assets..................................................... (2,072) 17,627
Accounts payable and accrued liabilities......................... 67,779 (9,597)
Payable to broker for unsettled trade............................ (5,696,725) 0
Accrued profit sharing........................................... (13,710) 127,959
Current income tax liability..................................... (857,656) (256,875)
Deferred rent.................................................... (2,313) (2,313)
---------------- ----------------
Net cash used in operating activities................................ (5,624,925) (830,498)
Cash flows from investing activities:
Net (purchase) sale of short-term investments
and marketable securities..................................... (7,211,448) 6,753,035
Proceeds from investments........................................ 12,088 180,211
Investment in private placements and loans....................... (750,000) (2,425,000)
Purchase of fixed assets......................................... (1,330) (1,821)
---------------- ----------------
Net cash (used in) provided by investing activities.................. (7,950,690) 4,506,425
Cash flows from financing activities:
Payment of bank loan payable..................................... 0 (3,449,037)
Proceeds from bank loan payable.................................. 7,724,207 0
---------------- ----------------
Net cash provided by (used in) financing activities.................. 7,724,207 (3,499,037)
Net increase (decrease) in cash and cash equivalents:
Cash and cash equivalents at beginning of the period............. 5,967,356 135,135
Cash and cash equivalents at end of the period................... 115,948 312,025
---------------- ----------------
Net (decrease) increase in cash and cash equivalents................. $ (5,851,408) $ 176,890
=============== ===============
Supplemental disclosures of cash flow information:
Income taxes paid............................................ $ 565,000 $ 290,748
Interest paid................................................ $ 0 $ 11,108
The accompanying notes are an integral part of these consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
Changes in net assets from operations:
Net operating loss............................................. $ (584,460) $ (556,233)
Net realized gain (loss) on investments........................ (2,541) 76,456
Net increase in unrealized appreciation
on investments as a result of sales....................... 0 0
Net decrease in unrealized appreciation on
investments held.......................................... (628,126) (557,157)
---------------- ----------------
Net decrease in net assets resulting from operations................. (1,215,127) (1,036,934)
Net increase (decrease) in net assets................................ (1,215,127) (1,036,934)
---------------- ----------------
Net assets:
Beginning of the period........................................ 27,256,046 24,334,770
---------------- ----------------
End of the period.............................................. $ 26,040,919 $ 23,297,836
================ ================
The accompanying notes are an integral part of these consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2003
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Investments in Unaffiliated Companies (8)(9)(10) - 9.2% of total investments
Private Placement Portfolio (Illiquid) - 9.2% of total investments
AlphaSimplex Group, LLC (2)(12) - Investment advisory firm headed by
Dr. Andrew W. Lo, holder of the Harris & Harris Group Chair at MIT
Limited Liability Company interest............................................(D) -- $ 4,301
Continuum Photonics, Inc. (1)(2)(6) - Develops optical networking
components by merging cutting-edge materials, MEMS and
electronics technologies - 3.73% of fully diluted equity
Series B Convertible Preferred Stock..........................................(D) 2,000,000 123,394
Exponential Business Development Company (1)(2)(5)(12) --
Venture capital partnership focused on early stage companies
Limited partnership interest..................................................(A) -- 25,000
Kriton Medical, Inc. (1)(2)(5)(6) - Develops ventricular assist devices -
1.73% of fully diluted equity
Series B Convertible Preferred Stock..........................................(D) 476,191 0
NanoGram Devices Corporation (1)(2)(4)(6) - Develops power
components for biomedical applications by utilizing a patented
nanomaterial synthesis process - 4.63% of fully diluted equity
Series A-2 Convertible Preferred Stock........................................(B) 750,000 750,000
NanoOpto Corporation (1)(2)(6) - Develops high performance,
integrated optical communications sub-components on a chip by
utilizing patented nano-manufacturing technology -
1.45% of fully diluted equity
Series A-1 Convertible Preferred Stock........................................(D) 267,857 237,866
Nantero, Inc. (1)(2)(5)(6) - Develops a high density nonvolatile random
access memory chip using nanotechnology - 4.15% of fully diluted equity
Series A Convertible Preferred Stock..........................................(A) 345,070 489,999
NeoPhotonics Corporation (1)(2)(6) - Develops and manufactures
planar optical devices and components using nanomaterials
deposition technology - 1.76% of fully diluted equity
Series D Convertible Preferred Stock..........................................(D) 1,498,802 320,071
Optiva, Inc. (1)(2)(5)(6) - Develops and commercializes nanomaterials
for advanced applications - 1.99% of fully diluted equity
Series C Convertible Preferred Stock..........................................(B) 1,249,999 1,250,000
-----------
Total Private Placement Portfolio (cost: $6,143,161)......................................................... $3,200,631
-----------
Total Investments in Unaffiliated Companies (cost: $6,143,161)............................................... $3,200,631
-----------
The accompanying notes are an integral part of this consolidated schedule.
