UNITED STATES
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, 2002 Commission File No. 0-11576
HARRIS & HARRIS GROUP, INC.
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(Exact Name of Registrant Specified in Its Charter)
New York 13-3119827
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Rockefeller Plaza, Rockefeller Center, New York, New York 10020
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 332-3600
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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
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(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 ]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2)
Yes [ ] No [ X ]
The aggregate market value of the common stock held by non-
affiliates of Registrant as of June 28, 2002 was $22,643,078 based
on the last sale price as quoted by the Nasdaq National Market on
such date (only officers and directors are considered affiliates
for this calculation).
As of March 17, 2003 the registrant had 11,498,845 shares of
common stock, par value $.01 per share, outstanding.
TABLE OF CONTENTS
Page
PART I
Item 1. Business..................................... 1
Item 2. Properties................................... 22
Item 3. Legal Proceedings............................ 22
Item 4. Submission of Matters to a Vote of
Security Holders............................. 22
PART II
Item 5. Market for Company's Common Equity and
Related Stockholder Matters.................. 24
Item 6. Selected Financial Data...................... 26
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 27
Item 7a. Quantitative and Qualitative Disclosures
About Market Risk............................ 37
Item 8. Consolidated Financial Statements
and Supplementary Data....................... 38
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure................................... 61
PART III
Item 10. Directors and Executive Officers of the
Company...................................... 62
Item 11. Executive Compensation....................... 62
Item 12. Security Ownership of Certain Beneficial
Owners and Management........................ 62
Item 13. Certain Relationships and Related
Transactions................................. 62
Item 14. Controls and Procedures...................... 62
PART IV
Item 15. Exhibits, Consolidated Financial Statement,
Schedules and Reports on Form 8-K............ 63
Signatures............................................. 65
Exhibit Index.......................................... 69
PART I
Item 1. Business
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 (the "1940
Act"). The Company's investment 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 privately held start-up companies and in the development
of new technologies in a broad range of industry segments. These
privately held businesses generally tend to be thinly capitalized,
unproven, small companies based on risky technologies that lack
management depth and have as yet not attained profitability or have
no history of operations. In early 2002, the Company decided to
focus its new business activities on tiny technology, including but
not limited to nanotechnology, microsystems and
microelectromechanical systems (MEMS) technology. As a venture
capital company, the Company invests in and provides managerial
assistance to its portfolio companies which, in its opinion, have
significant potential for growth. The Company is managed by its
Board of Directors and officers and has no investment advisor.
The Company's website is www.TinyTechVC.com. The Company
makes available free of charge through the Company's website: the
Company's annual report on Form 10-K; the Company's quarterly
reports on Form 10-Q; the Company's current reports on Form 8-K;
and amendments to those reports as soon as reasonably practicable
after filing or furnishing such materials to the Securities and
Exchange Commission.
The Company intends to make its initial private equity
investments in tiny-technology companies. For this purpose, tiny-
technology companies are companies involved in nanotechnology,
microsystems or microelectromechanical systems (MEMS). Although
the Company intends to invest exclusively in companies involved
significantly in tiny technologies, it may also make follow-on
investments in existing portfolio companies involved in other
technologies. This investment policy is not a fundamental policy
and accordingly may be changed without shareholder approval,
although the Company intends to give shareholders at least 60 days
prior notice of any change in its policy.
Neither the Company's investments, nor an investment
in the Company, is intended to constitute a balanced investment
program. The Company expects to be risk seeking rather than risk
averse in its investment approach. To such end, the Company
reserves the fullest possible freedom of action, subject to its
certificate of incorporation, applicable law and regulations, and
policy statements contained herein. There is no assurance that the
Company's investment objective will be achieved.
The Company expects to invest a substantial or major 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.
1
The Company expects to make speculative investments
with limited marketability and a greater risk of investment loss
than less speculative issues. Although the Company recently
decided to focus its new investments in tiny technology, such
technology is enabling technology applicable to a wide range of
fields and businesses, and the Company does not seek to invest in
any particular industries or categories of investments. The
Company's securities investments may consist of private, public or
governmental issuers of any type. Subject to the diversification
requirements pertaining to a regulated investment company ("RIC"),
the Company may commit all of its assets to only a few investments.
Achievement of the Company's investment objectives is
basically dependent upon the judgment of the Company's management.
