SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
_ X__QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
or
____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ________________
Commission File Number__________0-11576__________
Harris & Harris Group, Inc.
(Exact name of registrant as specified in its charter)
New York 13-3119827
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Rockefeller Plaza
Suite 1430
New York, New York 10020
(Address of principal executive offices)
(212) 332-3600
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. The number of shares of
common stock, par value $.01 per share, outstanding on October 29, 1997 was
10,584,971.
Harris & Harris Group, Inc.
Form 10-Q, September 30, 1997
TABLE OF CONTENTS
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements . . . . . . . . . . . . . . . . 3
Statements of Assets and Liabilities . . . . . . . . . . . . 4
Statements of Operations . . . . . . . . . . . . . . . . . . 5
Statements of Cash Flows . . . . . . . . . . . . . . . . . . 6
Statements of Changes in Net Assets. . . . . . . . . . . . . 7
Schedule of Investments. . . . . . . . . . . . . . . . . . . 8
Notes to Financial Statements. . . . . . . . . . . . . . . . 16
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Financial Condition. . . . . . . . . . . . . . . . . . . . . 23
Results of Operations. . . . . . . . . . . . . . . . . . . . 25
Liquidity and Capital Resources. . . . . . . . . . . . . . . 26
Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
PART II OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . 28
Item 2. Changes in Securities. . . . . . . . . . . . . . . . 28
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information. . . . . . . . . . . . . . . . . . 28
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . 28
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . 29
Signature. . . . . . . . . . . . . . . . . . . . . . . . . . 30
2
Harris & Harris Group, Inc.
Form 10-Q, September 30, 1997
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
The information furnished in the accompanying financial
statements reflects all adjustments that are, in the opinion of
management, necessary for a fair presentation of the results for the
interim period presented.
On June 30, 1994, the Company's shareholders approved a proposal
to allow the Company to make an election to become a Business
Development Company ("BDC") under the Investment Company Act of 1940, as
amended. The Company made such election on July 26, 1995. Certain
information and disclosures normally included in the financial
statements in accordance with Generally Accepted Accounting Principles
have been condensed or omitted as permitted by Regulation S-X and
Regulation S-K. It is suggested that the accompanying financial
statements be read in conjunction with the audited financial statements
and notes thereto for the year ended December 31, 1996 contained in the
Company's 1996 Annual Report.
On September 25, 1997, the Company's Board of Directors approved
a proposal to seek qualification in 1998 as a Regulated Investment
Company ("RIC") under Sub-Chapter M of the Internal Revenue Code. As a
RIC, the Company must distribute at least 90% of its taxable net
investment income and may either distribute or retain its taxable net
realized capital gains on investments. There can be no assurance that
the Company will qualify as a RIC or that if it does qualify that it
will continue to qualify.
3
STATEMENTS OF ASSETS AND LIABILITIES
------------------------------------
ASSETS
September 30, 1997 December 31, 1996
(Unaudited) (Audited)
Investments, at value (See accompanying
schedule of investments and notes) . . . $ 29,049,614 $ 35,648,682
Cash and cash equivalents. . . . . . . . . 202,438 155,440
Interest receivable. . . . . . . . . . . . 74,602 198,342
Taxes receivable (Note 5). . . . . . . . . 2,506,512 2,119,492
Receivable from brokers. . . . . . . . . . 557,606 0
Prepaid expenses . . . . . . . . . . . . . 17,319 81,501
Other assets . . . . . . . . . . . . . . . 228,288 351,833
------------ ------------
Total assets . . . . . . . . . . . . . . . $ 32,636,379 $ 38,555,290
============ ============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities . $ 481,478 $ 374,326
Deferred rent. . . . . . . . . . . . . . . 53,975 60,914
Deferred income tax liability (Note 5) . . 246,957 2,187,447
------------ ------------
Total liabilities. . . . . . . . . . . . . 782,410 2,622,687
Commitments and contingencies (Note 6) ------------ ------------
Net assets . . . . . . . . . . . . . . . . $ 31,853,969 $ 35,932,603
============ ============
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; 10,442,682 issued
and outstanding at 9/30/97 and 12/31/96 104,427 104,427
Additional paid in capital . . . . . . . . 15,850,576 15,850,576
Accumulated net realized income. . . . . . 15,066,154 15,606,009
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $390,502 at 9/30/97 and
$2,295,998 at 12/31/96. . . . . . . . . . . 832,812 4,371,591
------------ ------------
Net assets . . . . . . . . . . . . . . . . . . $ 31,853,969 $ 35,932,603
============ ============
Shares outstanding . . . . . . . . . . . . . . 10,442,682 10,442,682
------------ ------------
Net asset value per outstanding share. . . . . $ 3.05 $ 3.44
============ ============
The accompanying notes are an integral part of these financial statements.