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2003
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Investments in Unaffiliated Companies (8)(9)(11) - 25.7% of total investments
Private Placement Portfolio (Illiquid) - 25.7% of total investments
Agile Materials & Technologies, Inc. (1)(2)(5)(6) - Develops and sells
variable integrated passive electronic equipment components -
8.15% of fully diluted equity
Series A Convertible Preferred Stock..........................................(A) 3,732,736 $1,000,000
Experion Systems, Inc. (1)(2)(5)(7) - Develops and sells
software to credit unions - 12.86% of fully diluted equity
Series A Convertible Preferred Stock..........................................(B) 294,118
Series B Convertible Preferred Stock..........................................(B) 35,294
Series C Convertible Preferred Stock..........................................(B) 222,184 $1,037,000
Nanopharma Corp. (1)(2)(6) - Develops advanced nanoscopic drug
delivery vehicles and systems - 14.69% of fully diluted equity
Series A Convertible Preferred Stock..........................................(A) 684,516 350,000
Nanotechnologies, Inc. (1)(2)(5)(6) - Develops high-performance
nanoscale materials for industry - 6.48% of fully diluted equity
Series B Convertible Preferred Stock .........................................(A) 1,538,837 750,000
NeuroMetrix, Inc. (1)(2)(5) - Develops and sells medical devices for
monitoring neuromuscular disorders - 12.10% of fully diluted equity
Series A Convertible Preferred Stock..........................................(B) 875,000
Series B Convertible Preferred Stock..........................................(B) 625,000
Series C-2 Convertible Preferred Stock........................................(B) 1,148,100
Series E Convertible Preferred Stock..........................................(B) 499,996
Series E-1 Convertible Preferred Stock........................................(B) 235,521 5,075,426
Questech Corporation (1)(2)(5) - Manufactures and markets
proprietary metal decorative tiles - 6.68% of fully diluted equity
Common Stock..................................................................(B) 646,954
Warrants at $5.00 expiring 11/15/04...........................................(B) 1,966
Warrants at $1.50 expiring 11/16/05...........................................(B) 1,250
Warrants at $1.50 expiring 12/14/06...........................................(B) 8,500
Warrants at $1.50 expiring 11/21/07...........................................(B) 3,750 724,588
----------
Total Private Placement Portfolio (cost: $9,359,300)......................................................... $8,937,014
----------
Total Investments in Non-Controlled Affiliated Companies (cost: $9,359,300).................................. $8,937,014
----------
The accompanying notes are an integral part of this consolidated schedule.
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2003
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
U.S. Government and Agency Obligations - 65.1% of total investments
U.S. Treasury Bills - due date 04/10/03.......................................(K) $3,450,000 $ 3,448,896
U.S. Treasury Bills - due date 04/17/03.......................................(K) 5,100,000 5,097,195
U.S. Treasury Bills - due date 04/24/03.......................................(K) 2,700,000 2,697,921
U.S. Treasury Bills - due date 05/22/03.......................................(K) 3,700,000 3,694,080
Federal Home Loan Bank Note - due date 02/15/05...............................(H) 7,700,000 7,724,101
------------
Total Investments in U.S. Government (cost: $22,645,616)................................................... $22,662,193
------------
Total Investments - 100% (cost: $38,148,077)............................................................... $34,799,838
------------
The accompanying notes are an integral part of this consolidated schedule.
- -------------------------------------------------------------------------------
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2003
(Unaudited)
- -------------------------------------------------------------------------------
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that have
not paid dividends within the last 12 months are considered to be
non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the Asset
Valuation Policy Guidelines.
(4) Initial investment was made during 2003.
(5) No changes in valuation occurred in these investments during the three
months ended March 31, 2003.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of its
efforts to establishing a new business, and either it has not yet
commenced its planned principal operations or it has commenced such
operations but has not realized significant revenue from them.
(7) Previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in which the
Company owns less than five percent of the portfolio company. Investments
in non-controlled affiliated companies consist of investments in which the
Company owns more than five percent but less than 25 percent of the
portfolio company. Investments in controlled affiliated companies consist
of investments in which the Company owns more than 25 percent of the
portfolio company.
(9) The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential equity
interest in each such portfolio company. The calculated percentage
represents the amount of the issuer's equity securities the Company owns
or can acquire as a percentage of the issuer's total outstanding equity
securities plus equity securities reserved for issued and outstanding
warrants, convertible securities and all authorized stock options, both
granted and ungranted.
(10) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $6,143,161. The gross unrealized appreciation
based on the tax cost for these securities is $1,140. The gross unrealized
depreciation based on the tax cost for these securities is $2,943,670.
(11) (The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $9,359,300. The gross unrealized
appreciation based on the tax cost for these securities is $2,414,044. The
gross unrealized depreciation based on the tax cost for these securities
is $2,836,330.
