Venture
Capital for Nanotechnology and Microsystems
ANNUAL
REPORT 2009
FELLOW
SHAREHOLDERS:
We ended our 2008 Annual Letter to
Shareholders with the mantra “survive to thrive.” In subsequent
Shareholder Letters and in the Management’s Discussion and Analysis (“MD&A”)
of our Quarterly Reports on Form 10-Q, we described the current venture
environment and the steps we took to position ourselves not only to survive, but
when the opportunity presented itself, to thrive. In this letter, we
will continue to refine our strategy for the current venture
environment.
However,
first we believe some self assessment is in order. Our founder,
Charles Harris, used to say, “Good management is reacting appropriately to
events. Great management is anticipating events.” In 2009,
although we endeavored to anticipate events, our actions and our timing could
have been better. First, we could have been better prepared to raise
capital a month or two earlier. This would have permitted us to feel
comfortable stepping up our investment sooner in some of our most mature
portfolio companies in the hope of increasing our potential
returns. Second, we recognized the opportunity in investing in
micro-capitalization public companies, but we were slow to invest in these
potential opportunities. We missed much of the steep climb off
the March 2009 low in prices.
In 2009,
we believe we exhibited some of the qualities of good management, although we
will strive for better performance. First, we
survived. Second, we positioned ourselves to thrive in the current
venture capital climate. Third, since then, we have been
opportunistic in pursuing follow-on investments and new investments at what we
believe are appropriate valuations.
Operationally, we continue to reduce
our expenses. Our total expenses reported in our consolidated
statement of operations in our Annual Report on Form 10-K have decreased for the
third straight year. Our cash expenses in 2009 were
$5,683,624. Salaries, benefits and stock-based compensation have
decreased in each of the past three years. Both cash and non-cash
stock-based compensation components of this expense have decreased in
2009. Administration and operations expenses as well as Director’s
fees and expenses have decreased in each of the past three years. It
is only in our professional fees that more is not being done with less, but I
believe our shareholders benefit from increased audit and compliance
oversight.
As we
discussed in both our Third Quarter Letter to Shareholders and our Letter to
Shareholders on February 3, 2010, we believe our venture capital portfolio has
been positioned for this difficult venture-financing environment. As
of December 31, 2009, of our top 10 holdings by value, comprising 69 percent of
our venture capital portfolio, only three of these companies require financing
in 2010. This is critical in a venture capital environment where
financing risk is significant. One of these companies has already
consummated its financing, and the financing was done at a premium to where the
company was valued at December 31, 2009. Our privately held portfolio
companies generated approximately $267 million in aggregate revenue in 2009, a
10.5 percent increase from revenue generated in 2008. Our most mature
companies, Bridgelux, Metabolon, Molecular Imprints, NeoPhotonics and Solazyme
all generated record revenue in 2009.
As of
December 31, 2009, we have seen stabilization in our net asset value per share
(“NAV”). It increased from $4.24 at December 31, 2008, to $4.35 at
December 31, 2009. We believe the increase in NAV reflects positive
events within our portfolio. NeoPhotonics, Molecular Imprints,
Xradia, BioVex and Ensemble each increased in value in the fourth quarter of
2009.
In 2010,
shareholders should expect that there will be decreases in the values of some
companies within our venture capital portfolio. We will continue to
make the difficult decisions not to invest in portfolio companies we do not
believe can survive the current market environment or that we do not believe can
create meaningful value for Harris & Harris Group’s
shareholders. In some of these companies we have significant
investments, and our decision may cause us to lose most or all of our
investment. However, we also believe that some of our companies will
continue their growth, and their success may be reflected in increases to their
valuations in 2010 and 2011. Reallocating investment to these latter
companies may help us realize greater returns for Harris & Harris Group’s
shareholders.
