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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K
Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
For the fiscal year
ended December 31, 2000 Commission File No. 0-11576
HARRIS & HARRIS GROUP, INC.
(Exact Name of Registrant 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, Rockefeller Center, New York, NY 10020
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 332-3600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $ .01 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of the Common Stock held by non-
affiliates of Registrant as of March 7, 2001 was $19,235,405
based on the last sale price as quoted by NASDAQ National Market
on such date (only officers and directors are considered
affiliates for this calculation).
As of March 7, 2001, the registrant had 9,064,231 shares of
common stock, par value $.01 per share, outstanding.
Portions of the registrant's definitive Proxy Statement for
the Annual Meeting of Shareholders to be held on April 24, 2001
are incorporated by reference into Part III of this report.
TABLE OF CONTENTS
Page
PART I
Item 1. Business. . . . . . . . . . . . . . . . . . 1
Item 2. Properties. . . . . . . . . . . . . . . . . 12
Item 3. Legal Proceedings . . . . . . . . . . . . . 12
Item 4. Submission of Matters to a Vote of
Security Holders. . . . . . . . . . . . . 12
PART II
Item 5. Market for Company's Common Equity and
Related Stockholder Matters. . . . . . . . 13
Item 6. Selected Financial Data . . . . . . . . . . 15
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . 16
Item 7a. Quantitative and Qualitative Disclosures
About Market Risk. . . . . . . . . . . . . 27
Item 8. Consolidated Financial Statements
and Supplementary Data . . . . . . . . . . 29
Item 9. Disagreements on Accounting and
Financial Disclosure . . . . . . . . . . . 52
PART III
Item 10. Directors and Executive Officers of
the Company . . . . . . . . . . . . . . . 52
Item 11. Executive Compensation . . . . . . . . . . 52
Item 12. Security Ownership of Certain
Beneficial Owners and Management. . . . . 52
Item 13. Certain Relationships and Related
Transactions. . . . . . . . . . . . . . . 52
PART IV
Item 14. Exhibits, Consolidated Financial
Statements, Schedules and Reports on
Form 8-K. . . . . . . . . . . . . . . . . 53
Signatures . . . . . . . . . . . . . . . . . . . . . 55
Exhibit Index. . . . . . . . . . . . . . . . . . . . 57
PART I
Item 1. Business
Harris & Harris Group, Inc. (the "Registrant" or "Company")
is a venture capital investment company, operating as a Business
Development Company ("BDC") under the Investment Company Act of
1940 (the "1940 Act"). The Company's objective is to achieve
long-term capital appreciation, rather than current income, from
its investments. The Company has invested a substantial portion
of its assets in private development stage or start-up companies
and in the development of new technologies in a broad range of
industry segments. These private businesses tend to be thinly
capitalized, unproven, small companies based on risky
technologies that lack management depth and have not attained
profitability or have no history of operations. The Company may
also invest, to the extent permitted under the 1940 Act, in
publicly traded securities, including high risk securities as
well as investment grade securities. The Company may
participate in expansion financing and leveraged buyout
financing of more mature operating companies as well as other
investments. As a venture capital company, the Company invests
in and provides managerial assistance to its private investees
which, in its opinion, have significant potential for growth.
There is no assurance that the Company's investment objective
will be achieved.
The Company was incorporated under the laws of the State of
New York in August 1981. Prior to September 30, 1992, the
Company had a class of securities registered, and filed under
the reporting requirements, of the Securities Exchange Act of
1934 (the "1934 Act") as an operating company. On that date the
Company commenced operations as a closed-end, non-diversified
investment company under the 1940 Act. On July 26, 1995, the
Company elected to become a BDC subject to the provisions of
Sections 55 through 65 of the 1940 Act. As a BDC, 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.
Venture Capital Investments
The Company has invested a substantial portion of its
assets in private development stage or start-up companies. The
Company may initially own 100 percent of the securities of a
start-up investee company for a period of time and may control
such company for a substantial period. In connection with its
venture capital investments, the Company may be involved in
recruiting management, formulating operating strategies, product
development, marketing and advertising, assisting in financial
plans, as well as providing management in the initial start-up
stages and establishing corporate goals. The Company may assist
in raising additional capital for such companies from other
potential investors and may subordinate its own investment to
that of other investors. The Company may introduce such
companies to potential joint-venture partners, suppliers and
customers. In addition, the Company may assist in establishing
relationships with investment bankers and other professionals.
The Company may also assist with mergers and acquisitions. The
Company may also find it necessary or appropriate to provide
1
additional capital of its own. The Company may derive income
from such companies for the performance of any of the above
services. Because of the speculative nature of these investments
and the lack of any market for such securities, there is
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 likely to
become successful, but never realize their potential. The
Company has in the past sought, and will continue in the future
to seek, investments that offer the potential for significantly
higher returns but that involve a significantly greater degree
of risk than other investments.
The Company may control an investee company for which it
has provided venture capital, or it may be represented on the
company's board of directors by one or more of its officers or
directors, who may also serve as officers of such company.
Particularly during the early stages of an investment, the
Company may in effect be conducting the operations of the
investee company. As a venture company emerges from the
developmental stage with greater management depth and
experience, the Company expects that its role in the company's
operations will diminish. The Company seeks to assist each
investee company in establishing its own independent
capitalization, management and board of directors. The Company
expects to be able to reduce its active involvement in the
management of its investment in those start-up companies that
become successful by a liquidity event, such as a public
offering or sale of a company.
The Company has invested a substantial portion of its
assets in securities that do not pay interest or dividends and
that are subject to legal or contractual restrictions on resale
that may adversely affect the liquidity and marketability of
such securities.
In addition to the information discussed above, please see
Item 8. "Consolidated Financial Statements and Supplementary
Data."
Intellectual Property
The Company believes there is a role for organizations like
itself that can assist in technology transfer. Scientists and
institutions that develop and patent intellectual property
increasingly seek the rewards of entrepreneurial
commercialization of their inventions, particularly as
governmental, philanthropic and industrial funding for research
has become harder to obtain. The Company believes that several
factors combine to give it a high value-added role to play in
the commercialization of technology: its experience in
organizing and developing successful new companies; its
willingness to invest its own capital at the highest risk- seed
stage; its access to high-grade institutional sources of
intellectual property; its experience in mergers, acquisitions
and divestitures; its access to and knowledge of the capital
markets; and its willingness to do as much of the early work as
it is qualified and has time to do.
The Company invests principally but not exclusively in
securities issued by companies involved in: 1) research and
development of a technology and/or obtaining licensing rights to
intellectual property or patents; 2) outright acquisition of
2
intellectual property or patents; and 3) formation and funding
of companies or joint ventures to commercialize intellectual
property. Income from the Company's investments in intellectual
property or its development may take the form of participation
in licensing or royalty income or some other form of
remuneration. At some point during the commercialization of a
technology, the Company's investment may be transformed into
ownership of securities of a development stage or start-up
company as discussed above. Investing in intellectual property
is highly risky.
Illiquidity of Investments
Many of the Company's investments consist of securities
acquired directly from the issuer in private transactions.
These investments may be subject to restrictions on resale or
otherwise be illiquid. The Company does not anticipate that
there will be any established trading market for such
securities. Additionally, many of the securities that the
Company may invest in will not be eligible for sale to the
public without registration under the Securities Act of 1933, as
amended, which could prevent or delay any sale by the Company of
such investments or reduce the amount of proceeds that might
otherwise be realized therefrom. Restricted securities
generally sell at a price lower than similar securities not
subject to restrictions on resale. Further, even if a portfolio
company registers its securities and becomes a reporting company
under the 1934 Act, the Company may be considered an insider by
virtue of its board representation or otherwise and would be
restricted in sales of such company's securities.
Managerial Assistance
The Company generally is required by the 1940 Act to make
significant managerial assistance available with respect to
investee companies that the Company treats as qualifying assets
for purposes of the 70 percent test (see "Regulation"). "Making
available significant managerial assistance" as defined in the
1940 Act with respect to a BDC such as the Company means (a) any
arrangement whereby a BDC, through its directors, officers,
employees or general partners, offers to provide, and if
accepted, does so provide, significant guidance and counsel
concerning the management, operations, or business objectives
and policies of a portfolio company; or (b) the exercise by a
BDC of a controlling influence over the management or policies
of a portfolio company by a BDC acting individually or as a part
of a group acting together which controls such portfolio
company. The Company believes that providing managerial
assistance to its investees is critical to its business
development activities. The nature, timing and amount of
managerial assistance provided by the Company vary depending
upon the particular requirements of each investee company.
The Company may be involved with its investees in
recruiting management, product planning, marketing and
advertising and the development of financial plans, operating
strategies and corporate goals. In this connection, the Company
may assist clients in developing and utilizing accounting
procedures to efficiently and accurately record transactions in
books of account, which will facilitate asset and cost control
and the ready determination of results of operations. The
Company also seeks capital for its investees from other
3
potential investors and occasionally subordinates its own
investment to those of other investors. The Company may
introduce its investees to potential suppliers, customers and
joint venture partners and assists its investees in establishing
relationships with commercial and investment bankers and other
professionals, including management consultants, recruiters,
legal counsel and independent accountants. The Company also
assists with joint ventures, acquisitions and mergers.
In connection with its managerial assistance, the Company
may be represented by one or more of its officers or directors
on the board of directors of an investee. As an investment
matures and the investee develops management depth and
experience, the Company's role ordinarily will become
progressively less active. However, when the Company owns or
acquires a substantial proportion of a more mature investee
company's equity, the Company may remain active in and may
initiate planning of major transactions by the investee. The
Company typically seeks to assist each investee company in
establishing its own independent and effective board of
directors and management.
Need for Follow-On Investments
Following an initial investment in investees, the Company
may make additional investments in such investees as "follow-on"
investments, in order to: (1) increase its ownership
percentage; (2) exercise warrants, options or convertible
securities that were acquired in the original or subsequent
financing; (3) preserve the Company's proportionate ownership in
a subsequent financing; or (4) attempt to preserve or enhance
the value of the Company's investment.
There can be no assurance that the Company will make
follow-on investments or have sufficient funds to make such
investments; the Company has the discretion to make any follow-
on investments as it determines, subject to the availability of
capital resources. The failure to make such follow-on
investments may, in certain circumstances, jeopardize the
continued viability of an investee and the Company's initial
investment, or may result in a missed opportunity for the
Company to increase its participation in a successful operation.
Even if the Company has sufficient capital to make a desired
follow-on investment, it may elect not to make a follow-on
investment either because it does not want to increase its
concentration of risk, because it prefers other opportunities or
because it is inhibited by compliance with BDC or RIC
requirements, even though the follow-on investment opportunity
appears attractive.
Competition
Numerous companies and individuals are engaged in the
venture capital business and such business is intensely
competitive. Many of the competitors have significantly greater
resources and managerial capabilities than the Company and are
therefore in a better position than the Company to obtain access
to attractive venture capital investments. There can be no
assurance that the Company will be able to compete against these
competitors for attractive investments.
4
Regulation
The Small Business Investment Incentive Act of 1980 added
the provisions of the 1940 Act applicable to BDC's, which are a
special type of closed-end investment company. After filing its
election to be treated as a BDC, a company may not withdraw its
election without first obtaining the approval of holders of a
majority of its outstanding voting securities. The following is
a brief description of the 1940 Act provisions applicable to
BDC's, and is qualified in its entirety by reference to the full
text of the 1940 Act and the rules issued thereunder by the SEC.
Generally, to be eligible to elect BDC status, a company
must primarily engage in the business of furnishing capital and
managerial expertise to companies which do not have ready access
to capital through conventional financial channels. Such
portfolio companies are termed "eligible portfolio companies."
In general, in order to qualify as a BDC, a company must (i) be
a domestic company; (ii) have registered a class of its
securities pursuant to Section 12 of the 1934 Act; (iii) operate
for the purpose of investing in the securities of certain types
of portfolio companies, namely, immature or emerging companies
and businesses suffering or just recovering from financial
distress (see following paragraph); (iv) make available
significant managerial assistance to such portfolio companies;
(v) have a majority of "disinterested" directors (as defined in
the 1940 Act); and (vi) file a proper notice of election with
the SEC.