(12) Non-registered investment company.
The accompanying notes are an integral part of this consolidated
schedule.
- -------------------------------------------------------------------------------
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
- -------------------------------------------------------------------------------
ASSET VALUATION POLICY GUIDELINES
The Company's investments can be classified into five broad categories
for valuation purposes:
(a) EQUITY-RELATED SECURITIES
(b) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
(c) LONG-TERM FIXED-INCOME SECURITIES
(d) SHORT-TERM FIXED-INCOME INVESTMENTS
(e) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in the Company's portfolio to determine net asset
value. Under the 1940 Act, unrestricted securities with readily available
market quotations are to be valued at the current market value; all other
assets must be valued at "fair value" as determined in good faith by or under
the direction of the Board of Directors.
The Company's Board of Directors is responsible for (1) determining
overall valuation guidelines and (2) ensuring the valuation of investments
within the prescribed guidelines.
The Company's Valuation Committee (formerly named the "Investment and
Valuation Committee"), comprised of at least three or more independent Board
members, is responsible for reviewing and approving the valuation of the
Company's assets within the guidelines established by the Board of Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing the assets of the Company, external measures of
value, such as public markets or third-party transactions, are utilized
whenever possible. Valuation is not based on long-term work-out value, nor
immediate liquidation value, nor incremental value for potential changes that
may take place in the future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as such amounts depend on future circumstances and cannot reasonably
be determined until the individual investments are actually liquidated.
The Company's valuation policy with respect to the five broad
investment categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at value using one or more of
the following basic methods of valuation:
A. Cost: The cost method is based on the original cost to the Company.
This method is generally used in the early stages of a company's development
until significant positive or negative events occur subsequent to the date of
the original investment that dictate a change to another valuation method. Some
examples of such events are: (1) a major recapitalization; (2) a major
refinancing; (3) a significant third-party transaction; (4) the development of
a meaningful public market for the company's common stock; and (5) significant
positive or negative changes in the company's business.
B. Private Market: The private market method uses actual third-party
transactions in the company's securities as a basis for valuation, using
actual, executed, historical transactions in the company's securities by
responsible third parties. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by the
Company. The Company discounts market value for securities that are subject to
significant legal and contractual restrictions. Other securities, for which
market quotations are readily available, are carried at market value as of the
time of valuation.
Market value for securities traded on securities exchanges or on the
Nasdaq National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter market and
listed securities for which no sale was reported on that day, market value is
the mean of the closing bid price and asked price on that day.
This method is the preferred method of valuation when there is an
established public market for a company's securities, as that market provides
the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market in
the company's securities or when the factual information available to the
Company dictates that an investment should no longer be valued under either the
cost or private market method. This valuation method is inherently imprecise
and ultimately the result of reconciling the judgments of the Company's
Valuation Committee members, based on the data available to them. The resulting
valuation, although stated as a precise number, is necessarily within a range
of values that vary depending upon the significance attributed to the various
factors being considered. Some of the factors considered may include the
financial condition and operating results of the company, the long-term
potential of the business of the company, the values of similar securities
issued by companies in similar businesses, the proportion of the company's
securities owned by the Company and the nature of any rights to require the
company to register restricted securities under applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT
IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on the original cost to the Company.
Such method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and development in
technology or product development until significant positive or adverse events
occur subsequent to the date of the original investment that dictate a change
to another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development in
technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where the
factual information available to the Company dictates that an investment should
no longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of the Company's Valuation Committee members. The
resulting valuation, although stated as a precise number, is necessarily within
a range of values that vary depending upon the significance attributed to the
various factors being considered. Some of the factors considered may include
the results of research and development, product development progress,
commercial prospects, term of patent and projected markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services
that provide market quotations based primarily on quotations from dealers and
brokers, market transactions, and other sources.
J. Other Fixed-Income Securities that are not readily marketable are
valued at fair value by the Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
K. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days or
less is valued at amortized cost.
ALL OTHER INVESTMENTS
L. All Other Investments are reported at fair value as determined in
good faith by the Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Valuation Committee's
judgment of fair values as of the valuation date using the outlined basic
methods of valuation. They do not necessarily represent an amount of money that
would be realized if the securities had to be sold in an immediate liquidation.
Thus valuations as of any particular date are not necessarily indicative of
amounts that may ultimately be realized as a result of future sales or other
dispositions of investments held.
- -------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- -------------------------------------------------------------------------------
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company") is a venture capital
investment company operating as a business development company ("BDC") under
the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type of
investment company under the 1940 Act. The Company operates as an internally
managed investment company whereby its officers and employees, under the
general supervision of its Board of Directors, conduct its operations.