4
STATEMENTS OF OPERATIONS
(Unaudited)
------------------------
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1996 1997 1996
Investment income:
Interest from:
Fixed-income securities $ 147,099 $ 194,570 $ 362,330 $ 625,434
Affiliated companies. . 11,111 9,556 30,000 29,667
Dividend Income --
Unaffiliated Companies 0 0 0 8,024
Other income. . . . . . . 10,000 13,440 18,369 49,146
----------- ----------- ----------- -----------
Total investment income 168,210 217,566 410,699 712,271
Expenses:
Salaries and benefits . . 442,888 367,772 1,229,131 1,152,078
Administration and
operations. . . . . . . 77,800 130,061 303,576 384,379
Professional fees . . . . 47,071 132,208 189,900 475,188
Directors' fees and
expenses. . . . . . . . 36,577 20,132 87,303 47,203
Rent. . . . . . . . . . . 28,846 41,784 101,562 119,628
Depreciation. . . . . . . 15,000 14,500 45,000 43,187
Custodian fees. . . . . . 5,039 2,929 12,182 9,040
Restructuring expenses. . 100,000 0 100,000 0
----------- ----------- ----------- -----------
Total expenses . . . . 753,221 709,386 2,068,654 2,230,703
----------- ----------- ----------- -----------
Operating loss before
income taxes. . . . . . (585,011) (491,820) (1,657,955) (1,518,432)
Income tax benefit (Note 5) 497,297 171,181 665,644 524,458
----------- ----------- ----------- -----------
Net operating loss. . . . . (87,714) (320,639) (992,311) (993,974)
Net realized (loss) gain
on investments:
Realized (loss) gain on
sale of investments (95,052) (51,277) 696,086 (213,584)
----------- ----------- ----------- -----------
Total realized
(loss) gain (95,052) (51,277) 696,086 (213,584)
Income tax benefit
(provision) (Note 5) 33,268 17,947 (243,630) 74,754
----------- ----------- ----------- -----------
Net realized (loss)
gain on investments (61,784) (33,330) 452,456 (138,830)
----------- ----------- ----------- -----------
Net realized loss. . . . (149,498) (353,969) (539,855) (1,132,804)
Net increase (decrease)
in unrealized appreciation
on investments:
Increase as a result
of investments sales 102,314 37,831 0 0
Decrease as a result
of investments sales (391,084) 0 (1,730,910) 0
Increase on investments
held . . . . . . . . 2,391,856 93,404 4,770,561 3,885,217
Decrease on investments
held . . . . . . . . (953,126) (518,112) (8,483,926) (1,409,833)
----------- ---------- ----------- -----------
Change in unrealized
appreciation on
investments . . . 1,149,960 (386,877) (5,444,275) 2,475,384
Income tax (provision)
benefit (Note 5) (390,502) 135,406 1,905,496 (866,385)
----------- ---------- ----------- -----------
Net increase (decrease)
in unrealized
appreciation on
investments. . . . . 759,458 (251,471) (3,538,779) 1,608,999
----------- ---------- ----------- -----------
Net increase (decrease)
in net assets from
operations:
Total. . . . . . . . . $ 609,960 $ (605,440) $(4,078,634) $ 476,195
=========== =========== =========== ===========
Per outstanding share $ 0.06 $ (0.06) $ (0.39) $ 0.05
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
5
STATEMENTS OF CASH FLOWS
(Unaudited)
-----------------------
Nine Months Ended Nine Months Ended
September 30, 1997 September 30, 1996
Cash flows (used in) provided by
operating activities:
Net (decrease) increase in net assets
resulting from operations . . . . . $ (4,078,634) $ 476,195
Adjustments to reconcile (decrease)
increase in net assets from operations
to net cash used in operating activities:
Net realized and unrealized loss (gain)
on investments. . . . . . . . . 4,748,189 (2,261,800)
Deferred income taxes . . . . . . (1,940,490) 867,442
Depreciation. . . . . . . . . . . 45,000 43,187
Other . . . . . . . . . . . . . . 0 (1,893)
Changes in assets and liabilities:
Receivable from brokers . . . . . (557,606) 205,789
Prepaid expenses. . . . . . . . . 64,182 58,288
Interest receivable . . . . . . . 123,740 239,286
Taxes receivable. . . . . . . . . (387,020) (600,271)
Other assets. . . . . . . . . . . 102,162 (4,292)
Accounts payable and accrued
liabilities . . . . . . . . . . 107,152 (21,664)
Deferred rent . . . . . . . . . . (6,939) 3,341
Purchase of fixed assets. . . . . (23,618) (32,815)
----------- -----------
Net cash used in operating activities (1,803,882) (1,029,207)
Cash flows provided by (used in)
investing activities:
Net sale of short-term investments
and marketable securities . . . . . 5,011,522 5,156,883
Investment in private placements. . . (3,160,642) (4,406,614)
----------- -----------
Net cash provided by investing activities 1,850,880 750,269
Cash flows provided by financing activities:
Proceeds from exercise of stock options 0 87,500
----------- -----------
Net cash provided by financing activities 0 87,500
Net increase (decrease) in cash and cash equivalents:
Cash and cash equivalents at
beginning of the period . . . . . . 155,440 364,354
Cash and cash equivalents at
end of the period . . . . . . . . . 202,438 172,916
----------- -----------
Net increase (decrease) in cash
and cash equivalents . . . . . . . . . $ 46,998 $ (191,438)
============ ============
Supplemental disclosures of cash flow information:
Income taxes paid. . . . . . . . . . . . $ 5,959 $ 57,234
============ ============
The accompanying notes are an integral part of these financial statements.