An eligible portfolio company generally is a domestic
company that is not an investment company and that (i) does not
have a class of equity securities on which "margin" credit can
be extended or (ii) is controlled by a BDC (control under the
1940 Act is presumed to exist where a BDC owns at least 25
percent of the outstanding voting securities of the investee).
The 1940 Act prohibits or restricts companies subject to
the 1940 Act from investing in certain types of companies, such
as brokerage firms, insurance companies, investment banking
firms and investment companies. Moreover, the 1940 Act requires
that at least 70 percent of the value of the Company's assets
consist of qualifying assets. Qualifying assets include: (i)
securities of companies that were eligible portfolio companies
at the time the Company acquired their securities; (ii)
securities of bankrupt or insolvent companies that were eligible
at the time of the Company's initial investment in those
companies; (iii) securities received in exchange for or
distributed in or with respect to any of the foregoing; and (iv)
cash items, government securities and high quality short-term
debt. The 1940 Act also places restrictions on the nature of
the transactions in which, and the persons from whom, securities
can be purchased in order for the securities to be considered
qualifying assets.
The Company is permitted by the 1940 Act, under specified
conditions, to issue multiple classes of senior debt and a
single class of preferred stock if its asset coverage, as
defined in the 1940 Act, is at least 200 percent after the
issuance of the debt or the preferred stock (i.e., such senior
securities may not be in excess of its net assets).
5
The Company may sell its securities at a price that is
below the prevailing net asset value per share only after a
majority of its disinterested directors has determined that such
sale would be in the best interest of the Company and its
stockholders and upon the approval by the holders of a majority
of its outstanding voting securities, including a majority of
the voting securities held by non-affiliated persons. If the
offering of the securities is underwritten, a majority of the
disinterested directors must determine in good faith that the
price of the securities being sold is not less than a price
which closely approximates market value of the securities, less
any distribution discount or commission. As defined by the 1940
Act, the term "majority of the Company's outstanding voting
securities" means the vote of (i) 67 percent or more of the
Company's Common Stock present at the meeting, if the holders of
more than 50 percent of the outstanding Common Stock are present
or represented by proxy or (ii) more than 50 percent of the
Company's outstanding Common Stock, whichever is less.
Certain transactions involving certain closely related
persons of the Company, including its directors, officers and
employees, may require the prior approval of the SEC. However,
the 1940 Act ordinarily does not restrict transactions between
the Company and investee companies.
Sub-Chapter M Status
On September 25, 1997, the Company's Board of Directors
approved a proposal to seek qualification of the Company as a
Regulated Investment Company ("RIC") under Sub-Chapter M of the
Internal Revenue Code (the "Code"). At that time, the Company
was taxable under Sub-Chapter C of the Code (a "C Corporation").
In order to qualify as a RIC, the Company must, in general (1)
annually derive at least 90 percent of its gross income from
dividends, interest and gains from the sale of securities; (2)
quarterly meet certain investment diversification requirements;
and (3) annually distribute at least 90 percent of its
investment company taxable income as a dividend. In addition to
the requirement that the Company must annually distribute at
least 90 percent of its investment company taxable income, the
Company may either distribute or retain its taxable net capital
gains from investments, but any net capital gains not
distributed could be subject to corporate level tax. Further,
the Company could be subject to a four percent excise tax if it
fails to distribute 98 percent of its annual taxable income and
would be subject to income tax if it fails to distribute 100
percent of its taxable income.
Because of the specialized nature of its investment
portfolio, the Company could satisfy the diversification
requirements under Sub-Chapter M of the Code only if it received
a certification from the SEC that it is "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." On April 8, 1998,
the Company announced that it had received a certification from
the Securities and Exchange Commission ("SEC") for 1997 relating
to the Company's status under section 851(e) of the Code. That
certification was necessary for the Company to qualify as a RIC
for 1998 and subsequent taxable years.
6
Pursuant to the Company's receipt of the section 851(e)
certification and its intention to qualify as a RIC , in 1998
the Company's Board of Directors declared and paid a one-time
cash dividend of $0.75 per share, for a total of $8,019,728, to
meet one of the Company's requirements for qualification for
Sub-Chapter M tax treatment.
As noted above, the qualification of the Company as a RIC
under Sub-Chapter M of the Code depends on it satisfying certain
technical requirements regarding its income, investment
portfolio and distributions. The Company was unable to satisfy
these requirements for the 1998 tax year owing to the nature of
the Company's ownership interest in one of its investee
companies, and therefore it did not elect Sub-Chapter M status
for 1998. In addition, because the Company realized taxable
losses in 1998, it was not strategically advantageous for the
Company to elect Sub-Chapter M tax status for 1998.
The Company changed the nature of its ownership interest in
the non-qualifying investee company effective January 1, 1999 in
order to meet the Sub-Chapter M requirements. In 1999, because
of changes in its investment portfolio, the Company requested
recertification from the SEC relating to the Company's status
under section 851(e) of the Code. On February 24, 2000, the
Company received the certification, and the Company filed for
1999 to elect treatment as a RIC. On March 8, 2001, the Company
received SEC certification and qualified for RIC treatment for
2000. Although the SEC certification for 1999 and 2000 was
issued, there can be no assurance that the Company will receive
such certification for subsequent years (to the extent it needs
additional certification as a result of changes in its portfolio)
or that it will actually qualify for Sub-Chapter M treatment in
subsequent years. In addition, under certain circumstances, even
if the Company qualified for Sub-Chapter M treatment in 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.
A C Corporation that elects to qualify as a RIC and that
makes an appropriate election 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 incurred
ordinary and capital losses during its C Corporation taxable
years that remain available for use and may be carried forward
to its 2000 and subsequent taxable years. On February 17, 1999,
the Company received rulings from the IRS regarding issues
relevant to the Company's tax status as a RIC, including a
ruling from the IRS concluding that the Company can carry
forward its C Corporation losses to offset any Built-In Gains
resulting from sales of its C Corporation Assets. That ruling
may enable the Company to retain some or all of the proceeds
from such sales without disqualifying itself as a RIC or
incurring corporate level income tax, depending on whether the
Company's sale of C Corporation Assets with Built-In Gains will
generate C Corporation E&P. In general, a RIC is not permitted
to have, as of the close of any RIC taxable year, E&P
accumulated during any C Corporation taxable year. However,
because the realization of Built-In Gains will occur while the
Company is a RIC, a strong argument exists that, under current
law and IRS pronouncements, the sale of C Corporation Assets
7
with Built-In Gains during RIC taxable years will not generate C
Corporation E&P. In 1999, the Company used the $6.3 million
loss carryforward (which resulted in a tax credit of
approximately $2.2 million) to reduce the taxes resulting from
Built-In Gains.
If necessary for liquidity purposes or to fund investment
opportunities, in lieu of distributing its taxable net capital
gains, the Company as a RIC may retain such net capital gains
and elect to be deemed to have made a distribution of the gains,
or part thereof, to the shareholders under the "designated
undistributed capital gain" rules of section 852(b)(3) of the
Code. In that case, the "deemed dividend" is taxable to the
shareholders, although 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.
To the extent that the Company declares a deemed dividend,
each shareholder will receive an IRS Form 2439 which will
reflect receipt of the deemed dividend income and a tax credit
equal to the shareholder's proportionate share of the tax paid
by the Company. This tax credit, which is paid at the corporate
rate, is often credited at a higher rate than the actual tax due
by a shareholder on the deemed dividend income. The "residual"
credit can be used by the shareholder to offset other taxes due
in that year. (See "Note 6 of Notes to Consolidated Financial
Statements" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data" and Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Recent Developments - Sub-Chapter M Status.")
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 Harris & Harris Enterprises, Inc.
(sole general partner) and Harris & Harris Group, Inc. (sole
limited partner).
Harris Newco, Inc. is currently a 100 percent wholly owned
investment of the Company; however, the Company anticipates that
in 2001 Harris Newco will issue shares to unrelated third
parties and will become a medical device technology company
based on proprietary technology.
Employees
The Company currently employs directly four full-time
employees, and a wholly owned subsidiary of the Company employs
two additional full-time employees.
8
Risk Factors
Investing in the Company's Stock is Highly Speculative and the
Investor Could Lose Some or All of the Amount Invested
The value of the Company's 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 the Company's
shares. The securities markets frequently experience extreme
price and volume fluctuation which affect market prices for
securities of companies generally and technology companies in
particular. Because of the Company's focus on the technology
sector, its stock price is likely to be impacted by these market
conditions. General economic conditions, and general conditions
in the Internet and information technology and life sciences and
other high technology industries, will also affect the Company's
stock price.
Investing in the Company's Shares May be Inappropriate for the
Investor's Risk Tolerance
The Company's investments, in accordance with its
investment objective and principal strategies, may result in an
above average amount of risk and volatility or loss of
principal. The Company's investments in portfolio companies are
highly speculative and aggressive and, therefore, an investment
in its shares may not be suitable for all investors.
The Market for Venture Capital Investments is Highly
Competitive. In Some Cases, the Company's Status as a Regulated
Business Development Company May Hinder its Ability to
Participate in Investment Opportunities.
The Company faces substantial competition in its investing
activities from private venture capital funds, investment
affiliates of large industrial, technology, service and
financial companies, small business investment companies,
wealthy individuals and foreign investors. As a regulated
business development company, the Company is required to
disclose quarterly the name and business description of
portfolio companies and value of any portfolio securities. Most
of the Company's competitors are not subject to this disclosure
requirement. The Company's obligation to disclose this
information could hinder its ability to invest in certain
portfolio companies. Additionally, other regulations, current
and future, may make the Company less attractive as a potential
investor to a given portfolio company than a private venture
capital fund not subject to the same regulations.
The Company Operates in a Regulated Environment
The Company is subject to substantive SEC regulations as a
BDC. Securities and tax laws and regulations governing the
Company's activities may change in ways adverse to the Company's
and its shareholders' interests and interpretations of such laws
9
and regulations may change with unpredictable consequences. Any
change in the law or regulations that govern the Company's
business could have an adverse impact on the Company or its
operations.
The Company is Dependent Upon Key Management Personnel for
Future Success
The Company is dependent for the selection, structuring,
closing and monitoring of its investments on the diligence and
skill of its senior management and other management members.
The future success of the Company depends to a significant
extent on the continued service and coordination of its senior
management team, particularly the Chairman and Chief Executive
Officer. The departure of any of the executive officers or key
employees could materially adversely affect the Company's
ability to implement its business strategy. The Company does
not maintain key man life insurance on any of its officers or
employees.
Investment in Small, Private Companies
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 with risky
technologies 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 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.
Illiquidity of Portfolio Investments
Most of the investments of the Company are or will be
equity securities acquired directly from small companies. The
Company's portfolio of equity securities are and will usually be
subject to restrictions on resale or otherwise have no
established trading market. The illiquidity of most of the
Company's portfolio of equity securities may adversely affect
the ability of the Company to dispose of such securities at
times when it may be advantageous for the Company to liquidate
such investments.
10
The Inability of the Company's Portfolio Companies to Market
Successfully Their Products Would Have a Negative Impact on its
Investment Returns
Even if the Company's portfolio companies are able to
develop commercially viable products, the market for new
products and services is highly competitive and rapidly
changing. Commercial success is difficult to predict and the
marketing efforts of the Company's portfolio companies may not
be successful.
Valuation of Portfolio Investments
There is typically no public market for equity securities
of the small private companies in which the Company invests. As
a result, the valuation of the equity securities in the
Company's portfolio is subject to the good faith estimate of the
Company's Board of Directors. (See "Asset Valuation Policy
Guidelines" in "Footnote to Consolidated Schedule of
Investments" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.") In the absence of a
readily ascertainable market value, the estimated value of the
Company's portfolio of equity securities may differ
significantly from the values that would be placed on the
portfolio if a ready market for the equity securities existed.
Any changes in estimated net asset value are recorded in the
Company's consolidated statements of operations as a change in
the "Net (decrease) increase in unrealized appreciation on
investments." (See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations.")