The Company elected to become a BDC on July 26, 1995, after receiving
the necessary approvals. From September 30, 1992, until the election of BDC
status, the Company operated as a closed-end, non-diversified investment
company under the 1940 Act. Upon commencement of operations as an investment
company, the Company revalued all of its assets and liabilities at fair value
as defined in the 1940 Act. Prior to such time, the Company was registered and
filed under the reporting requirements of the Securities and Exchange Act of
1934 as an operating company and, while an operating company, operated directly
and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent
wholly owned subsidiary of the Company. Enterprises holds the lease for the
office space, which it subleases to the Company and an unaffiliated party;
operates a financial relations and consulting firm; is a partner in Harris
Partners I, L.P. and is taxed as a C corporation. Harris Partners I, L.P. is a
limited partnership and owned, until December 31, 2002, a 20 percent limited
partnership interest in PHZ Capital Partners L.P. The partners of Harris
Partners I, L.P. are Enterprises (sole general partner) and Harris & Harris
Group, Inc. (sole limited partner).
The Company filed for the 1999 tax year to elect treatment as a
Regulated Investment Company ("RIC") under Sub-Chapter M of the Internal
Revenue Code of 1986 (the "Code") and qualified for the same treatment for
2000-2002. There can be no assurance that the Company will qualify as a RIC for
2003 and subsequent years or that if it does qualify, it will continue to
qualify for subsequent years. In addition, even if the Company were to qualify
as a RIC for a given year, the Company might take action in a subsequent year
to ensure that it would be taxed in that subsequent year as a C Corporation,
rather than as a RIC. As a RIC, the Company must, among other factors,
distribute at least 90 percent of its investment company taxable income and may
either distribute or retain its realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies followed
in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for investment companies and include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "value" as
defined in the 1940 Act and in the applicable regulations of the Securities and
Exchange Commission. Value, as defined in Section 2(a)(41) of the 1940 Act, is
(i) the market price for those securities for which a market quotation is
readily available and (ii) for all other assets is as determined in good faith
by, or under the direction of, the Board of Directors. (See "Asset Valuation
Policy Guidelines" in the "Footnote to Consolidated Schedule of Investments.")
Securities Transactions. Securities transactions are accounted for on
the date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined on specific
identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, the Company recorded income
taxes using the liability method in accordance with the provision of Statement
of Financial Accounting Standards No. 109. Accordingly, deferred tax
liabilities had been established to reflect temporary differences between the
recognition of income and expenses for financial reporting and tax purposes,
the most significant difference of which relates to the Company's unrealized
appreciation on investments.
The March 31, 2003 consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of December
31, 1998, net of the unutilized operating and capital loss carryforwards
incurred by the Company through December 31, 1998.
The Company pays federal, state and local income taxes on behalf of
its wholly owned subsidiary, Harris & Harris Enterprises, which is a C
corporation. (See "Note 6. Income Taxes.")
Estimates by Management. The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of March 31, 2003, and
December 31, 2002, and the reported amounts of revenues and expenses for the
three months ended March 31, 2003, and March 31, 2002. The most significant
estimates relate to the fair valuations of investments for the three months
ended March 31, 2003, and March 31, 2002. Actual results could differ from
these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- -------------------------------------
On August 3, 1989, the shareholders of the Company approved the 1988
Long Term Incentive Compensation Plan (the "1988 Plan"). The Company's 1988
Plan was cancelled as of December 31, 1997, canceling all outstanding stock
options and eliminating all potential stock option grants. As a substitution
for the 1988 Plan, the Company adopted an employee profit-sharing plan.
As of January 1, 1998, the Company implemented the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan (the "1998 Plan") that provided for
profit sharing equal to 20 percent of the net realized income of the Company as
reflected on the Consolidated Statements of Operations for such year, less the
nonqualifying gain, if any. The 1998 Plan was terminated by the Company as of
December 31, 1999, subject to the payment of any amounts owed on the 1999
realized gains under the 1998 Plan.
In March 2000, the Company paid out 90 percent of the profit sharing
in the amount of $1,024,696 on the 1999 realized gains; the remaining 10
percent or $113,855 was paid out in September 2000, upon the completion and
filing of the Company's 1999 federal tax return.
As of January 1, 2000, the Company implemented the Harris & Harris
Group, Inc. Employee Profit-Sharing Plan (the "Plan") that provides for profit
sharing by its officers and employees equal to 20 percent of the net realized
income of the Company as reflected on the consolidated statements of operations
of the Company for such year, less the nonqualifying gain, if any.
Under the Plan, net realized income of the Company includes investment
income, realized gains and losses, and operating expenses (including taxes paid
or payable by the Company), but is calculated without regard to dividends paid
or distributions made to shareholders, payments under the Plan, unrealized
gains and losses, and loss carry-overs from other years ("Qualifying Income").
The portion of net after-tax realized gains attributable to asset values as of
September 30, 1997 is considered nonqualifying gain, which reduces Qualifying
Income.