6
STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
-----------------------------------
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1996 1997 1996
Changes in net assets from operations:
Net operating loss $ (87,714) $ (320,639) $ (992,311) $ (993,974)
Net realized (loss)
gain on investments (61,784) (33,330) 452,456 (138,830)
Net (decrease) increase
in unrealized
appreciation on
investments as a
result of sales. . (190,710) 24,590 (1,125,092) 0
Net increase (decrease)
in unrealized
appreciation on
investments held 950,168 (276,061) (2,413,687) 1,608,999
------------ ------------ ------------ ------------
Net increase
(decrease) in net
assets resulting
from operations 609,960 (605,440) (4,078,634) 476,195
Changes in net assets from
capital stock transactions:
Proceeds from exercise of
stock options 0 0 0 87,500
Tax benefit of restricted
stock award and common
stock transactions 0 0 0 72,188
------------ ------------ ------------ ------------
Net increase in net
assets resulting
from capital stock
transactions 0 0 0 159,688
------------ ------------ ------------ ------------
Net increase (decrease)
in net assets . . . 609,960 (605,440) (4,078,634) 635,883
Net assets:
Beginning of period 31,244,009 37,803,232 35,932,603 36,561,909
------------ ------------ ------------ ------------
End of period $ 31,853,969 $ 37,197,792 $ 31,853,969 $ 37,197,792
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
7
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1997
(Unaudited)
------------------------------------------
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated
Companies (8)(13)(14) --
12.0% of total investments
Publicly Traded Portfolio
(Common stock unless noted
otherwise) -- 8.6% of total
investments
Oil and Gas Related
CORDEX Petroleums Inc. (1)
Argentine and Chilean
oil and gas exploration
Class A Common Stock. . . . . . . . . (C) 4,052,080 $ 189,865
Biotechnology and Healthcare Related
Fuisz Technologies, Ltd. (1)(4) . . . . (C) 125,000 1,765,625
PharmaPrint, Inc. (1)(4) . . . . . . . (C) 20,000 270,000
Zonagen, Inc. (1)(4). . . . . . . . . . (C) 7,500 270,000
------------
Total Publicly Traded Portfolio (cost: $1,673,212). . . . . . . $ 2,495,490
Private Placement Portfolio (Illiquid) -- 3.4% of total investments
Exponential Business Development
Company (1)(2)(5)
Venture capital partnership
focused on early stage companies
Limited partnership interest . . . . . (A) -- $ 25,000
Princeton Video Image, Inc. (1)(2)(6)(7)
Real time sports and entertainment
advertising 2.8% of fully diluted equity
Common Stock . . . . . . . . . . . . . (D) 150,200 976,300
------------
Total Private Placement Portfolio (cost: $683,075). . . . . . . $ 1,001,300
------------
Total Investments in
Unaffiliated Companies (cost: $2,356,287). . . . . . . . . . . $ 3,496,790
------------
The accompanying notes are an integral part of this schedule.
8
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1997
(Unaudited)
------------------------------------------
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in
Non-Controlled Affiliates (8)(14)
(Illiquid) -- 51.5% of total investments
Dynecology Incorporated (1)(2)(6) --
Develops various environmental
intellectual properties -- Option
expiring 12/16/98 to purchase
at $15 per share 135,000 shares of
Common Stock equaling 18.2% of
fully diluted equity. . . . . . . . . . . . . (D) -- $ 25,000
Gel Sciences, Inc. (1)(2)(6) --
Develops engineered response gels
for controlled release systems --
10.9% of fully diluted equity
Warrants at $1.65 expiring 02/01/00 . . . . . (D) 27,766
Common Stock. . . . . . . . . . . . . . . . . (D) 171,172
Series A Preferred Stock. . . . . . . . . . . (D) 135,178
Series A-1 Preferred Stock. . . . . . . . . . (D) 57,607
Series B Convertible Preferred Stock. . . . . (D) 397,409
Series C Convertible Preferred Stock. . . . . (D) 101,515
Demand Promissory Note. . . . . . . . . . . . (A) $ 316,000 696,000
Genomica Corporation (1)(2)(6)(9) --
Develops software that enables
the study of complex genetic diseases --
11.0% of fully diluted equity
Common Stock. . . . . . . . . . . . . . . . . (A) 199,800
Series A Voting Convertible Preferred Stock . (A) 1,660,200 1,000,304
Harber Brothers Productions, Inc. (1)(2)(6) --
Finances, produces and markets media
products that combine entertainment,
music, learning and interactivity --
18.7% of fully diluted equity
Series A Voting Convertible Preferred Stock (D) 967,500 1
Demand Promissory Note. . . . . . . . . . . . (D) $ 250,000 1
Highline Capital Management, LLC. (2)(5) --
Organizes and manages investment
partnerships -- 24.9% of fully
diluted equity. . . . . . . . . . . . . . . . (A) -- 500,000
Highline Offshore Advisors, LLC. (1)(2)(4)(6) --
Organizes and manages offshore
investment vehicles -- 24.9% of fully
diluted equity. . . . . . . . . . . . . . . . (A) -- 500,000
NBX Corporation (1)(2)(6)(11) -- Exploits
innovative distributed computing
technology for use in small business
telephone systems -- 15.4% of fully diluted equity
Series A Convertible Preferred Stock. . . . . (B) 500,000
Series C Convertible Preferred Stock. . . . . (B) 240,793
Series D Convertible Preferred Stock. . . . . (B) 59,965 4,540,298
Nanophase Technologies Corporation (1)(2)(6) --
Manufactures and markets inorganic
crystals of nanometric dimensions
6.4% of fully diluted equity
Series D Convertible Preferred Stock. . . . . (B) 1,162,204 3,486,612
PHZ Capital Partners Limited Partnership (2)(5)
-- Organizes and manages investment
partnerships -- 20.0% of fully diluted equity
Limited partnership interest. . . . . . . . . (B) 1,000,000
One year 8% note due 9/22/98. . . . . . . . . (A) $ 500,000 500,000
PureSpeech, Inc. (1)(2)(6) -- Develops and
markets innovative speech recognition
technology -- 8.3% of fully diluted equity
Series A Voting Convertible Preferred Stock (D) 476,190 187,120
Convertible Promissory Note . . . . . . . . . (A) $ 243,980 243,980
Questech Corporation (1)(2)(5)(6)(10) --
Manufactures and markets proprietary
decorative tiles and signs -- 15.4% of
fully diluted equity
Common Stock. . . . . . . . . . . . . . . . . (D) 565,792 2,263,168
Warrants at $4.00 expiring 11/28/01 . . . . . (A) 166,667 167
------------
Total Private Placement Portfolio in
Non-Controlled Affiliates (cost: $12,171,802) . . . . . . . $ 14,942,651
------------
The accompanying notes are an integral part of this schedule.