Fluctuations of Quarterly Results
The Company's quarterly operating results could fluctuate
as a result of a number of factors. These include, among
others, variations in and the timing of the recognition of
realized and unrealized gains or losses, the degree to which the
Company encounters competition in its markets and general
economic 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. (See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of
Operations.")
Risk of Loss of Pass Through Tax Treatment
If the Company meets certain income, diversification and
distribution requirements under the Code, it may qualify as a
RIC under the Code for pass-through tax treatment. The Company
would cease to qualify for pass-through tax treatment if it were
unable to comply with these requirements, or if it ceased to
qualify as a BDC under the 1940 Act. The Company also could be
subject to a four percent excise tax (and, in certain cases,
corporate level income tax) if it failed to make certain
distributions. (See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations --
Recent Developments -- Sub-Chapter M Status.") The lack of Sub-
Chapter M tax treatment could have a material adverse effect on
the total return, if any, obtainable from an investment in the
Company. If the Company fails to qualify as a RIC, the Company
11
would become subject to federal income tax as if it were an
ordinary C Corporation, which would result in a substantial
reduction in the Company's net assets and the amount of income
available for distribution to the Company's stockholders.
Because the Company Must Distribute Income, the Company Will
Continue to Need Additional Capital
The Company will continue to need capital to fund
investments and to pay for operating expenses. The Company must
distribute at least 90 percent of its net operating income other
than net realized long-term capital gains to its stockholders to
maintain its RIC status. As a result such earnings will not be
available to fund investments. If the Company fails to generate
net realized long-term capital gains or to obtain funds from
outside sources, it could have a material adverse effect on the
Company's financial condition and results. The Company does not
normally establish reserves for taxes on unrealized capital
gains. To the extent that the Company retains capital gains,
either as a C corporation or as a Sub-Chapter M corporation, it
will have to make provisions for federal taxes and possibly
state and local taxes. In addition, as a BDC, the Company is
generally required to maintain a ratio of at least 200 percent
of total assets to total borrowings, which may restrict its
ability to borrow in certain circumstances.
Item 2. Properties
The Company maintains its offices at One Rockefeller Plaza,
New York, New York 10020, where it leases approximately 4,700
square feet of office space pursuant to a lease agreement
expiring in 2003. A portion of this space was sublet in 1997
and 1998 to an early-stage company in which the Company then had
an equity interest. In 1999, the same space was sublet to an
unaffiliated party. (See "Note 7 of Notes to Consolidated
Financial Statements and Schedules" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of its
shareholders during the fourth quarter of the 2000 fiscal year.
12
PART II
Item 5. Market for Company's Common Equity and Related
Stockholder Matters
Stock Transfer Agent
The Bank of New York, 101 Barclay Street, Suite 12W, New
York, New York 10286 (Telephone 800-524-4458, Attention: Ms.
Diane Ajjan) serves as transfer agent for the Company's common
stock. Certificates to be transferred should be mailed directly
to the transfer agent, preferably by registered mail.
Market Prices
The Company's common stock is traded on the Nasdaq
National Market under the symbol "HHGP." The following table
sets forth the range of the high and low selling price of the
Company's shares during each quarter of the last two years, as
reported by Nasdaq National Market. The quarterly stock prices
quoted represent interdealer quotations and do not include
markups, markdowns or commissions.
2000 Quarter Ending Low High
March 31 $9.25 $32.50
June 30 $5.25 $17.125
September 30 $5.75 $10.1875
December 31 $2.4375 $6.4375
1999 Quarter Ending Low High
March 31 $1.3125 $2.125
June 30 $1.625 $2.00
September 30 $1.71875 $3.125
December 31 $2.9375 $14.250
On February 23, 1999, the Company announced that
subsequent to the sale of NBX Corporation to 3Com Corporation,
the Board of Directors of the Company declared a cash dividend
of $0.35 per share (approximately $3.7 million) to shareholders
of record on March 19, 1999, payable on March 25, 1999.
On September 20, 2000, the Company declared a cash
dividend of $0.02 per share, payable on November 15, 2000 to
shareholders of record on October 15, 2000.
On December 14, 2000, the Company declared a designated
undistributed capital gain dividend (also known as a "deemed
dividend") of $1.78 per share with a corresponding tax credit
of $0.62 per share to shareholders of record on December 29,
2000.
Prior to 1998, the Company had not paid dividends since
1991. (See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Recent
Developments -- Sub-Chapter M Status" and "Note 6 of Notes to
Consolidated Financial Statements" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
13
Recent Sales of Unregistered Securities
The Company did not sell unregistered shares in the years
ended December 31, 2000 and 1999 other than the restricted
common stock shares sold to Directors as part of their
compensation program. In 1997, the Board of Directors voted
that, effective January 1, 1998, 50 percent of all directors'
fees be used to purchase Company common stock directly from the
Company. On March 1, 1999, the Directors voted to purchase
their shares in the open market rather than directly from the
Company. In 1999 and 2000, the Directors purchased a total of
29,305 (5,816 shares directly from the Company, prior to March
1, 1999, and 23,489 shares in the open market) and 15,818
shares in 2000. (See "Note 4 of Notes to Consolidated Financial
Statements" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.")
Shareholders
As of March 1, 2001, there were approximately 151 holders
of record of the Company's common stock which, the Company has
been informed, hold the Company's common stock for
approximately 6,750 beneficial owners.
14
Item 6. Selected Financial Data
The following tables should be read in conjunction with
the Consolidated Financial Statements and Supplementary Data
included in Item 8 of this Form 10-K.
BALANCE SHEET DATA
Financial Position as of December 31:
2000 199 1998 1997 1996
Total
Assets $43,343,423 $65,320,768 $25,358,859 $39,273,784 $38,555,290
Total
Liabilities $11,509,948 $11,685,963 $ 2,802,150 $ 5,618,850 $ 2,622,687
Net assets $31,833,475 $53,634,805 $22,556,709 $33,654,934 $35,932,603
Net asset
value per
outstanding
share $ 3.51 $ 5.80 $ 2.13 $ 3.15 $ 3.44
Cash dividends
Paid $ 0.02 $ 0.35 $ 0.75 $ 0.00 $ 0.00
Shares
Outstanding 9,064,231 9,240,831 10,591,232 10,692,971 10,442,682
Operating Data for year ended December 31:
2000 1999 1998 1997 1996
Total investment
Income $ 687,050 $ 287,684 $ 585,486 $ 561,546 $ 1,013,417
Total
expenses* $(2,623,200)$ 9,924,020 $ 3,634,786 $ 3,045,290 $ 2,985,316
Net operating
income
(loss) $ 3,310,250 $(9,636,336) $(2,815,112) $(1,550,641)$(1,291,065)
Net realized
gain (loss)
on
invest-
ments $18,963,832 $ 8,615,670 $(1,718,528) $(2,027,177) $(2,465,175)
Net realized
income
(loss) $22,274,082 $(1,020,666)$(4,533,640) $(3,577,818) $(3,756,240)
Net (decrease)
increase in
unrealized
appreciation
on
invest-
ments $(37,781,289)$38,102,047 $ 1,655,830 $ 969,243 $ 2,967,248
Net (decrease)
increase in
net assets
resulting
from
opera-
tions $(15,507,207)$37,081,381 $(2,877,810) $(2,608,575) $ (788,992)
(Decrease)
increase in
net assets
resulting
from operations
per outstanding
share $ (1.71)$ 4.01 $ (0.27) $ (0.24) $ (0.08)
Certain reclassifications have been made to the December 31, 1998
and December 31, 1999 financial statements to conform to the
December 31, 2000 presentation.
*Included in Total expenses are the following profit-sharing
(reversals) accruals: ($4,812,675) in 2000; $8,110,908 in 1999;
$899,751 in 1998; $423,808 in 1997 and $0 in 1996.
15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The information contained in this section should be read in
conjunction with Company's 2000 Consolidated Financial
Statements and notes thereto.
Forward-Looking Statements
The information contained herein contains certain forward-
looking statements. These statements include the plans and
objectives of management for future operations and financial
objectives, portfolio growth and availability of funds. These
forward-looking statements are subject to the inherent
uncertainties in predicting future results and conditions.
Certain factors that could cause actual results and conditions
to differ materially from those projected in these forward-
looking statements are set forth herein. (See "Risk Factors"
contained in Item 1. "Business.") Other factors that could cause
actual results to differ materially include the uncertainties of
economic, competitive and market conditions, and future business
decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions
underlying the forward-looking statements included herein are
reasonable, any of the assumptions could be inaccurate and
therefore there can be no assurance that the forward-looking
statements included or incorporated by reference herein will
prove to be accurate. Therefore, the inclusion of such
information should not be regarded as a representation by the
Company or any other person that the objectives and plans of the
Company will be achieved.
Statement of Operations
The Company accounts for its operations under accounting
principles generally accepted in the United States for
investment companies. On this basis, the principal measure of
its financial performance is captioned "Net increase (decrease)
in net assets resulting from operations," which is the sum of
three elements. The first element is "Net operating income
(loss)," which is the difference between the Company's income
from interest, dividends, fees and other income and its
operating expenses, net of applicable income tax benefit
(expense). 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 benefit (expense).
These two elements are combined in the Company's financial
statements and reported as "Net realized income (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 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).
16
Financial Condition
The Company's total assets decreased by $21,977,345 or 33.6
percent to $43,343,423 and its net assets decreased by
$21,801,330 or 40.6 percent to $31,833,475 at December 31, 2000,
versus $65,320,768 and $53,634,805 at December 31, 1999.
Net asset value per share ("NAV") was $3.51 at December 31,
2000, versus $5.80 at December 31, 1999. NAV was reduced by
$0.02 in 2000 and $0.35 in 1999 by the cash dividends paid by
the Company.
Among the significant increases in values of the Company's
holdings during 2000 including holdings which the Company sold
during 2000 were: $5,854,446 in Alliance Pharmaceutical Corp.
(including realized gain), in which the Company sold its
position during 2000; $3,709,449 in Nanophase Technologies;
$1,330,949 in Genomica, as a result of its initial public
offering (Genomica Corporation commenced trading on Nasdaq on
September 29, 2000); and $854,467 in Essential.com which
acquired Sundial Marketplace.
Among the significant decreases in values of the Company's
holdings during 2000 were: $26,102,456 in SciQuest.com (net of
the gain realized on the sale of its original position and
including the unrealized loss on the shares purchased during the
year); $3,816,204 in Kana Communications, which acquired Silknet
Software, (net of the gain realized on the sale of 61,043
shares); and $1,165,874 in Questech Corporation.
Net assets were further affected by a decrease in the
Company's profit-sharing plan accrual of $4,812,675, as a result
of a net decrease in unrealized appreciation for the year; and
an increase in the Company's total tax liability of $5,598,262,
reflecting the shareholder tax payable on long-term gains
realized on the sales of shares of SciQuest.com, Alliance
Pharmaceutical Corp. and Kana Communications. The Company plans
to retain the proceeds of these gains rather than distribute the
funds to shareholders as a cash dividend. Accordingly, the
Company declared an undistributed capital gain dividend. (See
"Recent Developments -- Sub Chapter M Status.")
The Company's shares outstanding as of December 31, 2000
were 9,064,231, versus 9,240,831 at December 31, 1999. 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. Through December
31, 2000, the Company had purchased a total of 176,600 shares at
approximately $3.00 per share for a total of $530,051.
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, are dependent on new, commercially unproven
technologies and have no history of operations. At December 31,
2000, $10,240,018 or 23.6 percent of the Company's total assets
consisted of investments at fair value in publicly traded
17
securities (three of which were private businesses at the time
the Company made the investments), of which net unrealized
appreciation was $5,539,997; $16,782,438 or 38.7 percent of the
Company's total assets consisted of non-publicly traded
securities at fair value in private businesses and publicly
traded companies, of which net unrealized appreciation was
$3,406,915. At December 31, 1999, $41,556,607 or 63.6 percent
of the Company's total assets consisted of investments at fair
value in publicly traded securities (that were private
businesses at the time the Company made the investments), of
which net unrealized appreciation was $38,864,873; $18,892,731
or 29.0 percent of the Company's total assets consisted of non-
publicly traded securities at fair value in private businesses
and publicly traded companies, of which net unrealized
appreciation was $8,553,549.