Charles E. Harris, Chairman and Chief Executive Officer of the
Company, and a "control" person as defined in the 1940 Act, is
primarily responsible, and Mel P. Melsheimer, President and Chief
Operating Officer, is secondarily responsible, for making or
supervising all investment decisions of the Company under the
direction of the Company's Board of Directors. Douglas W. Jamison,
Vice President, who joined the Company in September 2002, is
rapidly becoming involved in the Company's investment process.
There can be no assurance that a suitable replacement could be
found for Mr. Harris in the event of his death, resignation,
retirement or inability to act on behalf of the Company.
Subject to continuing to meet the tests for being a BDC, there
are no limitations on the types of securities or other assets in
which the Company may invest. Investments may include the
following:
o Equity, equity-related securities (including warrants) and
debt with equity features from either private or public
issuers.
o Venture capital investments, whether in corporate,
partnership or other form, including development stage or
start-up entities.
o Intellectual property or patents or research and development
in technology or product development that may lead to
patents or other marketable technology.
o Debt obligations of all types having varying terms with
respect to security or credit support, subordination,
purchase price, interest payments and maturity.
o Foreign securities.
o Miscellaneous investments.
The following is a brief description of the types of assets
which the Company may invest in, the investment strategies the
Company may utilize and the attendant risks associated with its
investments and strategies:
2
Equity, Equity-Related Securities and Debt with Equity Features
The Company may invest in equity, equity-related
securities and debt with equity features ("Equity Securities").
Equity Securities include common stock, preferred stock, debt
instruments convertible into common or preferred stock, limited
partnership interests, other beneficial ownership interests, and
warrants, options or other rights to acquire any of the foregoing.
Investments may be made in companies with operating
histories that are unprofitable or marginally profitable, that have
negative net worth or that are involved in bankruptcy or
reorganization proceedings. Such investments would involve
businesses that management believes have turnaround potential
through the infusion of additional capital and management
assistance. In addition, the Company may make investments in
connection with the acquisition or divestiture of companies or
divisions of companies. There is a significantly greater risk of
loss with these types of securities than is the case with
traditional investment securities.
The Company may also invest in publicly-traded
securities of whatever nature,including relatively small, emerging
growth companies that management believes have long-term growth
possibilities.
Warrants, options and convertible or exchangeable
securities generally give the investor the right to acquire
specified Equity Securities of an issuer at a specified price
during a specified period or on a specified date. Warrants and
options fluctuate in value in relation to the value of the
underlying security and the remaining life of the warrant or
option, while convertible or exchangeable securities fluctuate in
value both in relation to the intrinsic value of the security
without the conversion or exchange feature and in relation to the
value of the conversion or exchange feature, which is like a
warrant or option. When the Company invests in these securities,
it incurs the risk that the option feature will expire worthless,
thereby either eliminating or diminishing the value of the
Company's investment.
Investments in Equity Securities of private companies
involve securities that are restricted as to sale and cannot be
sold in the open market without registration under the Securities
Act of 1933 or pursuant to a specific exemption from such
registration, and therefore the opportunities for sale are more
limited than in the case of marketable securities, although such
investments may be purchased at more advantageous prices and may
offer attractive investment opportunities. Even if the private
company completed an initial public offering, the Company is
typically subject to a lock-up agreement, and the stock price may
decline substantially before the Company is free to sell. Even if
the Company has registration rights to make its investments more
marketable, a considerable amount of time may elapse between a
decision to sell or register such securities for sale and the time
when the Company is able to sell such securities, hence the prices
obtainable upon sale may be adversely affected by market conditions
or negative conditions affecting the issuer during the intervening
time.
3
Venture Capital Investments
The Company expects to invest in development stage or
start-up businesses. These businesses tend to be undercapitalized,
unproven small companies that lack management depth and have not
attained profitability or have no history of operations. Tiny-
technology companies have science and engineering risks in addition
to commercialization risk. Because of the speculative nature of
these investments by the Company and the lack of any market for the
securities purchased by the Company, 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 that potential.
The Company may own 100 percent of the securities of a
start-up investment for a period of time and may control such
company for a substantial period. Start-up companies are more
vulnerable than better capitalized companies to adverse business or
economic developments. Start-up businesses generally have limited
product lines, service niches, markets and/or financial resources.