9
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1997
(Unaudited)
------------------------------------------
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in Controlled
Affiliates (8)(14) (Illiquid) -- 4.4% of
total investments
BioSupplyNet, Inc. (1)(2)(6)(12) --
Expands commercially the print and
World Wide Web product directories
developed by Cold Spring Harbor
Laboratory Press
38.3% fully diluted equity
Series A Convertible Preferred Stock. . . . . (A) 775,000 $ 775,000
MultiTarget, Inc. (1)(2)(6) -- Developing
intellectual property related to localized
treatment of cancer
37.5% of fully diluted equity
Series A Convertible Preferred Stock. . . . . (D) 375,000 0
NeuroMetrix, Inc. (1)(2)(6) -- Developing
devices for: 1) diabetics to monitor their
blood glucose and 2) detection of carpal tunnel
syndrome -- 30.0% of fully diluted equity
Series A Convertible Preferred Stock. . . . . (A) 175,000
Series B Convertible Preferred Stock. . . . . (A) 125,000 410,000
nFX Corporation (1)(2) -- Develops neural-network
software 38.3% of fully diluted equity
Series A Voting Convertible Preferred Stock (D) 1,294,288
Series B Non-Voting Convertible
Preferred Stock . . . . . . . . . . . . . . (D) 689,920
Demand Promissory Note. . . . . . . . . . . . (D) $ 200,000 100,000
------------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $4,028,116). . . . . . . . . . $ 1,285,000
------------
U.S. Government Obligations -- 32.1% of total investments
U.S. Treasury Note dated 03/01/93 due date
02/28/98 -- 5.125% rate . . . . . . . . . . (H) $ 5,000,000 $ 4,993,750
U.S. Treasury Bill dated 04/10/97 due date
10/09/97 -- 5.1% yield. . . . . . . . . . . (K) $ 400,000 396,432
U.S. Treasury Bill dated 11/14/96 due date
11/13/97 -- 5.5% yield. . . . . . . . . . . (K) $ 1,590,000 1,534,183
U.S. Treasury Bill dated 05/22/97 due date
11/20/97 -- 4.9% yield. . . . . . . . . . . (K) $ 600,000 595,280
U.S. Treasury Bill dated 05/29/97 due date
11/28/97 -- 4.8% yield. . . . . . . . . . . (K) $ 525,000 520,922
U.S. Treasury Bill dated 12/12/96 due date
12/11/97 -- 5.0% yield. . . . . . . . . . . (K) $ 1,300,000 1,284,606
------------
Total Investments in U.S. Government Obligations
(cost: $9,270,095) . . . . . . . . . . . . . . . . . . . . . $ 9,325,173
------------
Total Investments -- 100% (cost: $27,826,300). . . . . . . . . . $ 29,049,614
============
The accompanying notes are an integral part of this schedule.
10
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1997
(Unaudited)
------------------------------------------
Notes to Schedule of Investments:
(1) Represents a non-income producing security. Equity investments that have
not paid dividends within the last twelve 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 Method of
Valuation A to L.
(4) These investments were made during 1997. Accordingly, the amounts shown
on the schedule represent the gross additions in 1997.
(5) No activity (either sales/purchases of securities or changes in valuation)
occurred in these investments during the nine months ended September 30,
1997.
(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 has not yet commenced
its planned principal operations or has commenced such operations but has
not realized significant revenue from them.
(7) Formerly named Princeton Electronic Billboard, Inc.
(8) Investments in unaffiliated companies consist of investments where Harris
& Harris Group, Inc. (the "Company") owns less than 5 percent of the
investee company. Investments in non-controlled affiliated companies
consist of investments where the Company owns more than 5 percent but
less than 25 percent of the investee company. Investments in controlled
affiliated companies consist of investments where the Company owns more
than 25 percent of the investee company.
(9) Genomica Corporation was cofounded by the Company, Cold Spring Harbor
Laboratory and Falcon Technology Partners, LP. Mr. G. Morgan Browne
serves on the Board of the Company and is Administrative Director of Cold
Spring Harbor Laboratory.
(10) Formerly named Intaglio, Ltd.
(11) Formerly named PowerVoice Technologies, Inc.
(12) BioSupplyNet, Inc. was cofounded by the Company, Cold Spring Harbor
Laboratory and other investors. Mr. G. Morgan Browne serves on the Board
of Directors and is Administrative Director of Cold Spring Harbor
Laboratory.
(13) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $2,463,964. The gross unrealized appreciation
based on the tax cost for these securities is $1,341,037. The gross
unrealized depreciation based on the tax cost for these securities is
$308,211.
(14) The percentage ownership of each investee disclosed in the Schedule of
Investments expresses the potential common equity interest in each such
investee. The calculated percentage represents the amount of 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 option
grants.
The accompanying notes are an integral part of this schedule.
11
FOOTNOTE TO 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 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.
Valuation assumes that, in the ordinary course of its business, the
Company will eventually sell its investment.
12
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, including large
blocks in relation to trading volume. 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 System 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.
13
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.
14
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.
15
NOTES TO 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 July 31, 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.