Transparency and liquidity will remain
our guiding principles in 2010. Berkshire Hathaway’s recent
shareholder letter stated, “To build a compatible shareholder population, we try
to communicate with our owners directly and informatively. Our goal
is to tell you what we would like to know if our positions were
reversed.” We concur with this sentiment. This can be a
difficult task when managing a venture capital firm that invests in early-stage
private companies. We are limited by confidentiality agreements with
our private venture capital companies. However, we continue to
initiate practices that we believe provide meaningful and incremental
transparency to our shareholders.
First, in our Annual Report on Form
10-K, in the MD&A, readers will find more detailed information about our
portfolio.
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On
pages 39-40, we provide our rationale for maintaining the amount of
liquidity we maintain on our balance
sheet.
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On
pages 41-42, we provide a table detailing our board seats and observer
positions in 25 of our 31 private venture capital
companies.
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On
page 44, we provide two tables that organize our portfolio companies into
relevant market domains and break these out into existing market domains
and emerging market domains.
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On
page 45, we provide a table detailing three levels of maturity for our
portfolio companies and delineating the value of our venture capital
portfolio represented by each
level.
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On
Pages 46-47, we have included more detailed information on the venture
capital industry and the difficulties facing the industry including
raising capital and supporting existing portfolio
companies.
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On
page 50, we provide a table that discusses some of the inputs used to
value our private venture capital portfolio during the past four
quarters. This table describes the nature of the contributions
these different inputs have to our valuation changes in a given
quarter. We believe this helps to provide shareholders with
information on the dominant factors driving the value of our venture
capital portfolio.
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We hope this and other disclosures
within our Form 10-K and our Proxy Statement for our 2010 Annual Meeting of
Shareholders, which will be filed shortly, relevant to compensation, help to
provide more transparency for our shareholders.
Second, we have instituted a
shareholder call three times a year. These calls will complement our
Annual Meeting of Shareholders on May 6, 2010. Our first shareholder
call will take place on Friday, March 19, 2010, at 10 a.m. EDT. The
purpose of the call is 1) to have management present information from our most
recent financials; 2) to provide insight into portfolio companies and new
investments; and 3) to allow analysts and shareholders to ask questions of
management. We believe this call provides an opportunity for
investors to hear from management on the opportunities and challenges we face in
2010 and beyond.
Third, we will host our second “Meet
the Portfolio Day” on May 7, 2010, in New York City at the Nasdaq MarketSite in
Times Square. The Chief Executive Officers from eight of our Nanotech
for HealthcareSM
companies and the CEO of Solazyme, which has a health sciences business, will
present their companies to an audience comprised of institutional investors,
strategic investors, analysts, investment bankers and
shareholders. The event begins at 8:30 a.m. EDT, and more information
can be found on our website at www.hhvc.com. For
those who cannot be in New York City, the event will be webcast.
As we
stated in our February 2010 Letter to Shareholders, “We are looking forward to
2010.... [O]ur number one priority heading into 2010 is to look for opportunities
to monetize our portfolio companies at appropriate valuations.” We
believe this potential liquidity will strengthen Harris & Harris
Group.
We
believe we are in a strong position to monetize some of our more mature private
investments through initial public offerings (“IPOs”) or mergers and
acquisitions (“M&A”) over the next two years, although continued company
performance, market conditions and general economic trends will influence our
decisions and our ability to monetize these investments. Some of our
companies are leaders in their respective industries. Many of these
companies have reached their current state of maturity without the need for
significant amounts of venture capital dollars in comparison to their
peers. These companies have strong venture syndicates that have been
efficient in providing capital at what we believe are appropriate
valuations. These companies have increased their revenue year over
year. In other words, we believe there is opportunity for investors
to realize gains, even in the current value-conscious market for IPOs and
M&A transactions.
Our
strategy for continuing to deploy our capital will be straightforward over the
next two years. We have a robust deal flow in privately held
companies operating at various stages of maturity. Technology
platforms and interesting intellectual property estates are being formed that
may be interesting on their own or combined with our existing nanotechnology
companies. We believe our leadership position in and focus on
nanotechnology strengthened during the recession. We had capital to
deploy, and we demonstrated our ability to raise capital and deploy it in our
most promising companies at appropriate valuations.