The decrease in the value of publicly traded securities of
$31,316,589 or 75.4 percent from $41,556,607 in 1999 to
$10,240,018 in 2000 was primarily owing to: the sales and
decrease in value of shares of SciQuest.com of $26,102,456; and
the sales and the decrease in the value of shares of Kana
Communications of $3,816,204. These decreases were partially
offset by the increase in value of $1,330,949 and
reclassification of Genomica Corporation to a publicly traded
security as a result of its initial public offering (Genomica
Corporation commenced trading on Nasdaq on September 29, 2000;
the Company's position in Genomica is subject to a lock-up
agreement which expires on March 27, 2001), and the increase in
the value of Nanophase Technologies of $3,709,449. The changes
in the value of SciQuest.com, Kana Communications and Nanophase
Technologies occurred during a period of extreme volatility of
publicly traded, small capitalization, high technology stocks.
The volatility of the overall market may continue to have a
significant impact on the performance of the Company's
investments. In addition, the Company may be subject to lock-up
agreements which may limit the Company's ability to sell
investments. The value of the Company's investments will vary
on a quarterly basis. (See "Risk Factors.")
The decrease in the value of the non-publicly traded
securities of $2,110,293 or 11.2 percent from $18,892,731 at
December 31, 1999 to $16,782,438 at December 31, 2000 was
primarily owing to: the reclassification of Genomica
Corporation, valued at $1,209,730 at December 31, 1999, to a
publicly traded security as a result of its initial public
offering; the sale of the Company's position in Alliance
Pharmaceutical valued at $5,041,000 at December 31, 1999; the
liquidation of Adaptive Web Technologies valued at $1,000,000 at
December 31, 1999; and the decrease in the valuation of the
Company's investment in Questech Corporation of $1,165,874 net
of the Company's additional $100,000 investment in that company.
These decreases were offset by investments in NeuroMetrix, Inc.
of $750,000; in Sundial Marketplace of $577,500 as well as an
increase in its value of $854,467 as a result of its June 29,
2000 tax-free acquisition by Essential.com; Experion Systems
(formerly named MyPersonalAdvocate.com, Inc.) of $1,500,000;
Informio, Inc. of $500,000 (formerly named iPacer Corporation);
and Harris Newco, Inc. of $2,000,000.
18
A summary of the Company's investment portfolio is as
follows:
December 31, 2000 December 31, 1999
Investments, at cost $33,620,631 $16,653,130
Unrealized appreciation 8,947,928 46,882,521
----------- -----------
Investments, at fair value $42,568,559 $63,535,651
=========== ===========
__________________
The accumulated unrealized appreciation on investments net of
deferred taxes is $7,317,422 at December 31, 2000, versus
$45,098,711 at December 31, 1999.
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) exercise
warrants, options or convertible securities that were acquired
in the original or subsequent financing; (3) preserve the
Company's proportionate ownership in a subsequent financing; or
(4) attempt to preserve or enhance the value of the Company's
investment. There can be no assurance that the Company will
make follow-on investments or have sufficient funds to make
additional investments. The Company has the discretion to make
follow-on investments as it determines, subject to the
availability of capital resources. The failure to make such
follow-on investments may, in certain circumstances, jeopardize
the continued viability of the investee company and the
Company's initial investment or may result in a missed
opportunity for the Company to increase its participation in a
successful operation. Even if the Company has sufficient
capital to make a desired follow-on investment, it may elect not
to make a follow-on investment either because it does not want
to increase its concentration of risk, because it prefers other
opportunities, or because it is inhibited by compliance with BDC
or RIC requirements, even though the follow-on investment
opportunity appears attractive.
The following table is a summary of the cash investments
and loans made by the Company in its private placement portfolio
during the year ended December 31, 2000:
New Investments: Amount
Experion Systems, Inc. (1) $1,500,000
Informio, Inc. (2) $500,000
Harris Newco, Inc. $2,000,000
----------
Additional Investments:
Genomica Corporation $500,000
Sundial Marketplace Corporation (3) $427,500
----------
(1) Formerly named MyPersonalAdvocate.com, Inc.
(2) Formerly named iPacer Corporation.
(3) Acquired by Essential.com, Inc.
19
Loans:
NeuroMetrix, Inc. (4) $750,000
Questech Corporation (5) $100,000
Sundial Marketplace Corporation (3) $150,000
----------
Exercise of Warrants Held:
Alliance Pharmaceutical Corp. $490,000
----------
Total $6,417,500
==========
(3) Converted to equity and acquired by Essential.com, Inc.
(4) Converted to equity as part of a recently completed $13 million
equity financing of NeuroMetrix, Inc.
(5) Converted to equity as part of a $3.4 million equity financing
of Questech Corporation.
Results of Operations
Investment Income and Expenses:
The Company had a net operating income (loss) of $3,310,250
in 2000, ($9,636,336) in 1999 and ($2,815,112) in 1998. The net
operating income for 2000 reflected a decrease in the employee
profit-sharing accrual that resulted in a credit to expenses of
($4,812,675). The net operating losses in 1999 and 1998 reflect
accruals for employee profit sharing of $8,110,908 and $899,751,
respectively. When unrealized appreciation as of a certain
period subsequently decreases the profit-sharing accrual will be
decreased accordingly, resulting in a credit to expenses,
thereby reducing expenses for such subsequent year by that
amount.
The Company's primary investment objective is to achieve
long-term capital appreciation rather than current income from
its investments. Therefore, a significant portion of the
investment portfolio is structured to attempt to enhance 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 also received or accrued net after-tax
distributions from its investment in PHZ Capital Partners, L.P.
in 2000 of $121,510, in 1999 of $490,950 and in 1998 of $50,000.
The Company does not regard distributions from PHZ as
predictable.
The Company had total investment income of $687,050 in
2000, $287,684 in 1999 and $585,486 in 1998. The Company had
interest income from fixed-income securities of $554,233 in
2000, $234,347 in 1999 and $355,591 in 1998. The increase from
1999 to 2000 of $319,886 or 136.5 percent was owing to the
Company having additional funds to invest as the result of the
sale of the SciQuest.com and Alliance Pharmaceutical securities.
The decrease from 1998 to 1999 of $121,244 or 34.1 percent was
primarily owing to a decline in the balance of the Company's
fixed-income portfolio during 1999 and 1998 as a result of the
payment of dividends, additional investments and operating
expenses.
20
The Company had interest income from affiliated companies
of $64,950 in 2000, $48,526 in 1999 and $124,877 in 1998. The
increase from 1999 to 2000 of $16,424 or 33.8 percent and the
decrease from 1998 to 1999 of $76,351 or 61.1 percent is owing
to the change in amount of outstanding loans during the periods.
The amount of outstanding loans to investee companies varies.
Typically, loans made to investee companies are bridge loans and
are converted into equity at the next financing.
The Company had other income of $65,867 in 2000, $3,911 in
1999 and $102,468 in 1998. The other income in 2000 represents
rental income for subleasing office space; in December 1999, the
Company began subleasing office space to an unaffiliated party.
The other income in 1998 reflected income from an affiliated
company, BioSupplyNet, to reimburse the Company for consulting
fees previously paid and expensed by the Company on behalf of
BioSupplyNet.
Operating expenses were ($2,623,200) in 2000, $9,924,020 in
1999 and $3,634,786 in 1998. The operating expenses for the year
ended December 31, 2000 reflect a reversal of a prior expense
accrual of $4,812,675 in the employee profit-sharing plan, as a
result of a net decrease in unrealized appreciation for the
current year, resulting in a credit to expenses. Salaries and
benefits increased $202,037 or 24.2 percent primarily as a
result of the Company's contribution to the Supplemental
Executive Retirement Plan or SERP. (See "Note 5 of Notes to
Consolidated Financial Statements" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
Professional fees decreased by $21,288 or 6.4 percent.
Administration and operations expenses increased $66,441 or 20.8
percent primarily as a result of increased printing and
distribution costs for the Company's shareholder reports as a
result of a significant increase in the number of beneficial
shareholders from 1999 to 2000. During 2000, the Company
incurred a total of $146,141 in interest costs on outstanding
debt during the first quarter of 2000; $36,500 interest paid on
a note and $109,641 on warrants. Director's fees and expenses
decreased by $19,859 or 16.5 percent as the result of the
Company holding fewer director meetings in 2000 than in 1999.
The increase in expenses from 1998 to 1999 of $6,289,234 or
173.0 percent is primarily owing to an increase in the expense
for the Company's employee profit-sharing plan of $7,211,157 or
an 801.5 percent increase over the prior year as a result of the
net increase in unrealized appreciation of the Company's
investments of approximately $40,709,767. A total of $1,138,551
of the profit-sharing on the 1999 net realized gains was paid in
2000. (See "Note 3 of Notes to Consolidated Financial
Statements" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.")
Other than the increase in the employee profit-sharing plan
accrual and a decrease in professional fees, which decreased by
$79,591 or 19.3 percent as a result of lower legal fees,
expenses remained stable. Salaries and benefits increased by
$3,579 or less than one percent; administration and operations
decreased by $11,712 or 3.5 percent; depreciation decreased by
$12,481 or 26.0 percent as a result of assets that were fully
depreciated as of the end of 1998; rent increased by $3,472 or
2.2 percent; directors' fees and expenses decreased by $8,925 or
21
6.9 percent because the Company had one fewer director in 1999
than in 1998. Other expense in 1998 includes the final payment
on the Harris & Harris Group Senior Professorship pledge to the
Massachusetts Institute of Technology of $728,862.
During 1999, the Company had no interest expense and no
outstanding debt.
The Company has in the past relied, and continues to rely
to a large extent, on proceeds from sales of investments, rather
than on investment income, to defray a significant portion of
its operating expenses. Because such sales are unpredictable,
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 three years ended December 31, 2000, 1999 and
1998, the Company sold various investments and received
distributions, realizing net gains (losses) of $19,065,267,
$10,976,714 and ($1,718,528), respectively.
During 2000, the Company realized total net gains of
$19,065,267 including $9,693,446 on the sale of its entire
position in Alliance Pharmaceutical, $7,407,377 on the sale of
its original position in SciQuest.com (the Company purchased an
additional 350,000 shares during the year); $1,054,818 on the
sale of 61,043 shares of Kana Communications, $241,025 on the
sale of 85,100 shares of Nanophase Technologies; $528,021 from
PHZ Capital Partners LP; and $147,528 on the realization of the
reserve on the NBX/3Com escrow (the Company received in full the
escrowed funds on March 6, 2000). As a result of the gains and
losses realized during 2000, unrealized appreciation decreased
by $21,400,036.
During 1999, the Company realized total net gains of
$10,976,714, including $10,584,630 on the sale of NBX
Corporation to 3Com Corporation; $160,918 on the sale of 87,600
shares of Princeton Video Image, Inc.; and the receipt of a cash
distribution from PHZ Capital Partners, L.P. of approximately
$612,170. The Company also incurred losses of approximately
$381,004 on the sale of various publicly traded investments. As
a result of gains and losses realized during 1999, unrealized
appreciation decreased by $4,234,794.
During 1998, the Company realized total net losses of
$1,718,528. These net losses included: $209,999 on its
privately held investment in MultiTarget, Inc.; losses on
publicly held investments that were once privately held,
including (1) CORDEX Petroleums, Inc. in the amount of $357,736;
(2) Princeton Video Image, Inc., $288,369; and (3) Voice Control
Systems, Inc. (which purchased the Company's investee company,
PureSpeech, Inc.), $724,826. The Company also had a realized
net loss of $187,598 in various publicly traded securities.
During 1998, the Company received a cash distribution of $50,000
from PHZ Capital Partners, L.P. As a result of gains and losses
realized during 1998, unrealized appreciation increased by
$1,171,496.