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification in 1998 as a Regulated Investment Company
("RIC") under Sub-Chapter M of the Internal Revenue Code. As a RIC, the
Company must distribute at least 90% of its taxable net investment income and
may either distribute or retain its taxable net realized capital gains on
investments. There can be no assurance that the Company will qualify as a RIC
or that if it does qualify it will continue to qualify.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed in
the preparation of the financial statements:
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 the Asset Valuation Policy Guidelines in the Footnote to 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 the
first-in, first-out basis for financial reporting and tax basis.
16
Income Taxes. The Company records income taxes using the liability method
in accordance with the provision of Statement of Financial Accounting Standards
No. 109. Accordingly, deferred tax liabilities have 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.
Reclassifications. Certain reclassifications have been made to the
September 30, 1996 and December 31, 1996 financial statements to conform to the
September 30, 1997 presentation.
Estimates by Management. The preparation of the financial statements in
conformity with Generally Accepted Accounting Principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of September 30, 1997 and December 31,1996 and the reported
amounts of revenues and expenses for the three and nine months ended September
30, 1997 and September 30, 1996. Actual results could differ from these
estimates.
NOTE 3. STOCK OPTION PLAN AND WARRANTS OUTSTANDING
On August 3, 1989, the shareholders of the Company approved the 1988 Long
Term Incentive Compensation Plan. On June 30, 1994, the shareholders of the
Company approved various amendments to the 1988 Long Term Incentive
Compensation Plan: 1) to conform to the provisions of the Business Development
Company regulations under the 1940 Act, which allow for the issuance of stock
options toqualified participants; 2) to increase the reserved shares under
the amended plan; 3) to call the plan the 1988 Stock Option Plan, as Amended
and Restated (the "1988 Plan"); and 4) to make various other amendments. On
October 20, 1995, the shareholders of the Company approved an amendment to the
1988 Plan authorizing automatic 20,000 share grants of non-qualified stock
options to newly elected non-employee directors of the Company.
Under the 1988 Plan, the number of shares of common stock of the Company
reserved for issuance is equal to 20 percent of the outstanding shares of
common stock of the Company at the time of grant. However, so long as
warrants, options, and rights issued to persons other than the Company's
directors, officers, and employees at the time of grant remain outstanding,
the number of reserved shares under the 1988 Plan may not exceed 15 percent of
the outstanding shares of common stock of the Company at the time of grant,
subject to certain adjustments.
The 1988 Plan provides for the issuance of incentive stock options and
non-qualified stock options to eligible employees as determined by the
Compensation Committee of the Board (the "Committee"), which is composed of
four non-employee directors. The Committee also has the authority to construe
and interpret the 1988 Plan, to establish rules for the administration of the
1988 Plan and, subject to certain limitations, to amend the terms and
conditions of anyoutstanding awards. Options may be exercised for up to 10
years from the date of grant at prices not less than the fair market value of
the Company's common stock at the date of grant. The 1988 Plan provides that
payment by the optionee upon exercise of an option may be made using cash or
Company stock held by the optionee.
17
The Company accounts for the 1988 Plan under APB Opinion No. 25, under
which no compensation cost has been recognized. Had compensation cost for the
1988 Plan been determined consistent with the fair value method required by
FASB Statement No. 123 ("FASB No. 123"), the Company's net realized loss and
net asset value per share would have been reduced to the following pro-forma
amounts:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 1997 Sept. 30, 1996 Sept. 30, 1997 Sept. 30, 1996
Net realized loss:
As Reported $ (149,498) $ (353,969) $ (539,855) $ (1,132,804)
Pro Forma $ (255,264) $ (454,783) $ (857,152) $ (1,435,246)
Net Asset Value per share:
As Reported $ 3.05 $ 3.56 $ 3.05 $ 3.56
Pro Forma $ 3.04 $ 3.55 $ 3.02 $ 3.52
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions:
Sept. 30, 1997 Sept. 30, 1996
Stock volatility 0.60 0.61
Risk-free interest rate 6.3 % 6.3 %
Option term in years 7 7
Stock dividend yield -- --
Because the FASB No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro-forma compensation
cost and related impact on net realized loss and net asset value per share may
not be representative of that value to be expected in future years.
The Company has granted options on 1,130,000 shares and 237,605 warrants
through September 30, 1997.
18
A summary of the status of the Company's 1988 Plan at September 30, 1997
and 1996 and changes during the nine months then ended is presented in the
table and narrative below:
September 30, 1997 September 30, 1996
------------------ ------------------
Shares Weighted Shares Weighted
Average Average
-------- --------
Exercise Exercise
Price Price
Outstanding at beginning
of the period 1,080,000 $4.58 1,050,000 $4.44
Granted 320,000 $3.94 80,000 $6.39
Exercised - - 50,000 $1.75
Forfeited 270,000 $5.34 64,000 $5.38
Expired - - - -
Outstanding at end
of period 1,130,000 $4.22 1,016,000 $4.67
Exercisable at end
of period 439,000 $3.60 398,000 $3.38
Weighted average fair
value of options granted $2.50 $4.09
The range of exercise prices for the outstanding options as of September
30, 1997:
Options Exercise Price Remaining Life
(Years)
8,000 $1.1875 0.25
150,000 $1.6250 0.25
50,000 $3.0000 0.25
50,000 $3.7500 0.25
410,000 $5.3750 0.25
2,000 $5.7500 0.25
60,000 $6.1875 0.25
20,000 $7.0000 0.25
80,000 $3.6250 0.25
300,000 $3.8750 0.25
The Company's 1988 Plan will be cancelled as of December 31, 1997,
eliminating all stock options. Instead, as of January 1, 1998, the Company
will implement an employee profit-sharing plan that provides for profit
sharing equal to 20 percent of net after-tax income, with the exception of
unrealized gains as of September 30, 1997, on which gains the Company will
not pay employee profit-sharing.