With our
current portfolio, with our current asset size and with the current state of the
venture capital market, we are primarily focused on examining private company
opportunities at the earliest stages of maturity and at later stages of
maturity. In early-stage private companies, we are looking for
opportunities where there is the potential for generating near-term revenue and
where we may have the opportunity to own greater than 10 percent of the company
at the time of exit. During the fourth quarter of 2009 through the
first quarter of 2010, we made $250,000 investments in each of two early stage
private companies, Enumeral Technologies, Inc., and ABS Materials
Inc. In both of these companies, we led or co-led the capital raise,
and we provided the first institutional investment in the company.
In
late-stage private companies, we are looking for opportunities where the company
has a clear path to revenue growth, where there is a near-term exit opportunity,
where the valuation is low and where we believe the current round of financing
may be the last round of private financing. Although we did not make
any new late-stage private company investments in 2009 or in early 2010, we did
increase our position in two of our late stage companies, NeoPhotonics and
BioVex.
On pages
38-39 of our Annual Report on Form 10-K, we present our strategy for investing
in micro-capitalization public companies. With private venture-backed
companies requiring greater maturity before exit, we believe a strategy that
permits us “to ring the cash register” on a more frequent basis is beneficial to
our shareholders. We estimate that our public company investments
will be held from one to three years, but we will be certain to always have the
ability to access the liquidity inherent to these publicly traded
securities. We have invested in two public companies, Orthovita,
Inc., and Satcon Technology Corporation.
We
believe that our focus on micro-capitalization public companies is a logical
extension of our venture capital expertise. We believe the shorter
term nature of these investments permits us to generate returns more quickly
than in private venture-backed companies. We believe coupling this
shorter term strategy for investing in young public companies with our portfolio
approach to private venture capital investments provides shareholders with the
best opportunity for returns over the next few years.
We
believe it is important to ask continuously whether we are dedicating our time
and capital to the right investment strategy. We concluded that
investing directly in entrepreneurial-led innovations still provides the highest
potential for return to our investors and our society. The
uncertainty involved in early-stage venture capital companies permits the
potential for significant returns while the downside risk is limited to the
amount of capital we have invested. As investors, we like the skewed
nature of these probabilities. We have early insights into emerging
market domains that may create the next wave of wealth. Many of these
emerging markets are enabled by nanotechnology. Many of our companies
are working with and partnered with large, industry leaders that could be
potential acquirers. We are confident that this investment strategy
has the potential to provide outsized returns to our shareholders. We
think it is the highest use of our shareholders’ capital and our management’s
time.
Please
join us on March 19th at 10
a.m. EDT for our first quarterly call.
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Douglas
W. Jamison
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Daniel
B. Wolfe
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Chairman
and Chief Executive Officer
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President
and Chief Operating Officer
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Managing
Director
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Chief
Financial Officer Managing Director
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Michael
A. Janse
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Alexei
A. Andreev
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Executive
Vice President
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Executive
Vice President
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Managing
Director
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Managing
Director
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March 17,
2010
This
letter may contain statements of a forward-looking nature relating to future
events. These forward-looking statements are subject to the inherent
uncertainties in predicting future results and conditions. These
statements reflect the Company's current beliefs, and a number of important
factors could cause actual results to differ materially from those expressed in
this letter. Please see the Company's Annual Report on Form 10-K for
the year ended December 31, 2009, as well as subsequent SEC filings, filed with
the Securities and Exchange Commission for a more detailed discussion of the
risks and uncertainties associated with the Company's business, including but
not limited to the risks and uncertainties associated with venture capital
investing and other significant factors that could affect the Company's actual
results. Except as otherwise required by Federal securities laws,
Harris & Harris Group, Inc., undertakes no obligation to update or revise
these forward-looking statements to reflect new events or
uncertainties. The reference to the website www.HHVC.com has been
provided as a convenience, and the information contained on such website is not
incorporated by reference into this letter.