As soon as practicable following the year-end audit, the Compensation
Committee (the "Committee") will determine whether, and if so how much,
Qualifying Income exists for a plan year, and 90 percent of the Qualifying
Income will be paid out to Plan participants pursuant to the distribution
percentages set forth in the Plan. The remaining 10 percent will be paid out
after the Company has filed its federal tax return for that year in which
Qualifying Income exists.
As of January 1, 2003, the Company implemented the Amended and
Restated Harris & Harris Group, Inc. Employee Profit-Sharing Plan (the "2002
Plan"). The shareholders of the Company approved the performance goals under
the 2002 Plan in accordance with Section 162(m) of the Internal Revenue Code of
1986 ("Code"). The Code generally provides that a public company such as the
Company may not deduct compensation paid to its chief executive officer or to
any of its four most highly compensated officers to the extent that the
compensation paid to any such officer/employee exceeds $1 million in any tax
year, unless the payment is made upon the attainment of objective performance
goals that are approved by the Company's shareholders.
Under the 2002 Plan, net realized income of the Company includes
investment income, realized qualifying gains and losses, and operating expenses
(including taxes paid or payable by the Company), but is calculated without
regard to dividends paid or loss carry-overs from other years ("Qualifying
Income").
Under the 2002 Plan, awards previously granted to the Plan's four
current Participants (Messrs. Harris and Melsheimer and Mss. Shavin and
Matthews, herein referred to as the "grandfathered participants") will be
reduced by 10% with respect to "Non-Tiny Technology Investments" (as defined in
the 2002 Plan) and by 25% with respect to "Tiny Technology Investments" (as
defined in the 2002 Plan) and will become permanent. These reduced awards are
herein referred to as "grandfathered participations." The amount by which such
awards are reduced will be allocable and reallocable each year by the
Compensation Committee ("Committee") among current and new participants as
awards under the 2002 Plan. The grandfathered participations will be honored by
the Company whether or not the grandfathered participant is still employed by
the Company or is still alive (in the event of death, the grandfathered
participations will be paid to the grandfathered participant's estate), unless
the grandfathered participant is dismissed for cause, in which case all awards,
including the grandfathered participations, will be immediately cancelled and
forfeited. With regard to new investments and follow-on investments made after
the date on which the first new employee begins participating in the 2002 Plan,
both current and new participants will be required to be employed by the
Company at the end of a plan year in order to participate in profit sharing on
such investments with respect to such year.
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which the
Company remains a "business development company" within the meaning of 1940 Act
be greater than 20 percent of the Company's "net income after taxes" within the
meaning of Section 57(n)(1)(B) of the 1940 Act. In the event the awards as
calculated exceed such amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the Committee
at any time. Notwithstanding the foregoing, the grandfathered participations
may not be modified. Nothing in the 2002 Plan will preclude the Committee from
naming additional participants in the 2002 Plan or, except for grandfathered
participations, changing the Award Percentage of any Participant (subject to
the overall percentage limitations contained in the 2002 Plan). Under the 2002
Plan, the distribution amounts for non-grandfathered investments for each
officer and employee currently are as follows: Charles E. Harris, 10.790
percent; Mel P. Melsheimer, 4.233 percent; Douglas W. Jamison, 3.0 percent;
Helene B. Shavin, 1.524 percent; and Jacqueline M. Matthews, 0.453 percent. In
one case, for a former employee who left the Company for reason other than due
to termination for cause, any amount earned will be accrued and may
subsequently be paid to such participant.
The grandfathered participations are set forth below:
Grandfathered Participations
----------------------------
Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
----------------------- -------------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews .40770 .33975
Total 18.00000 15.00000
Accordingly, an additional 2.00% of Qualifying Income with respect to
grandfathered Non-Tiny Technology Investments, 5.00% of Qualifying Income with
respect to grandfathered Tiny Technology Investments and the full 20.00% of
Qualifying Income with respect to new investments are available for allocation
and reallocation from year to year. Currently, Douglas W. Jamison is allocated
0.80% of the Non-Tiny Technology Grandfathered Participations and 2.00% of the
Tiny Technology Grandfathered Participations.
The Company calculates the profit-sharing accrual at each quarter end
based on the realized and unrealized gains at that date, net of operating
expenses for the year. Any adjustments to the profit-sharing accrual are then
reflected in the Consolidated Statements of Operations for the quarter. The
profit-sharing accrual is not paid out until the gains are realized. During the
first quarter of 2003, the Company, under the Harris & Harris Group, Inc.
Employee Profit-Sharing Plan, paid out 90 percent of the 2002 profit sharing in
the amount of $13,710. The remaining 10 percent of the 2002 profit sharing,
$1,523, will be paid out upon the completion and filing of the Company's 2002
federal tax return.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that, effective January 1,
1998, 50 percent of all Directors' fees be used to purchase Company common
stock from the Company. However, effective March 1, 1999, the directors may
purchase the Company's common stock in the open market, rather than from the
Company.