As of September 30, 1997, the Company's Chairman held outstanding warrants
to purchase 237,605 shares of common stock at a price of $2.0641 per share,
expiring in 1999. These warrants were exercised in October 1997.
19
NOTE 4. EMPLOYEE BENEFITS
As of August 15, 1990, the Company entered into a non-competition,
employment and severance contract with its Chairman, Charles E. Harris,
pursuant to which he is to receive compensation in the form of salary and other
benefits. This contract was amended on June 30, 1992, January 3, 1993, June
30, 1994 and September 25, 1997. The term of the contract expires on December
31, 1999.
Base salary is to be increased annually to reflect inflation and in
addition may be increased by such amount as the Compensation Committee of the
Board of Directors of the Company deems appropriate. In addition, Mr. Harris
would be entitled, under certain circumstances, to receive severance pay under
the employment and severance contracts.
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. The Company's contribution to the plan is determined by the
Compensation Committee during the fourth quarter.
On June 30, 1994, the Company adopted a plan to provide medical and
health coverage for retirees, their spouses and dependents who, at the time of
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 September 30, 1997, the Company had
a reserve of $232,415 for the plan.
NOTE 5. INCOME TAXES
Prior to 1998, the Company had not elected tax treatment available to
Regulated Investment Companies ("RIC") under Sub-Chapter M of the Internal
Revenue Code. Accordingly, for federal and state income tax purposes, the
Company is taxed at statutory corporate rates on its income, which enables the
Company to offset any future net operating losses against prior years' net
income. The Company may carry back operating losses against net income two
years and carry forward such losses 20 years. In 1998, the Company will seek
to qualify as a RIC. There can be no assurance that the Company will qualify
as a RIC or that if it does qualify that it will continue to qualify.
20
For the three and nine months ended September 30, 1997 and 1996, the
Company's income tax (benefit) provision was allocated as follows:
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1996 1997 1996
Investment operations. . . . . $ (497,297)$ (171,181)$ (665,644)$ (524,458)
Realized (loss) gain
on investments . . . . . . . (33,268) (17,947) 243,630 (74,754)
Increase (decrease)
in unrealized appreciation
on investments . . . . . . . 390,502 (135,406) (1,905,496) 866,385
----------- ----------- ----------- -----------
Total income tax
(benefit) provision. . . . . $ (140,063)$ (324,534)$(2,327,510)$ 267,173
=========== =========== =========== ===========
The above tax (benefit) provision consists of the following:
Current -- Federal . . . . . . $ (387,020)$ (188,540)$ (387,020)$ (600,269)
Deferred -- Federal. . . . . . 246,957 (135,994) (1,940,490) 867,442
----------- ----------- ----------- -----------
Total income tax
(benefit) provision . . . . $ (140,063)$ (324,534)$(2,327,510)$ 267,173
=========== =========== =========== ===========
The Company's deferred tax liability at September 30, 1997 and December 31,
1996 consists of the following:
September 30, 1997 December 31, 1996
Unrealized appreciation on investments $ 390,502 $ 2,295,998
Medical retirement benefits (81,345) (72,320)
Other (62,200) (36,231)
----------- -----------
Net deferred income tax liability $ 246,957 $ 2,187,447
=========== ===========
The income tax benefit for the three months and nine months ended September
30, 1997 includes a tax benefit of $88,934 realized as a result of the Company
filing for a tax refund.
The exercise of nonqualified stock options and certain warrants give rise
to compensation which is includable in the taxable income of recipients and
deductible by the Company for federal and state income tax purposes.
Compensation resulting from increases in the fair market value of the Company's
common stock subsequent to the date of grant of the applicable exercised stock
options and warrants is not recognized, in accordance with Accounting
Principles Board Opinion No.25, as an expense for financial accounting
purposes.
21
NOTE 6. 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. Rent expense under this lease was $28,846 and $41,784 for the three
months ended September 30, 1997 and 1996, and $101,562 and $119,628 for the
nine months ended September 30, 1997 and 1996, respectively. Future minimum
lease payments in each of the following years are: 1998 -- $168,768; 1999 --
$176,030; 2000 -- $178,561; 2001 -- $178,561; 2002 -- $178,561; thereafter
$101,946. Currently, the Company sublets part of its space to a company in
which it has an investment.
In December 1993, the Company and MIT announced the establishment by the
Company of the Harris & Harris Group Senior Professorship at MIT. Prior to the
arrangement for the establishment of this Professorship, the Company had made
gifts of stock in start-up companies to MIT. These gifts, together with the
contribution of $700,000 in cash in 1993, which was expensed by the Company in
1993, were used to establish this named chair. The Company contributed to MIT
securities with a cost basis of $3,280, $20,000 and $20,000 in 1993, 1994, and
1995 respectively. These contributions will be applied to the MIT Pledge at
their market value at the time the shares become publicly traded or otherwise
monetized in a commercial transaction and are free from restriction as to sale
by MIT. At September 30, 1997, the Company would have to fund additional cash
and/or property that would have to be valued at a total of $756,720 by December
1998, in order for the Senior Professorship to become permanent.
In January 1997, the Company signed a loan agreement with one of its
investee companies for up to $500,000. As of September 30, 1997, the Company
had loaned $200,000 to the investee company. In addition, the Company has
guaranteed a bonus of up to $40,000 to the key employees of the investee
company.
In June 1997, the Company agreed to provide one of its investee companies
with a $450,000 revolving line of credit. The purpose of this line of credit,
which will be secured by accounts receivable, is to provide for seasonal cash
flow. To the extent that this line of credit is utilized, the Company will
also receive warrants to purchase common stock.