22
Unrealized Appreciation and Depreciation of Portfolio
Securities:
The Board of Directors values the portfolio securities on a
quarterly basis pursuant to the Company's Asset Valuation
guidelines in accordance with the 1940 Act. (See "Footnote to
Consolidated Schedule of Investments" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
In 2000, net unrealized appreciation on investments
decreased by $37,934,593 or 80.9 percent from $46,882,521 to
$8,947,928, primarily as a result of declines in the values of
the Company's holdings in SciQuest.com, Kana Communications, and
Questech Corporation of $26,102,456 (net of gain realized on
sale), $3,816,204 (net of gain realized on sale) and $1,165,874,
respectively, offset by increases in the values of the Company's
holdings in Nanophase Technologies Corporation, Genomica
Corporation and Essential.com of $3,709,449, $1,330,949 and
$854,467, respectively. (See "Consolidated Schedule of
Investments" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.")
In 1999, net unrealized appreciation on investments
increased by $36,474,973 or 350.5 percent, from $10,407,548 to
$46,882,521. The most significant increases in valuation during
1999 were in: SciQuest.com, Inc., $31,981,750; Silknet Software,
Inc. (which acquired InSite Marketing Technology, Inc.),
$4,899,062; Alliance Pharmaceutical Corp., $3,839,000; and
Nanophase Technologies Corporation, $1,935,016. The increase in
valuations was offset by the reclassification of the Company's
gain in NBX Corporation of $4,716,062 from unrealized to
realized.
In 1998, net unrealized appreciation on investments
increased by $2,248,816 or 27.6 percent, from $8,158,732 to
$10,407,548. The most significant increases in valuations
during 1998 were in: NBX Corporation, $1,865,766; NeuroMetrix,
Inc., $4,400,125; and PHZ Capital Partners, L.P., $443,432. The
most significant decrease during 1998 was in Nanophase
Technologies Corporation, $5,508,466. Other changes included an
increased valuation of Genomica Corporation, offset primarily by
decreased valuations in MedLogic Global Corporation and
Princeton Video Image, Inc.
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash,
receivables and freely marketable securities (net of discounts
for size of positions, if any). The Company's secondary sources
of liquidity are restricted securities of companies that are
publicly traded. At December 31, 2000, December 31, 1999 and
December 31, 1998, respectively, the Company's total primary
liquidity was $23,039,736, $6,622,216 and $5,547,984. On the
corresponding dates, the Company's total secondary liquidity was
$3,040,679, $38,230,812 and $0. The Company's tertiary source
of liquidity is its holding in PHZ Capital Partners, L.P., from
which the Company received or accrued net after-tax
distributions in 2000, 1999 and 1998 of approximately $121,510,
$490,950 and $50,000, respectively.
23
The increase in the Company's primary source of liquidity
from December 31, 1999 to December 31, 2000 is primarily owing
to: (1) Alliance Pharmaceutical shares which became freely
tradable and were subsequently sold for proceeds of $11,385,446;
(2) sale of SciQuest.com stock for proceeds of $8,257,377; (3)
increase in the value of Nanophase Technologies shares of
$3,709,449; (4) sale of 61,043 shares of Kana Communications for
proceeds of $1,504,762; (5) receipt of escrowed funds plus
interest of $1,541,136; and (6) receipt of funds from the
liquidation of Adaptive Web Technologies of $993,830.
This increase in the Company's primary liquidity was offset
by: (1) the payment of the 1999 employee profit sharing of
$1,138,551; (2) the investments of $2,000,000 in Harris Newco,
Inc., $1,500,000 in Experion Systems, $500,000 in Informio,
$500,000 in Genomica, $490,000 for the exercise of warrants to
purchase common stock in Alliance Pharmaceutical, $577,500 in
Sundial Marketplace (which was acquired on June 29, 2000 by
Essential.com in a tax-free merger); (3) the loans of $750,000 to
NeuroMetrix, and $100,000 to Questech; and (4) the use of funds
for operating expenses.
The decrease in the Company's secondary source of liquidity
from December 31, 1999 to December 31, 2000 is primarily owing
to the expirations of the lock-up periods on SciQuest.com and
Silknet Software (which subsequently merged with Kana
Communications) offset by the completion of the initial public
offering of Genomica Corporation, which commenced trading on
September 29, 2000. The Company's position in Genomica is
subject to a lock-up agreement which expires on March 27, 2001.
In 2000, the changes in the values of SciQuest.com, Kana
Communications, Nanophase Technologies and Alliance
Pharmaceutical reflected the extreme stock market volatility in
the shares of smaller, high technology companies.
From December 31, 1999 to December 31, 2000, restricted
funds increased by $265,183 or 100 percent as a result of the
establishment of the Company's contribution to the Supplemental
Executive Retirement Plan or SERP account. Funds in escrow
decreased by $1,327,748 or 100 percent, owing to the receipt of
the full escrowed funds plus accrued interest for a total of
$1,541,136 on March 6, 2000.
From December 31, 1999 to December 31, 2000, the Company's
liability for accrued profit sharing and deferred income tax
liability changed significantly. Accrued profit sharing
decreased by $5,951,226 to $3,483,241 as a result of payment of
$1,138,551 of the 1999 profit sharing and the reversal of a
prior expense accrual of $4,812,675 owing to the decrease in
unrealized appreciation for the year ended December 31, 2000.
Approximately $2,325,071 of the profit-sharing accrual will be
paid out in 2001 as follows: 90 percent in February 2001 and the
remaining 10 percent upon the completion and filing of the
Company's 2000 federal tax return.
The Company's total income tax liability increased by
$5,598,262 to $7,116,036 primarily as a result of the federal
income tax payable on the shareholders' behalf on the net
realized long-term capital gains which the Company currently
plans to retain rather than distribute as a cash dividend.
Accordingly, the Company declared a designated undistributed
24
capital gain dividend for a total of $16,253,987 and paid a
total of $5,688,896 in federal income taxes in January 2001.
(See "Note 6 of Notes to Consolidated Financial Statements"
contained in Item 8. "Consolidated Financial Statements and
Supplementary Data.")
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. Through
December 31, 2000, the Company had purchased a total of 176,600
shares at approximately $3.00 per share for a total of $530,051.
The Company's primary sources of liquidity, including cash,
receivables and freely marketable securities, are more than
adequate to cover the Company's gross cash operating expenses
over the next 12 months. Such gross cash operating expenses
totaled $2,051,086, $1,777,657 and $2,687,099 in 2000, 1999 and
1998, respectively. The Company's secondary sources of liquidity
are the restricted securities of companies, all of which are
scheduled to become freely tradable at various times in the year
2001. The Company cannot predict the amount, if any, of net
after-tax distributions that it might receive from its holding
in PHZ in the year 2001.
Recent Developments -- Portfolio Companies
During January 2001, the Company sold in the open market its
entire position of 350,000 shares of SciQuest.com, Inc. common
stock (NASDAQ: SQST) at an average net price of $2.08 per share,
resulting in a realized loss of $1,258,679.
On January 26, 2001, the Company announced that it had
invested $750,000 in a Series B Convertible Preferred security
for approximately a 10 percent fully diluted equity interest in
Schwoo, Inc. Schwoo is a privately held Pittsburgh-based
corporation. The company is developing software that
automatically manages e-commerce security infrastructure. The
Schwoo system is designed to operate on an integrated basis
across network, host and application layers to defend systems
from security attacks.
On February 28, 2001, the Company noted that it had
converted its NeuroMetrix Note to equity as part of NeuroMetrix's
$13 million third round venture financing.
Recent Developments -- Sub-Chapter M Status
The qualification of the Company as a RIC under Sub-Chapter
M of the Code depends on it satisfying certain technical
requirements regarding its income, investment portfolio and
distributions. (See "Sub-Chapter M Status" contained in Item.
1 "Business"). The Company was unable to satisfy these
requirements for the 1998 tax year owing to the nature of the
Company's ownership interest in one of its investee companies.
In addition, because it realized taxable losses in 1998, it was
not strategically advantageous for the Company to elect Sub-
Chapter M tax status for 1998. The Company changed the nature
of its ownership interest in the non-qualifying investee company
effective January 1, 1999 in order to meet the Sub-Chapter M
requirements.
25
In 1999, because of changes in its investment portfolio, the
Company requested recertification from the SEC relating to the
Company's status under section 851(e) of the Code. On February
24, 2000, the Company received the certification, and the Company
elected Sub-Chapter M tax treatment for 1999. During 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.
On March 8, 2001, the Company received SEC certification and
qualified for RIC treatment for 2000. Although the SEC
certification for 1999 and 2000 was issued, there can be no
assurance that the Company will receive such certification for
subsequent years (to the extent it needs additional certification
as a result of changes in its portfolio) or that it will actually
qualify as a RIC for subsequent years. In addition, under certain
circumstances, even if the Company qualified for Sub-Chapter M
treatment in 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.
On December 14, 2000, the Company announced that its Board
of Directors, in accordance with rules governing a RIC under Sub-
Chapter M of the Code, declared a designated undistributed
capital gain dividend (also known as a deemed dividend) of $1.78
per share, for a total of $16,253,987 and paid corporate taxes on
behalf of shareholders of $0.62 per share, for a total of
$5,688,896. Each shareholder will receive an IRS Form 2439 which
will reflect receipt of the deemed dividend income and a tax
credit equal to the shareholder's proportionate share of the tax
paid by the Company.
Tax Consequences of Net Capital Gains
The following simplified examples illustrate the tax
treatment under Sub-Chapter M of the Code for the Company and its
shareholders with regard to three possible alternatives, assuming
a net long-term capital gain of $1.00 per share, consisting
entirely of sales of non-real property assets held for more than
12 months.
Under Alternative A: 100 percent of net capital gain
declared as a dividend and distributed to shareholders:
1. No federal taxation at the Company level.
2. Taxable shareholders receive a $1.00 per share
dividend and pay a maximum federal tax of 20 percent* or $.20
per share, retaining $.80 per share.
*Assumes all capital gains qualify for long-term rates of 20
percent.
26
Under Alternative B: 100 percent of net capital gain
retained by the Company and designated as "undistributed capital
gain" or deemed dividend:
1. The Company pays a corporate-level federal income
tax of 35 percent on the undistributed gain or $.35 per share
and retains 65 percent of the gain or $.65 per share.
2. Taxable shareholders increase their cost basis in
their stock by $.65 per share. They pay a 20 percent* federal
capital gains tax on 100 percent of the undistributed gain of
$1.00 per share or $.20 per share in tax. Offsetting this tax,
shareholders receive a tax credit equal to 35 percent of the
undistributed gain or $.35 per share.
Under Alternative C: 100 percent of net capital gain
retained by the Company, with no designated undistributed
capital gain or deemed dividend:
1. The Company pays a corporate-level federal income
tax of 35 percent on the retained gain or $.35 per share plus an
excise tax of four percent of $.98 per share, or about $.04 per
share.
2. There is no tax consequence at the shareholder
level.
*Assumes all capital gains qualify for long-term rates of 20
percent.
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk
The Company's business activities contain elements of risk.
The Company considers a principal type of market risk to be
valuation risk. 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" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.")
Neither the Company's investments nor an investment in the
Company is intended to constitute a balanced investment program.
The Company has exposure to public-market price fluctuations to
the extent of its publicly traded portfolio.
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 public market
for these investments, there is 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.
27
Because there is typically no public market for the equity
interests of the small companies in which the Company invests,
the valuation of the equity interests in the Company's portfolio
is subject to the estimate of the Company's Board of Directors
in accordance with the Company's Asset Valuation Policy
Guidelines. In the absence of a readily ascertainable market
value, the estimated value of the Company's portfolio of equity
interests may differ significantly from the values that would be
placed on the portfolio if a ready market for the equity
interests existed. Any changes in valuation are recorded in the
Company's consolidated statements of operations as "Net
(decrease) increase in unrealized appreciation on investments."
28
Item 8. Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC.