Since 1998, the Company has repurchased a total of 1,859,047 of its
shares for a total of $3,496,388, including commissions and expenses, at an
average price of $1.88 per share. These treasury shares were reduced by the
purchases made by the Directors. On July 23, 2002, because of the Company's
strategic decision to invest in tiny technology, the Board of Directors
reaffirmed its commitment not to authorize the purchase of additional shares of
stock in the foreseeable future.
On July 8, 2002, the Company filed a final prospectus under Rule 497
of the Securities Act of 1933 with the SEC for the issuance of transferable
rights to its shareholders. The rights allowed the shareholders to subscribe
for a maximum of 2,954,743 new shares of the Company's common stock, of which
2,634,614 new shares were subscribed for pursuant to the rights offering. The
actual amount of gross proceeds raised upon completion of the offer was
$5,927,882; net proceeds were $5,643,470, after expenses of $284,412. The
Company intends to invest, under normal circumstances, directly or indirectly,
the net proceeds of the offer in accordance with its investment objectives and
policies, within the 12 months following the receipt of such proceeds,
depending on the available investment opportunities for the types of
investments in which the Company principally invests.
As of December 31, 2002, there are no distributable earnings. The
difference between the book basis and tax basis components of distributable
earnings is attributed to Built-In Gains generated at the time of the Company's
qualification as a RIC (see Note 6. "Income Taxes") and after tax earnings that
are not required to be distributed.
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with the Company (disclosed in a Form 8-K filed on October 27, 1999) (the
"Employment Agreement"), which superseded an employment agreement that was
about to expire on December 31, 1999. The Employment Agreement shall terminate
on December 31, 2004 ("Term") subject to either an earlier termination or an
extension in accordance with the terms; on January 1, 2000 and on each day
thereafter, the Term extends automatically by one day unless at any time the
Company or Mr. Harris, by written notice, decides not to extend the Term, in
which case the Term will expire five years from the date of the written notice.
During the period of employment, Mr. Harris shall serve as the
Chairman and Chief Executive Officer of the Company; be responsible for the
general management of the affairs of the Company and all its subsidiaries,
reporting directly to the Board of Directors of the Company; serve as a member
of the Board for the period of which he is and shall from time to time be
elected or reelected; and serve, if elected, as President of the Company and as
an officer and director of any subsidiary or affiliate of the Company.
Mr. Harris is to receive compensation under his Employment Agreement
in the form of base salary of $208,315 for 2000, with automatic yearly
adjustments to reflect inflation. In addition, the Board may increase such
salary, and consequently decrease it, but not below the level provided for by
the automatic adjustments described above. Mr. Harris is also entitled to
participate in the Company's Profit-Sharing Plan as well as in all compensation
or employee benefit plans or programs, and to receive all benefits,
perquisites, and emoluments for which salaried employees are eligible. Under
the Employment Agreement, the Company is to furnish Mr. Harris with certain
perquisites which include a company car, membership in certain clubs and up to
a $5,000 annual reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of $2,000,000;
provides reimbursement for uninsured medical expenses, not to exceed $10,000
per annum, adjusted for inflation, over the period of the contract; provides
Mr. Harris and his spouse with long-term care insurance; and disability
insurance in the amount of 100 percent of his base salary. These benefits are
for the term of the Employment Agreement.
The Employment Agreement provides for the Company to adopt a
supplemental executive retirement plan (the "SERP") for the benefit of Mr.
Harris. Under the SERP, the Company will cause an amount equal to one-twelfth
of Mr. Harris's current annual salary to be credited each month (a "Monthly
Credit") to a special account maintained for this purpose on the books of the
Company for the benefit of Mr. Harris (the "SERP Account"). The amounts
credited to the SERP Account will be deemed invested or reinvested in such
mutual funds or U.S. Government securities as determined by Mr. Harris. The
SERP Account will be credited and debited to reflect the deemed investment
returns, losses and expenses attributed to such deemed investments and
reinvestments. Mr. Harris's benefit under the SERP will equal the balance in
the SERP Account and such benefit will always be 100 percent vested (i.e., not
forfeitable). Mr. Harris will determine the form and timing of the distribution
of the balance in the SERP Account; provided, however, in the event of the
termination, the balance in the SERP Account will be distributed to Mr. Harris
or his beneficiary, as the case may be, in a lump-sum payment within 30 days of
such termination. The Company will establish a rabbi trust for the purpose of
accumulating funds to satisfy the obligations incurred by the Company under the
SERP. The restricted funds for the SERP Plan total $762,532 as of March 31,
2003. Mr. Harris' rights to benefits pursuant to this SERP will be no greater
than those of a general creditor of the Company.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the executive's
base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with the Company,
effective August 15, 1990. The severance compensation agreement provides that
if, following a change in control of the Company, as defined in the agreement,
such individual's employment is terminated by the Company without cause or by
the executive within one year of such change in control, the individual shall
be entitled to receive compensation in a lump sum payment equal to 2.99 times
the individual's average annualized compensation and payment of other welfare
benefits. If Mr. Harris' termination is without cause or is a constructive
discharge, the amount payable under the Employment Agreement will be reduced by
the amounts paid pursuant to the severance compensation agreement.