In September 1997, the Company announced that the Board of Directors had
voted to restructure the Company and become taxed as a RIC under Sub-Chapter M
of the Internal Revenue Code. The Company will seek to qualify as a RIC in
1998. There can be no assurance that the Company will qualify as a RIC or that
if it does qualify that it will continue to qualify.
One of the requirements to qualify as a RIC is for the Company to pay to
shareholders dividends, equal to at least the Company's cumulative realized
earnings and profits ("E&P") as defined. The Company currently estimates that
E&P as of the end of 1997 will be at least $7 million. Accordingly, the
Company intends to pay cash dividends totaling approximately $7 million before
year-end 1998.
22
In October 1997, the Company purchased for $1.1 million a 12 percent Note
of NeuroMetrix, Inc., due April 15, 1999, convertible into Preferred Stock that
is convertible into Common Stock under certain circumstances at a price no
higher than $5.50 per Common Share. If converted at $5.50 per share, Harris &
Harris Group would own additional NeuroMetrix Preferred Stock convertible into
200,000 NeuroMetrix Common Shares.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Statement of Operations
The Company accounts for its operations under Generally Accepted Accounting
Principles for investment companies. On this basis, the principal measure of
its financial performance is captioned "Net (decrease) increase in net assets
from operations," which is the sum of three elements. The first element is
"Net operating gain (loss)," which is the difference between the Company's
income from interest, dividends, and fees and its operating expenses, net of
applicable income tax benefits. The second element is "Net realized gain
(loss) on investments," which is the difference between the proceeds received
from dispositions of portfolio securities and their stated cost, net of
applicable income tax provisions (benefits). These two elements are combined
in the Company's financial statements and reported as "Net realized gain
(loss)." The third element, "Net (decrease) increase in unrealized
appreciation on investments," is the net change in the fair value of the
Company's investment portfolio, net of increase (decrease) in deferred income
taxes that would become payable if the unrealized appreciation were realized
through the sale or other disposition of the investment portfolio.
"Net realized gain (loss) on investments" and "Net (decrease) increase in
unrealized appreciation on investments" are directly related. When a security
is sold to realize a gain (loss), net unrealized appreciation decreases
(increases) and net realized gain increases (decreases).
Financial Condition
The Company's total assets and net assets were, respectively, $32,636,379
and $31,853,969 at September 30, 1997, versus $38,555,290 and $35,932,603 at
December 31, 1996. Net asset value per share was $3.05 at September 30, 1997,
versus $3.44 at December 31, 1996.
The Company's financial condition is dependent on the success of its
investments. The Company has invested a substantial portion of its assets in
private development stage or start-up companies. These private businesses tend
to be thinly capitalized, unproven, small companies that lack management depth
or have no history of operations. At September 30, 1997, 52.8 percent of the
Company's $32.6 million in total assets consisted of investments at fair value
in private businesses, of which net unrealized appreciation was approximately
$0.3 million. At December 31, 1996, 48.8 percent of the Company's $39.0
million in total assets consisted of investments at fair value in private
businesses, of which net unrealized appreciation was approximately $5.0
million before taxes.
23
A summary of the Company's investment portfolio is as follows:
September 30, 1997 December 31, 1996
Investments, at cost $ 27,826,300 $ 28,981,093
Unrealized appreciation 1,223,314 6,667,589
------------ ------------
Investments, at fair value $ 29,049,614 $ 35,648,682
============ ============
The accumulated unrealized appreciation on investments net of deferred taxes is
$832,812 at September 30, 1997, versus $4,371,591 at December 31, 1996.
Following an initial investment in a private company, the Company may make
additional investments in such investee in order to: (1) increase its ownership
percentage; (2) to exercise warrants or options that were acquired in a prior
financing; (3) to preserve the Company's proportionate ownership in a
subsequent financing; or (4) attempt to preserve or enhance the value of the
Company's investment. Such additional investments are referred to as
"follow-on" investments. There can be no assurance that the Company will make
follow-on investments or have sufficient funds to make additional investments.
The failure to make such follow-on investments could jeopardize the viability
of the investee company and the Company's investment or could result in a
missed opportunity for the Company to participate to a greater extent in an
investee's successful operations. The Company attempts to maintain adequate
liquid capital to make follow-on investments in its private investee portfolio
companies. The Company may elect not to make a follow-on investment either
because it does not want to increase its concentration of risk or because it
prefers other opportunities, even though the follow-on investment opportunity
appears attractive.
The following table is a summary of the cash investments made by the
Company in its private placement portfolio during the nine months ended
September 30, 1997:
Follow-on Investments: Amount
---------------------- ------
BioSupplyNet, Inc. $ 200,000
Highline Offshore Advisors, LLC. 500,000
MultiTarget, Inc. 45,585
NBX Corporation 1,190,002
-----------
Sub-total $ 1,935,587
Loans:
------
nFX Corporation $ 200,000
Gel Sciences, Inc. 316,000
Harber Brothers Productions, Inc. 250,000
PureSpeech, Inc. 243,980
-----------
Sub-total $ 1,009,980
Exercise of Warrants:
---------------------
NeuroMetrix, Inc. $ 200,000
Princeton Video Image, Inc. 15,075
-----------
Sub-total $ 215,075
-----------
Total $ 3,160,642
===========
24
Results of Operations
Investment Income and Expenses:
The Company's principal objective is to achieve capital appreciation.
Therefore, a significant portion of the investment portfolio is structured to
maximize the potential for capital appreciation and provides little or no
current yield in the form of dividends or interest. The Company does earn
interest income from fixed-income securities, including U.S. Government
Obligations. The amount of interest income earned varies based upon the
average balance of the Company's fixed-income portfolio and the average yield
on this portfolio.