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. . . . . . 30
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 2000 and 1999. . . . . . . . 31
Consolidated Statements of Operations for the
years ended December 31, 2000, 1999, and 1998 . 32
Consolidated Statements of Cash Flows for the
years ended December 31, 2000, 1999, and 1998. . 33
Consolidated Statements of Changes in Net Assets
for the years ended December 31, 2000, 1999,
and 1998 . . . . . . . . . . . . . . . . . . . . 34
Consolidated Schedule of Investments as of
December 31, 2000. . . . . . . . . . . . . . . . 35-39
Footnote to Consolidated Schedule of Investments . . 40-42
Notes to Consolidated Financial Statements . . . . . 43-50
Selected Per Share Data and Ratios for the
years ended December 31, 2000, 1999, 1998,
1997 and 1996 . . . . . . . . . . . . . . . . . . 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.
29
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, 2000 and 1999, including the
consolidated schedule of investments as of December 31, 2000, and
the related consolidated statements of operations, cash flows and
changes in net assets for the three years ended December 31,
2000, and the selected per share data and ratios for each of the
five years ended December 31, 2000. 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, 2000 and 1999, 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 $16,782,438 (52.72
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, 2000 and 1999, the
results of their operations, their cash flows and the changes in
their net assets for the three years ended December 31, 2000, and
the selected per share data and ratios for each of the five years
ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
/s/ Arthur Andersen LLP
-------------------------
New York, New York
February 28, 2001
30
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
December 31, 2000 December 31, 1999
Investments, at value (See accompanying consolidated
schedule of investments and notes). . . . $42,568,559 $63,535,651
Cash and cash equivalents . . . . . . . . 253,324 133,256
Restricted funds (Note 5) . . . . . . . . 265,183 0
Funds in escrow (Note 7). . . . . . . . . 0 1,327,748
Interest receivable . . . . . . . . . . . 30,082 44,189
Prepaid expenses. . . . . . . . . . . . . 82,615 74,328
Note receivable . . . . . . . . . . . . 10,888 32,663
Other assets. . . . . . . . . . . . . . . 132,772 172,933
----------- -----------
Total assets. . . . . . . . . . . . . . . $43,343,423 $65,320,768
=========== ===========
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities. $771,763 $ 700,566
Payable to broker for unsettled trade . . 115,005 0
Accrued profit sharing (Note 3) . . . . . 3,483,241 9,434,467
Deferred rent . . . . . . . . . . . . . . 23,903 33,156
Current income tax liability (Note 6) . . 5,751,566 0
Deferred income tax liability (Note 6). . 1,364,470 1,517,774
----------- -----------
Total liabilities . . . . . . . . . . . . 11,509,948 11,685,963
Commitments and contingencies (Notes 7) ----------- -----------
Net assets. . . . . . . . . . . . . . . . $31,833,475 $53,634,805
=========== ===========
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 12/31/00 and at 12/31/99. . . . . . . 106,930 106,930
Additional paid in capital (Note 4) . . . . 26,724,595 16,159,504
Additional paid in capital - common
stock warrants . . . . . . . . . . . . . 109,641 0
Accumulated net realized gain (loss). . . . 642,418 (5,192,860)
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $1,630,506 at 12/31/00
and $1,783,810 at 12/31/99. . . . . . . . . 7,317,422 45,098,711
Treasury stock, at cost (1,628,740
shares at 12/31/00 and
1,452,140 at 12/31/99). . . . . . . . . . . (3,067,531) (2,537,480)
------------ -----------
Net assets. . . . . . . . . . . . . . . . . $31,833,475 $53,634,805
=========== ===========
Shares outstanding. . . . . . . . . . . . . 9,064,231 9,240,831
=========== ===========
Net asset value per outstanding share . . . $ 3.51 $ 5.80
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
31
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December December December
31, 2000 31, 1999 31, 1998
Investment income:
Interest from:
Fixed-income
Securities. . . . . $ 554,233 $ 34,347 $ 355,591
Affiliated
Companies . . . . . 64,950 48,526 124,877
Dividend income --
unaffiliated
companies . . . . . 2,000 900 2,550
Other income. . . . . 65,867 3,911 102,468
------------- ---------- ------------
Total investment
Income . . . . . . 687,050 287,684 585,486
Expenses:
Profit-sharing
(reversal) accrual
(Note 3) . . . . . . (4,812,675) 8,110,908 899,751
Salaries and benefits. 1,036,737 834,700 831,121
Professional fees. . . 310,601 331,889 411,480
Administration and
Operations . . . . . 385,608 319,167 330,879
Rent . . . . . . . . . 166,816 162,987 159,515
Directors' fees
and expenses . . . . 100,469 120,328 129,253
Depreciation. . . . . 28,748 35,455 47,936
Custodian fees. . . . 14,355 8,586 10,513
Other expense . . . . 0 0 728,862
Interest expense
(Note 4). . . . . . 146,141 0 85,476
-------------- ----------- ------------
Total expenses. . . (2,623,200) 9,924,020 3,634,786
-------------- ----------- ------------
Operating income
(loss) before
income taxes. . . . 3,310,250 (9,636,336) (3,049,300)
Income tax benefit
(Note 6). . . . . . 0 0 234,188
-------------- ----------- -------------
Net operating
income (loss) . . . 3,310,250 (9,636,336) (2,815,112)
Net realized gain (loss) on investments:
Realized gain (loss)
on sale of
investments . . . . 19,065,267 10,976,714 (1,718,528)
------------- ----------- ------------
Total realized
gain (loss) . . . . 19,065,267 10,976,714 (1,718,528)
Income tax expense
(Note 6). . . . . . (101,435) (2,361,044) 0
------------- ----------- -----------
Net realized gain
(loss) on
investments . . . . 18,963,832 8,615,670 (1,718,528)
------------ ------------ ------------
Net realized
income (loss). . . . 22,274,082 (1,020,666) (4,533,640)
Net (decrease) increase in unrealized appreciation on investments:
Increase as a
result of
investment sales. . 0 704,801 2,135,176
Decrease as a
result of
investment sales. . (21,400,036) (4,939,595) (963,680)
Increase on
investments held. . 26,741,283 43,186,960 9,766,320
Decrease on
investments held. . (43,275,840) (2,477,193) (8,689,000)
------------- ----------- -----------
Change in unrealized
appreciation on
investments. . . . (37,934,593) 36,474,973 2,248,816
Income tax benefit
(expense) (Note 6). 153,304 1,627,074 (592,986)
------------ ---------- -----------
Net (decrease)
increase in
unrealized
appreciation
on investments. . . (37,781,289) 38,102,047 1,655,830
------------ ----------- -----------
Net (decrease) increase in net assets resulting from operations:
Total. . . . . . . . . $(15,507,207) $37,081,381 $(2,877,810)
============ =========== ===========
Per outstanding
Share . . . . . . . . $ (1.71) $ 4.01 $ (0.27)
============ =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
32
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December December December
31, 2000 31, 1999 31, 1998
Cash flows used in operating activities:
Net (decrease)
increase in net
assets resulting
from operations . . . $(15,507,207) $37,081,381 $ (2,877,810)
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. . . . . 18,869,326 (47,451,687) (480,288)
Deferred income
Taxes. . . . . . . . (153,304) 586,710 263,367
Depreciation. . . . . 28,748 35,455 47,936
Other . . . . . . . . 109,641 0 (2,927)
Interest received
in stock. . . . . . (27,009) 0 0
Changes in assets and liabilities:
Restricted funds . . (265,183) 0 0
Receivable from
broker for
unsettled trades. . 0 380,707 (380,707)
Funds in escrow. . . 1,327,748 (1,327,748) 0
Interest receivable. 14,107 (43,523) 110,440
Prepaid expenses . . (8,287) 16,321 (5,523)
Notes receivable . . 0 0 (32,663)
Other assets . . . . 18,384 (41,281) 86,312
Accounts payable
and accrued
liabilities . . . . 71,197 195,448 81,235
Payable to broker
for unsettled
trade . . . . . . . 115,005 0 0
Accrued profit
Sharing . . . . . . (5,951,226) 8,110,908 899,751
Deferred rent. . . . (9,253) (9,253) (9,253)
Current income tax
Liability . . . . . 62,670 0 0
------------- ------------ ----------
Net cash used in
operating
activities. . . . . (1,304,643) (2,466,562) (2,300,130)
Cash provided by investing activities:
Net (purchase) sale
of short-term
investments and
marketable
securities. . . . . (14,480,590) 240,590 14,683,171
Investment in
private placements
and loans . . . . . (6,417,500) (4,077,001) (960,308)
Proceeds from
sale of
investments . . . . 23,022,868 12,274,632 32,663
Purchase of
fixed assets. . . . (6,974) (9,261) (16,426)
------------ ----------- ----------
Net cash provided
by investing
activities. . . . . 2,117,804 8,428,960 13,739,100
Cash flows used in financing activities:
Payment of dividend. (184,817) (3,647,017) (8,019,728)
Purchase of
treasury stock
(Note 4). . . . . . (530,051) (2,373,551) (254,786)
Proceeds from
note payable. . . . 3,000,000 0 0
Payment of note
payable (Note 4). . (3,000,000) 0 (4,000,000)
Proceeds from
sale of stock
(Note 4). . . . . . 0 17,283 54,099
Collection on notes
Receivable. . . . . 21,775 10,000 800,000
----------- ------------ ----------
Net cash used
in financing
activities. . . . . (693,093) (5,993,285) (11,420,415)
---------- ----------- -----------
Net increase (decrease) in cash and cash equivalents:
Cash and cash
equivalents at
beginning of
the year. . . . . . 133,256 164,143 145,588
Cash and cash
equivalents at
end of the year. . . 253,324 133,256 164,143
---------- ---------- ----------
Net increase
(decrease) in
cash and cash
equivalents. . . . . $ 120,068 $ (30,887) $ 18,555
============ ============ ===========
Supplemental disclosures of cash flow information:
Income taxes paid . . $ 117,134 $ 122,560 $ 372
Interest paid . . . . $ 36,500 $ 0 $ 85,476
The accompanying notes are an integral part of
these consolidated financial statements.
33
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended Year Ended
December December December
31, 2000 31, 1999 31, 1998
Changes in net assets from operations:
Net operating income
(loss). . . . . . . . $ 3,310,250 $ (9,636,336) $(2,815,112)
Net realized gain
(loss) on
investments . . . . . 18,963,832 8,615,670 (1,718,528)
Net (decrease) increase
in unrealized
appreciation on
investments as a
result of sales . . . (21,246,732) (2,607,720) 578,510
Net (decrease)
increase in
unrealized
appreciation on
investments held. . . (16,534,557) 40,709,767 1,077,320
------------ ------------- -----------
Net (decrease)
increase in net assets resulting
from operations . . . (15,507,207) 37,081,381 (2,877,810)
Changes in net assets from
capital stock transactions:
Payment of dividend. . (184,817) (3,647,017) (8,019,728)
Purchase of
treasury stock. . . . (530,051) (2,373,551) (254,786)
Proceeds from sale
of stock. . . . . . . 0 17,283 54,099
Deemed dividend
shareholder tax
credit. . . . . . . . (5,688,896) 0 0
Additional paid in
capital warrants. . . 109,641 0 0
----------- ----------- -----------
Net decrease in net
assets resulting
from capital stock
transactions . . . . . (6,294,123) (6,003,285) (8,220,415)
----------- ----------- -----------
Net (decrease)
increase in net
assets . . . . . . . . (21,801,330) 31,078,096 (11,098,225)
----------- ----------- ------------
Net Assets:
Beginning of the year. 53,634,805 22,556,709 33,654,934
----------- ----------- -----------
End of the year. . . . $31,833,475 $53,634,805 $22,556,709
=========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
34
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2000
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated Companies (16)(18)(19) -- 17.2% of
total investments
Publicly Traded Portfolio -- 8.4% of total investments
Genomica Corporation (1)
(2)(6)(7) -- Develops
software that enables the
study of complex genetic
diseases -- 2.94% of
fully diluted equity
Common Stock. . . . . . . . (C) 731,111 $3,040,679
Kana Communications, Inc.