As of January 1, 1989, the Company adopted an employee benefits
program covering substantially all employees of the Company under a 401(k) Plan
and Trust Agreement. As of January 1, 1999, the Company adopted the Harris &
Harris Pension Plan and Trust, a money purchase plan which would allow the
Company to stay compliant with the 401(k) top-heavy regulations and deduction
limitation regulations. In 2001, Congress enacted the Economic Growth and Tax
Relief Reconciliation Act of 2001 which has increased the deduction limits for
plans such as the 401(k) Plan. This Act eliminates the need for the Company to
maintain two separate plans. Effective December 31, 2001, the Pension Plan
merged into the 401(k) Plan, with the 401(k) Plan being the surviving plan.
Contributions to the plan are at the discretion of the Company. During 2002,
contributions to the plan that have been charged to salaries and benefits
totaled approximately $51,500.
On June 30, 1994, the Company adopted a plan to provide medical and
health insurance for retirees, their spouses and dependents who, at the time of
their retirement, have ten years of service with the Company and have attained
50 years of age or have attained 45 years of age and have 15 years of service
with the Company. On February 10, 1997, the Company amended this plan to
include employees who "have seven full years of service and have attained 58
years of age." The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of March 31,
2003, the Company had a reserve of $446,302 for the plan.
On March 20, 2003, in order to begin planning for eventual management
succession, the Board of Directors voted to establish a mandatory retirement
plan for individuals who are employed by the Company in a bona fide executive
or high policy making position. There are currently two such individuals, the
Chairman and CEO, and the President and COO. Under this plan, mandatory
retirement will take place effective December 31 of the year in which the
eligible individuals attain the age of 65. On an annual basis beginning in the
year in which the designated individual attains the age of 65, a committee of
the Board consisting of non-interested directors may determine to postpone the
mandatory retirement date for that individual for one additional year for the
benefit of the Company.
Under applicable law prohibiting discrimination in employment on the
basis of age, the Company can impose a mandatory retirement age of 65 for its
executives or employees in high policy-making positions only if each employee
subject to the mandatory retirement age is entitled to an immediate retirement
benefit at retirement age of at least $44,000 per year. The benefits payable at
retirement to Charles E. Harris, the Company's Chairman and Chief Executive
Officer, and Mel P. Melsheimer, the Company's President, Chief Operating
Officer and Chief Financial Officer, under the Company's existing retirement
plans do not equal this threshold. Mr. Harris has offered, for the benefit of
the Company, to waive his right to exclude certain other benefits from this
calculation, which makes it unlikely that any provision will have to be made
for him in order for the Company to comply with this threshold requirement. For
Mr. Melsheimer, however, a new plan must be established to provide him with the
difference between the benefit required under the age discrimination laws and
that provided under the Company's existing plans. The expense to the Company of
providing the benefit under this new plan is currently estimated to be
$450,000. This benefit will be unfunded, and the expense will be amortized over
the fiscal periods through the year ended December 31, 2004.
NOTE 6. INCOME TAXES
- ---------------------
The Company elected Sub-Chapter M status for the year ended December
31, 1999. On February 23, 1999, the Company declared a cash dividend of $0.35
per share (for a total of $3,647,017), thereby distributing part of the
long-term capital gain generated in 1999 by the sale of NBX Corporation to 3Com
Corporation. Approximately $143,261 of the long-term capital gain for 1999 was
not distributed during 1999. Accordingly, on September 20, 2000, the Company
declared a $0.02 dividend (for a total of $184,817). For the year ended
December 31, 1999, the Company incurred approximately $20,000 in excise taxes.
Provided that a proper election is made, a corporation taxable under
Sub-Chapter C of the Internal Revenue Code (a "C Corporation") that elects to
qualify as a RIC continues to be taxable as a C Corporation on any gains
realized within 10 years of its qualification as a RIC (the "Inclusion Period")
from sales of assets that were held by the corporation on the effective date of
the RIC election ("C Corporation Assets") to the extent of any gain built into
the assets on such date ("Built-In Gain"). (If the corporation fails to make a
proper election, it is taxable on its Built-In Gain as of the effective date of
its RIC election.) The Company had Built-In Gains at the time of its
qualification as a RIC and made the election to be taxed on any Built-In Gain
realized during the Inclusion Period. Prior to 1999, the Company incurred
ordinary and capital losses from its operations. After the Company's election
of RIC status, those losses remained available to be carried forward to
subsequent taxable years. The Company has previously used loss carryforwards to
offset Built-In Gains. As of January 1, 2003, the Company had $501,640 of loss
carryforwards remaining and $4,663,457 of unrealized Built-In Gains.