The Company had interest income from fixed-income securities of $362,330
and $625,434 for the nine months ended September 30, 1997 and 1996,
respectively. The decrease is a result of a decline in the balance of the
Company's fixed-income portfolio. The Company also received dividends,
consulting and administrative fees which totaled $18,369 and $49,146 for the
nine months ended September 30, 1997 and 1996, respectively.
Operating expenses were $2,068,654 and $2,230,703 for the nine months
ended September 30, 1997 and 1996, respectively. Most of the Company's
operating expenses are related to employee and director compensation, office
and rent expenses and consulting and professional fees (primarily legal and
accounting fees). Operating expenses decreased as a result of the Company's
reduction in administration and operations expense and professional fees.
Net operating losses before taxes were $1,657,955 and $1,518,432 for the
nine months ended September 30, 1997 and 1996, respectively.
The Company has in the past relied, and continues to rely to a large
extent, upon proceeds from sales of investments, rather than investment income,
to defray a significant portion of its operating expenses. Because such sales
cannot be predicted with certainty, the Company attempts to maintain adequate
working capital to provide for fiscal periods when there are no such sales.
Realized Gains and Losses on Sales of Portfolio Securities:
During the nine months ended September 30, 1997, the Company sold various
public securities realizing a net pre-tax gain of $696,086, of which a net gain
of $1,730,910 had been recognized as unrealized in prior years, therefore, it
decreased unrealized appreciation on investments. During the nine months ended
September 30, 1996, the Company sold various public securities realizing a net
pre-tax loss of $213,584.
During the three months ended September 30, 1997, the Company sold various
public securities realizing a net pre-tax loss of $95,052, of which a net gain
of $288,770 had been recognized as unrealized in prior quarters, therefore, it
decreased unrealized appreciation on investments. During the three months
ended September 30, 1996, the Company sold various public securities
realizing a net pre-tax loss of $51,277.
25
Unrealized Appreciation and Depreciation of Portfolio Securities:
Net unrealized appreciation on investments before taxes decreased, during
the nine months ended September 30, 1997, by $5,444,275, from $6,667,589 to
$1,223,314, owing primarily to decreased valuations of Gel Sciences, Inc.,
Harber Brothers Productions, Inc., nFX Corporation, Princeton Video Image, Inc.
and PureSpeech, Inc., offset by the increased valuations of NBX Corporation and
Nanophase Technologies, Inc.
Net unrealized appreciation on investments before taxes increased, during
the nine months ended September 30, 1996, by $2,475,384, from $2,102,593 to
$4,577,977, owing primarily to increased valuations for Nanophase Technologies
Corporation, Gel Sciences, Inc. Princeton Video Image, Inc., PHZ Capital
Partners Limited Partnership, and Alliance Pharmaceutical Corporation, offset
by the decreased valuations of Micracor Inc., Sonex International Corporation,
Dynecology, Inc. and Cordex Petroleums, Inc.
Net unrealized appreciation on investments before taxes increased, during
the three months ended September 30, 1997, by $1,149,960, from $73,354 to
$1,223,314, owing primarily to increased valuations of NBX Corporation, Fuisz
Technologies and Zonagen, Inc., offset by decreased valuation of nFX
Corporation.
Net unrealized appreciation on investments before taxes decreased, during
the three months ended September 30, 1996, by $424,708, from $5,002,685 to
$4,577,977, owing primarily to decreased valuations of Micracor Inc.,
Dynecology, Inc. and Cordex Petroleums, Inc., offset slightly by an increase in
the valuation of Alliance Pharmaceutical Corporation and Gel Sciences, Inc.
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable securities
(the primary measure of liquidity) at September 30, 1997 of $15,161,821,
versus $19,296,591 at December 31, 1996. Management believes that its cash,
receivables and marketable securities provide the Company with sufficient
liquidity for its operations.
As part of the Company's restructuring to be qualified as a Regulated
Investment Company under Sub-Chapter M of the Internal Revenue Code, the
Company is required to distribute to shareholders all its cumulative realized
E&P before year end 1998 as a dividend. The Company currently estimates that
E&P as of the end of 1997 may be at least $7,000,000.
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Risks
Pursuant to Section 64(b)(1) of the Investment Company Act of 1940, a
Business Development Company is required to describe the risk factors involved
in an investment in the securities of such company inherent in the nature of
the company's investment portfolio. There are significant risks inherent in
the Company's venture capital business. The Company has invested a
substantial portion of its assets in private development stage or start-up
companies. These private businesses tend to be thinly capitalized, unproven,
small companies that lack management depth and have not attained profitability
or have no history of operations. Because of the speculative nature and the
lack of a public market for these investments, there is a significantly greater
risk of loss than is the case with traditional investment securities. The
Company expects that some of its venture capital investments will be a complete
loss or will be unprofitable and that some will appear to be likely to become
successful but never realize their potential. The Company has been risk
seeking rather than risk averse in its approach to venture capital and other
investments. Neither the Company's investments nor an investment in the
Company is intended to constitute a balanced investment program. The Company
has in the past relied and continues to rely to a large extent upon proceeds
from sales of investments rather than investment income to defray a significant
portion of its operating expenses.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index for Exhibits to the Form 10-Q
(b) None
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EXHIBIT INDEX
Item Number (of Item 601 of Regulation S-K)
27. Financial Data Schedule
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Harris & Harris Group, Inc.
By:/s/_______________________
Rachel M. Pernia, Vice President
Treasurer, Controller and Principal
Accounting Officer
Date: November 14, 1997
30