(1)(8) -- Provides customer-
centric e-business applications
and systems
Common Stock. . . . . . . . (C) 6,791 78,096
SciQuest.com, Inc. (1)(9)
-- Internet e-commerce
source for scientific
products
Common Stock. . . . . . . . (C) 350,000 459,375
----------
Total Publicly Traded Portfolio (cost: $3,537,817). . .$3,578,150
----------
Private Placement Portfolio (Illiquid) -- 8.8% of total investments
Essential.com, Inc. (1)(2)
(10) -- Online energy and
communications marketplace
- 0.59% of fully diluted equity
Common Stock. . . . . . . . (B) 169,185 $2,204,000
Exponential Business
Development Company (2)(5)
-- Venture capital
partnership focused on
early stage companies
Limited partnership
Interest . . . . . . . . . (A) - 25,000
Informio, Inc. (1)(2)(4)
(6)(11) -- Developing
audio web portal technology
Series A Convertible
Preferred Stock. . . . . . (A) - 504,601
Kriton Medical, Inc. (1)
(2)(5)(6) -- Research and
development of medical
devices -- 1.86% of fully
diluted equity
Series B Convertible
Preferred Stock . . . . . . (A) 476,191 1,000,001
MedLogic Global Corporation
(1)(2)(6) -- Medical
cyanoacrylate adhesive --
0.23% of fully diluted equity
Series B Convertible
Preferred Stock . . . . . . (D) 54,287
Common Stock . . . . . . . . (D) 25,798 --
----------
Total Private Placement Portfolio (cost: $3,912,910). .$3,733,602
----------
Total Investments in Unaffiliated Companies
(cost: $7,450,727). . . . . . . . . . . . . . . . . .$7,311,752
----------
The accompanying notes are an integral part of
this consolidated schedule.
35
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2000
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled Affiliated Companies (16)(19) -- 41.6%
of total investments
Publicly Traded Portfolio -- 15.6% of total investments
Nanophase Technologies
Corporation (1)(12) -
Manufactures and markets
inorganic crystals of
nanometric dimensions --
4.44% of fully diluted
equity
Common Stock. . . . . . . . (C) 672,916 $6,661,868
----------
Total Publicly Traded Portfolio (cost: $1,162,204). . .$6,661,868
----------
Private Placement Portfolio (Illiquid) -- 26.0% of total investments
Experion Systems, Inc. (1)
(2)(4)(6)(13) -- Provides
e-business software selling
platforms based on trust-
based marketing -- 15.35%
of fully diluted equity
Convertible Preferred Stock. (A) 187,500 $1,500,000
NeuroMetrix, Inc. (1)
(2)(6)(15) -- Medical
devices for monitoring
neuromuscular disorders
-- 15.63% of fully diluted
equity
Series A Convertible
Preferred Stock. . . . . . (B) 175,000
Series B Convertible
Preferred Stock. . . . . . (B) 125,000
Series C-2 Convertible
Preferred Stock. . . . . . (B) 229,620
8% Convertible Note . . . . (A) $750,000 6,708,225
PHZ Capital Partners
Limited Partnership (2)(14)
-- Organizes and manages
investment partnerships
-- 20.0% of fully diluted
equity
Limited partnership
Interest . . . . . . . . . (D) - 1,870,013
Questech Corporation (1)
(2)(6) -- Manufactures and
markets proprietary metal
decorative tiles and signs
-- 9.87% of fully diluted equity
Common Stock. . . . . . . . (B) 646,954
Warrants at $5.00
expiring 11/15/04. . . . . (A) 1,965
Warrants at $4.00
expiring 11/28/01. . . . . (A) 152,422
Warrants at $1.50
expiring 11/16/05. . . . . (A) 1,250 970,598
-----------
Total Private Placement Portfolio (cost: $7,462,613). $11,048,836
-----------
Total Investments in Non-Controlled Affiliated
Companies (cost: $8,624,817). . . . . . . . . . . . $17,710,704
-----------
The accompanying notes are an integral part of
this consolidated schedule.
36
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2000
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in Controlled Affiliated (16)(19) -- 4.7%
of total investments
Harris Newco, Inc. (1)
(2)(4)(6)(17) -- 100%
of fully diluted equity
Series A Convertible
Preferred Stock. . . . . (A) 100 $2,000,000
----------
Total Private Placement Portfolio in
Controlled Affiliates (cost: $2,000,000). . . . . . .$2,000,000
----------
U.S. Government and Agency Obligations -- 36.5% of total investments
Federal Home Loan Bank
Discount Notes -
due date 1/3/01. . . . . (K) $1,800,000 $1,799,046
Federal Home Loan Bank
Discount Notes -
due date 1/5/01. . . . . . (K) $2,000,000 1,998,240
U.S. Treasury Bill dated
7/27/00 due date -
1/25/01 - 5.5% yield . . (K) $1,600,000 1,593,872
Federal Home Loan Bank
Discount Notes -
due date 1/24/01 . . . . (K) $ 950,000 946,029
Federal Home Loan Bank
Discount Notes -
due date 02/07/01. . . . (K) $ 400,000 397,352
U.S. Treasury Bill dated
8/10/00 due date -
2/8/01 -- 5.4% yield . . (K) $2,800,000 2,783,648
Federal Farm Credit Bank
Discount Notes -
due date 3/1/01. . . . . (K) $1,000,000 989,560
Federal National Mortgage Assn.
Bank Discount Notes -
due date - 3/8/01. . . . (K) $3,300,000 3,261,522
Federal Home Loan Bank
Discount Notes -
due date 3/15/01. . . . (K) $1,800,000 1,776,834
-----------
Total Investments in U.S. Government and
Agency Obligations (cost: $15,545,087). . . . . . . $15,546,103
-----------
Total Investments -- 100% (cost: $33,620,631) . . . . $42,568,559
===========
The accompanying notes are an integral part of
this consolidated schedule.
37
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2000
Notes to Consolidated 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 Methods of Valuation A to L.
(4) These investments were made during 2000. Accordingly, the
amounts shown on the schedule represent the gross additions
in 2000.
(5) No changes in valuation occurred in these investments during
the 12 months ended December 31, 2000.
(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) In 1996, Genomica Corporation was cofounded by the Company,
Cold Spring Harbor Laboratory ("CSHL"), a not-for-profit
institution, and Falcon Technology Partners, LP. Mr. G.
Morgan Browne serves on the Board of Directors of the Company
and is Chief Financial Officer of CSHL. In late 1998,
Charles E. Harris, Chairman and CEO of Harris & Harris Group,
became a trustee of CSHL. On September 29, 2000, Genomica
Corporation (National Market Symbol: GNOM) commenced trading
on Nasdaq. The Company's 731,111 shareholding in Genomica
Corporation before a discount for the six month lock-up which
expires on March 27, 2001 and illiquidity was valued at
$3,861,180. On February 28, 2001 the market price per share
of Genomica Corporation was $5.625.
(8) On October 5, 1999, Silknet Software, Inc. acquired InSite
Marketing Technology, Inc. On April 19, 2000, Kana
Communications, Inc. (National Market Symbol: KANA) and
Silknet Software completed a merger, in which each share of
Silknet Software was exchanged tax free for 1.66 Kana
Communications shares. Upon the completion of the merger, 90
percent of the Kana Communications shares became freely
tradable, and the Company was subject to a lock-up agreement
on the remaining 10 percent of the stock that expired on
December 31, 2000. During 2000, the Company sold 90 percent
of the Kana Communications shares for proceeds of $1,504,762.
On February 28, 2001, the market price per share of Kana
Communications was $3.06.
(9) During January 2001, the Company sold all of the shares of
SciQuest.com, Inc. that it had acquired in the open market
and realized a loss of $1,258,679.
The accompanying notes are an integral part of
this consolidated schedule.
38
(10) On June 29, 2000, Sundial Marketplace Corporation was
acquired in a tax-free merger by Essential.com, Inc.
(11) Previously named iPacer Corporation.
(12) The Company's 672,916 share holding in Nanophase Technologies
Corporation (National Market Symbol: NANX) before a discount
for illiquidity was valued at $7,402,076. On February 28,
2001, the market price per share of Nanophase Technologies
was $7.06.
(13) Previously named MyPersonalAdvocate.com, Inc.
(14) 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.
(15) On February 27, 2001, the Note converted to equity as part
of NeuroMetrix's third round venture financing.
(16) Investments in unaffiliated companies consist of investments
in which the Company owns less than five percent of the
investee 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
investee company. Investments in controlled affiliated
companies consist of investments in which the Company owns
more than 25 percent of the investee company.
(17) Currently the Company owns 100 percent of Harris Newco, Inc.
(18) The aggregate cost for federal income tax purposes of
investments in unaffiliated companies is $7,450,727. The
gross unrealized appreciation based on the tax cost for these
securities is $2,422,882. The gross unrealized depreciation
based on the tax cost for these securities is $2,561,857.
(19) The percentage ownership of each investee company disclosed
in the Consolidated Schedule of Investments expresses the
potential common equity interest in each such investee. 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.
39
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 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.
40
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 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.
41
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.
42
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. 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 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 taxable net
realized capital gains on investments. (See Item 7.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Sub Chapter M Status.")
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.
43
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, 2000 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 net
realized 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,
2000 and 1999, and the reported amounts of revenues and expenses
for the three years ended December 31, 2000. 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.
44
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; Rachel M. Pernia, 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; paid out the 1999 profit sharing in the amount of
$1,138,551, both of which decreased the cumulative accrual under
the Plan to $3,483,241 at December 31, 2000.
The amounts payable under the Plan of approximately
$2,325,071 for the gains realized during the year ended December
31, 2000 will be 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.
45
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 on March 1, 1999, the directors may purchase the
Company's common stock in the market, rather than from the
Company. During 1998 and 1999, the Directors bought directly
from the Company 24,491 and 5,816 shares, respectively.
On April 15, 1998, the Company announced that the Board of
Directors had approved the purchase of up to 700,000 shares of
Company stock in the open market. The Company purchased a total
of 401,878 shares in the open market for a total of $795,529. 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.
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, 2000, the Company had repurchased
a total of 176,600 shares in the open market at approximately
$3.00 per share for a total of $530,051.
Since 1998, as a result of the shares purchased through the
tender offer in 1999, including the shares purchased in 2000 in
the open market, the Company has purchased a total of 1,659,047
shares for a total of $3,158,388, including commissions and
expenses, at an average price of $1.90 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 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.
The net of the total deemed dividend declared ($16,253,987)
and the taxes paid on behalf of shareholders ($5,688,896) is
considered to be reinvested by the shareholders; therefore,
during 2000 additional paid in capital has increased by such
amount ($10,565,091).
46
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 $265,183 as of December
31, 2000. Mr. Harris' rights to benefits pursuant to this SERP
will be no greater than those of a general creditor of the
Company.
47
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. Contributions to the plan are
at the discretion of the Company. During 2000, contributions to
both plans that have been charged to salaries and benefits
totaled approximately $50,000.
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, 2000 the Company had a reserve of $354,840 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
taxable 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.
48
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"). On
February 17, 1999, the Company received a ruling from the IRS
concluding that the Company can carry forward its C Corporation
losses to offset any Built-In Gains resulting from sales of its C
Corporation Assets. That ruling may enable the Company to retain
some or all of the proceeds from such sales without disqualifying
itself as a RIC or incurring corporate level income tax,
depending on whether the Company's sale of C Corporation Assets
with Built-In Gains will generate C Corporation E&P. In general,
a RIC is not permitted to have, as of the close of any RIC
taxable year, E&P accumulated during any C Corporation taxable
year. However, because the realization of Built-In Gains will
occur while the Company is a RIC, the Company believes that,
under current law and IRS pronouncements, the sale of C
Corporation Assets with Built-In Gains during RIC taxable years
will not generate C Corporation E&P. In 1999, the Company
utilized net operating loss and capital loss carryforwards of
approximately $6.3 million in order to retain most of its long-
term capital gain for 1999. The Company had accumulated net
ordinary and capital losses of approximately $7.0 million
(resulting in a potential tax credit of approximately $2.5
million) during its C Corporation taxable years, of which $0.8
million still remains available for use. The Company intends to
use the remaining $0.8 million loss carryforward (resulting in a
potential tax credit of approximately $0.3 million) to reduce its
taxes which are the result of 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.