Continued qualification as a RIC requires the Company to satisfy
certain investment asset diversification requirements in future years. The
Company's ability to satisfy those requirements may not be controllable by the
Company. There can be no assurance that the Company will qualify as a RIC in
subsequent years.
To the extent that the Company retains capital gains, and declares a
deemed dividend to shareholders, the dividend is taxable to the shareholders.
The Company would pay tax, at the corporate rate, on the distribution, and the
shareholders would receive a tax credit equal to their proportionate share of
the tax paid. The Company took advantage of this rule for 2000 and 2001. The
Company's financial statements for 2000 and 2001 include a tax liability of
$5,709,884 and $290,748, respectively. The taxes paid by the Company's
shareholders as a result of its deemed dividend declaration for 2000
($5,688,896) and 2001 ($271,467) are reflected as a deduction to the additional
paid-in capital in the Company's Consolidated Statement of Assets and
Liabilities rather than an expense in the Consolidated Statement of Operations.
During the three months ended March 31, 2003, the Company accrued a
net tax provision of $2,973. The Company pays federal, state and local taxes on
behalf of its wholly owned subsidiary, Harris & Harris Enterprises, Inc., which
is taxed as a C Corporation.
For the three months ended March 31, 2003, and 2002, the Company's
income tax provision was allocated as follows:
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
Investment operations.................................. $ 0 $ 0
Net realized gain on investments....................... 2,973 34,223
Net decrease in unrealized appreciation on investments. 0 0
------------ ------------
Total income tax provision............................. $ 2,973 $ 34,223
============ ============
The above tax provision consists of
the following:
Current................................................ $ 2,973 $ 34,223
Deferred - Federal..................................... 0 0
------------ ------------
Total income tax provision ............................ $ 2,973 $ 34,223
============ ============
The Company's net deferred tax liability at March 31, 2002, and
December 31, 2001, consists of the following:
March 31, 2003 December 31, 2002
Tax on unrealized appreciation on investments......... $ 844,918 $ 844,918
Net operating loss and capital carryforward........... (175,574) (175,574)
---------------- ---------------
Net deferred income tax liability..................... $ 669,344 $ 669,344
============== ==============
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
During 1993, the Company signed a 10-year lease with sublet provisions
for office space. In 1995, this lease was amended to include additional office
space. During 1999, the Company sublet this additional space to an unaffiliated
party. Rent expense under this lease for the year ended December 31, 2002 was
$178,561. Minimum lease payments in 2003 are $101,946.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, the Company established an asset account line of
credit of up to $12,700,000. The asset account line of credit is secured by the
Company's government and government agency securities. Under the asset account
line of credit, the Company may borrow up to 95 percent of the current value of
its government and government agency securities. The Company's outstanding
balance under the asset line of credit at March 31, 2003 and March 31, 2002 was
$7,724,207 and $8,996,740 respectively. The asset line of credit bears interest
at a rate of the Broker Call Rate plus 50 basis points. At March 31, 2003, the
asset account line of credit accrued interest at a rate of 3.5%.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
On April 1, 2003, the Company sold its investment in $7,700,000 of
Federal Home Loan Bank Notes. The proceeds of $7,748,561 were used to repay the
entire outstanding balance of $7,724,207 under the asset line of credit.
On April 7, 2003, the Company invested $1,500,000 in Series C
convertible preferred stock of privately held Nanosys, Inc. Nanosys, Inc. is
focused on the development of nanotechnology-enabled systems incorporating
novel and patent-protected zero and one-dimensional nanometer-scale materials
such as nanowires, nanotubes and nanodots (quantum dots).
On April 8, 2003, Kriton Medical, Inc. filed for Chapter 11
bankruptcy. The Company wrote off its investment in Kriton in 2002.
The Company has entered into a seven-year sublease for office space in
New York City to replace its existing lease which is expiring July 31, 2003.
The Company plans to occupy this new space beginning in August 2003. The rent
for the first 12 months will be $126,086.
NOTE 10. INTERIM FINANCIAL STATEMENTS
- --------------------------------------
The interim financial statements of the Company have been prepared in
accordance with the instructions to Form 10-Q and Article 10 of Regulations
S-X. Accordingly, they do not include all information and disclosures necessary
for a presentation of the Company's financial position, results of operations
and cash flows in conformity with generally accepted accounting principles in
the United States of America. In the opinion of management, these financial
statements reflect all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the Company's financial
position, results of operations and cash flows for such periods. The results of
operations for any interim period are not necessarily indicative of the results
for the full year. These financial statements should be read in conjunction
with the financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2002.
Until , all dealers effecting transactions in these
securities, whether or not participating in this offering, may be required to
deliver a Prospectus and Prospectus Supplement. This is in addition to the
obligation of dealers to deliver a Prospectus and Prospectus Supplement when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
[GRAPHIC OMITTED]
HARRIS & HARRIS GROUP, INC.