Accordingly, the Company's financial statements for 2000 include
a tax liability of $5,709,884. The taxes paid by the Company's
shareholders as a result of its deemed dividend declaration
($5,688,896) 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 believes that by
offsetting the realized short-term gain with current year
expenses, it will neither owe federal income taxes on this gain,
nor be required to distribute any portion of this gain to
shareholders.
For the years ended December 31, 2000, 1999 and 1998, the
Company's income tax (benefit) expense was allocated as follows:
2000 1999 1998
Investment operations. . . . $ 0 $ 0 $(234,188)
Realized gain (loss)
on investments . . . . . . 101,435 2,361,044 0
Increase in unrealized
appreciation on
investments. . . . . . . (153,304) (1,627,074) 592,986
--------- ---------- ---------
Total income tax
(benefit) expense. . . . $ (51,869) $ 733,970 $ 358,798
========= ========== =========
49
The above tax (benefit) expense consists of the following:
2000 1999 1998
Current. . . . . . . . . $101,435 $2,361,044 $ 95,430
Deferred -- Federal. . . (153,304) (1,627,074) 263,368
-------- ---------- --------
Total income tax
(benefit) expense. . . $(51,869) $ 733,970 $358,798
======== ========== ========
The Company's net deferred tax liability at December 31,
2000 and 1999 consists of the following:
2000 1999
Unrealized appreciation
on investments. . . . . . . . $1,630,506 $1,783,810
Net operating and capital
loss carryforward. . . . . . (266,036) (266,036)
---------- ----------
Net deferred income tax
Liability. . . . . . . . . . $1,364,470 $1,517,774
========== ==========
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, 2000 was
$178,561. Future minimum lease payments in each of the following
years are: 2001 -- $178,561; 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. SUBSEQUENT EVENTS
During January 2001, the Company sold all of the shares of
SciQuest.com, Inc. that it had acquired in the open market and
realized a loss of $1,258,679.
On January 26, 2001, the Company announced that it had
invested $750,000 in a Series B Convertible Preferred security
for approximately a 10 percent fully diluted equity interest in
Schwoo, Inc. Schwoo is a privately held Pittsburgh-based
corporation. The company is developing software that
automatically manages e-commerce security infrastructure. The
Schwoo system is designed to operate on an integrated basis
across network, host and application layers to defend systems
from security attacks.
On February 28, 2001, the Company noted that it had
converted its NeuroMetrix Note in the amount of $750,000 to
equity as part of NeuroMetrix's $13 million third round venture
financing.
50
SELECTED PER SHARE DATA AND RATIOS
Per share operating performance:
Year Year Year Year Year
Ended Ended Ended Ended Ended
Dec. Dec. Dec. Dec. Dec.
31, 31, 31, 31, 31,
2000 1999 1998 1997 1996
Net asset
value,
beginning
of period . $ 5.80 $ 2.13 $ 3.15 $ 3.44 $ 3.54
Net
operating
income
(loss). . . 0.37 (1.04) (0.26) (0.14) (0.12)
Net realized
gain (loss)
on
investments 2.09 0.93 (0.16) (0.19) (0.24)
Net (decrease)
increase in
unrealized
appreciation
as a result
of sales. . . (2.35) (0.46) 0.11 (0.17) 0.16
Net decrease
(increase) in
unrealized
appreciation
on investments
held. . . . . (1.82) 4.58 0.05 0.26 0.13
Net decrease
as a result
of cash
dividend. . . (0.02) (0.35) (0.75) 0.0 0.0
Net decrease
as a result
of deemed
dividend. . . (0.62) 0.00 0.00 0.00 0.00
Net increase
(decrease)
from capital
stock
transactions. 0.06 0.01 (0.01) (0.05) (0.03)
-------- --------- --------- --------- -------
Net asset
value, end of
period*. . . $ 3.51 $ 5.80 $ 2.13 $ 3.15 $ 3.44
======== ========= ========= ========= ========
Cash
dividends
paid per
share. . . $ 0.02 $ 0.35 $ 0.75 $ 0.00 $ 0.00
Deemed
dividend
per share. $ 1.78 $ 0.00 $ 0.00 $ 0.00 $ 0.00
Market
value per
share, end
of period. $ 2.4375 $ 11.50 $ 1.50 $ 3.50 $ 3.75
Total income
tax liability
per share. $ 0.78 $ 0.16 $ 0.09 $ 0.06 $ 0.21
Ratio of
expenses to
average net
assets. . 6.21% 34.08% 10.9% 9.1% 8.1%
Ratio of
net operating
gain (loss) to
average net
assets. . . 52.7% (3.50)% (10.4)% (4.5)% (3.5)%
Investment return based on:
Stock price. (78.8)% 666.7% (45.5)% (6.7)% (52.4)%
Net asset
Value. . . . (39.5)% 188.7% (8.3)% (8.4)% (2.8)%
Portfolio
Turnover. . 20.56% 53.54% 19.71% 77.2% 51.3%
Net assets,
end of
period. $31,833,475 $53,634,805 $22,556,709 $33,654,934 $35,932,603
Number of
shares
outstanding 9,064,231 9,240,831 10,591,232 10,692,971 10,442,682
*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.
51
Item 9. Disagreements on Accounting and Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Company
The information set forth under the captions "Election of
Directors" on page 2, "Executive Officers" on page 9 and "Section
16(a) Beneficial Ownership Reporting Compliance" on page 15 in
the Company's Proxy Statement for Annual Meeting of Shareholders
to be held April 24, 2001, filed pursuant to Regulation 14A under
the Securities Exchange Act of 1934 on or about March 26, 2001
(the "2001 Proxy Statement") is herein incorporated by reference.
Item 11. Executive Compensation
The information set forth under the captions "Summary
Compensation Table" on pages 9 and 10 and "Compensation of
Directors" on page 14 in the 2001 Proxy Statement is herein
incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
The information set forth under the caption "Security
Ownership of Directors and Executive Officers and other principal
holders of the Company's voting securities" on page 7 in the 2001
Proxy Statement is herein incorporated by reference.
Item 13.Certain Relationships and Related Transactions
There were no relationships or transactions within the
meaning of this item during the year ended December 31, 2000.
52
PART IV
Item 14. Exhibits, Consolidated Financial Statements, Schedules
and Reports on Form 8-K
(a) The following documents are filed as a part of this report:
(1) The following Consolidated Financial Statements of the
Company are set forth under Item 8:
Consolidated Statements of Assets and Liabilities as of
December 31, 2000 and 1999
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2000, 1999 and 1998
Consolidated Schedule of Investments as of December 31, 2000
Footnote to Consolidated Schedule of Investments
Notes to Consolidated Financial Statements
Selected Per Share Data and Ratios for the years ended
December 31, 2000, 1999, 1998, 1997 and 1996
(2) Report of Independent Public Accountant.
(3) The following exhibits are filed with this report or
are incorporated herein by reference to a prior filing, in
accordance with Rule 12b-32 under the Securities Exchange
Act of 1934. (Asterisk denotes exhibits filed with this
report.)
3.1(a) Restated Certificate of Incorporation of the
Company, as amended, incorporated by reference to
Exhibit 3.1 (a) to the Company's Form 10-K for the year
ended December 31, 1995.
3.1(b) Restated By-laws of the Company, incorporated by
reference to Exhibit 3.1(b) to the Company's Form 10-K
for the year ended December 31, 1995 and the Company's
Form 10-Q for the quarter ended September 30, 1998.
4.1 Specimen certificate of common stock certificate,
incorporated by reference to Exhibit 4 to Company's
Registration Statement on Form N-2 filed October 29,
1992.
9.1 Harris & Harris Group, Inc. Custodian Agreement with JP
Morgan, incorporated by reference to Exhibit 9.1 to the
Company's Form 10-K for the year ended December 31,
1995.
10.5 Severance Compensation Agreement by and between the
Company and Charles E. Harris dated August 15, 1990,
incorporated by reference as exhibit 10 (s) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1990.
10.13 Stock Purchase Agreement, Standstill Agreement and
Termination and Release by and among Harris & Harris
Group, Inc. and American Bankers Life Assurance Company
of Florida dated May 18, 1995, incorporated by reference
as Exhibit 10.13 to the Company's Form 10-K for the year
ended December 31, 1995.
53
10.14 Form of Indemnification Agreement which has been
established with all directors and executive officers of
the Company, incorporated by reference as Exhibit 10.14
to the Company's Form 10-K for the year ended December
31, 1995.
10.16 Demand Promissory Note, Corporate Certificate-
Borrowing, Statement of Purpose for an Extension of
Credit Secured by Margin Stock by and among Harris &
Harris Group, Inc. and J.P. Morgan incorporated by
reference as Exhibit 10.16 to the Company's Form 10-K
for the year ended December 31, 1997.
10.17 Harris & Harris Group, Inc. Employee Profit Sharing
Plan, incorporated by reference as Exhibit (c) to the
Company's Form 8-K filed June 15, 1998.
10.18 Employment Agreement Between Harris & Harris Group,
Inc. and Charles E. Harris, dated October 19, 1999,
incorporated by reference as Exhibit (C) to the
Company's Form 8-K filed on October 27, 1999.
10.19 Deferred Compensation Agreement Between Harris & Harris
Group, Inc. and Charles E. Harris, incorporated by
reference as Exhibit 10.19 to the Company's Form 10-K
for the year ended December 31, 1999.
10.20 Trust Under Harris & Harris Group, Inc. Deferred
Compensation Agreement, incorporated by reference as
Exhibit 10.20 to the Company's Form 10-K for the year
ended December 31, 1999.
10.21 Note due January 26, 2001; Form of Warrant to Purchase
25,263 Shares of Harris & Harris Group, Inc. common
stock, incorporated by reference as Exhibit 10.21 to the
Company's Form 10-K for the year ended December 31,
1999.
10.22 Harris & Harris Group, Inc. Employee Profit-Sharing
Plan, incorporated by reference as Exhibit 10.22 to the
Company's Form 10-K for the year ended December 31,
1999.
10.23* Harris & Harris Group, Inc. Directors Stock Purchase
Plan 2001.
11.0* Computation of Per Share Earnings is set forth under
Item 8.
23* Consent of Arthur Andersen LLP.
(b) Reports on Form 8-K. None
*Exhibits attached.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Company has duly caused this
report to be signed on its behalf by the undersigned, thereunto
duly authorized.
HARRIS & HARRIS GROUP, INC.
By:/s/ Charles E. Harris
------------------------
Date: March 20, 2001 Charles E. Harris
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the Company and in the capacities and on the
dates indicated.
Signatures Title Date
/s/ Charles E. Harris Chairman of the March 20, 2001
- --------------------- Board and Chief
Charles E. Harris Executive Officer
/s/ Mel P. Melsheimer President, Chief March 20, 2001
- --------------------- Operating Officer,
Mel P. Melsheimer Chief Financial Officer
and Chief Compliance Officer
/s/ Rachel M. Pernia Vice President, March 20, 2001
- --------------------- Controller, Treasurer
Rachel M. Pernia and Principal
Accounting Officer
/s/ C. Wayne Bardin Director March 19, 2001
- --------------------
C. Wayne Bardin
/s/ Phillip A. Bauman Director March 17,2001
- ---------------------
Phillip A. Bauman
55
/s/ G. Morgan Browne Director March 16, 2001
- --------------------
G. Morgan Browne
/s/ Harry E. Ekblom Director March 17, 2001
- -------------------
Harry E. Ekblom
/s/ Dugald A. Fletcher Director March 17, 2001
- ----------------------
Dugald A. Fletcher
/s/ Glenn E. Mayer Director March 15, 2001
- -------------------
Glenn E. Mayer
/s/ James E. Roberts Director March 21, 2001
- --------------------
James E. Roberts
56
EXHIBIT INDEX
The following exhibits are filed with this report in
accordance with Rule 12b-32 under the Securities Exchange Act of
1934.
Exhibit No. Description
10.23 Harris & Harris Group, Inc. Directors Stock Purchase Plan
2001
11.0 Computation of Per Share Earnings is set forth under Item
8.
23 Consent of Arthur Andersen LLP.
57