Start-up companies are not well-known to the investing public and
are subject to potential bankruptcy, general movements in markets,
and perceptions of potential growth.
In connection with the Company's venture capital
investments, it may be involved in recruiting management,
formulating operating strategies, product development, marketing
and advertising, assistance in financial plans, as well as
providing other management services 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 also find it necessary or appropriate to
provide additional capital of its own. 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 not derive income from such companies for the performance of
any of the above services.
The Company may control or be represented on the board
of directors of a company for which it has provided venture capital
by one or more of its officers or directors, who may also serve as
officers of such a company. The Company indemnifies its officers
and directors for serving on the boards of directors or as officers
of investee companies, which exposes the Company to additional
risks. Particularly during the early stages of an investment, the
Company may in effect be conducting the operations of the 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's
goal is to assist each company in establishing its own independent
capitalization, management and board of directors. The Company
expects to be able to reduce its interest in those start-up
companies which become successful.
4
Following an initial investment in portfolio
companies, the Company may make additional investments in such
portfolio companies as "follow-on" investments, in order to: (1)
increase or maintain in whole or in part its ownership percentage;
(2) exercise warrants, options or convertible securities that were
acquired in the original or subsequent financing; (3) preserve its
proportionate ownership in a subsequent financing; or (4) attempt
to preserve or enhance the value of its investment. Recently, "pay
to play" provisions have become common in venture capital
transactions; such provisions require proportionate investment in
subsequent rounds of financing in order to preserve certain
preferred rights such as anti-dilution protection or to prevent
preferred shares from being converted to common shares.
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 a portfolio 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, or may cause the Company
to lose certain or all preferred rights pursuant to "pay to play"
provisions. Even if the Company has sufficient capital to make a
desired follow-on investment, it may elect not to make a follow-on
investment because it may not want to increase its concentration of
risk, because it prefers other opportunities or because it is
inhibited by compliance with BDC or regulated investment company
requirements.
Intellectual Property
The Company believes there is a role for organizations
that can assist in technology transfer. Scientists and
institutions that develop and patent intellectual property perceive
the need for and rewards of entrepreneurial commercialization of
their inventions. The Company believes that its experience in
organizing and developing new companies; its willingness to invest
its own capital at the highest-risk seeding stage; its access to
high-grade institutional sources of intellectual property; its
knowledge of the capital markets; its experience with business
incubators; and its willingness, on a selective basis, to do as
much of the early work as it is qualified to do, combine to give it
a value-added role to play in the commercialization of technology.
The Company's form of investment may be: l) funding of
research and development in the development of a technology; 2)
obtaining licensing rights to intellectual property or patents; 3)
outright acquisition of intellectual property or patents; and 4)
formation and funding of companies or joint ventures to further
commercialize intellectual property. Income from its investments
in intellectual property or its development may take the form of
participation in licensing or royalty income, fee income, or some
other form of remuneration. Investment in developmental
intellectual property rights involves a high degree of risk that
can result in loss of the Company's entire investment as well as
additional risks including uncertainties as to the valuation of an
investment and potential difficulty in liquidating an investment.
Further, investments in intellectual property generally require
investor patience as investment return may be realized only after
5
or over a long period. 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 under "Venture Capital Investments" above. Investment
in intellectual property is highly risky.
Debt Obligations
The Company may hold debt securities for income and as
a reserve pending more speculative investments. Debt obligations
may include commercial paper, bankers' acceptances, receivables or
other asset-based financing, notes, bonds, debentures, or other
debt obligations of any nature and repurchase agreements related to
such securities. These obligations may have varying terms with
respect to security or credit support, subordination, purchase
price, interest payments and maturity from private, public or
governmental issuers of any type located anywhere in the world.
The Company may invest in debt obligations of companies with
operating histories that are unprofitable or marginally profitable;
that have negative net worth or that are involved in bankruptcy or
reorganization proceedings; or that are start-up or development
stage entities. In addition, the Company may participate in the
acquisition or divestiture of companies or divisions of companies
through issuance or receipt of debt obligations.
It is likely that the Company's investments in debt
obligations will be of varying quality, including non-rated, highly
speculative debt investments with limited marketability.
Investments in lower-rated and non-rated securities, commonly
referred to as "junk bonds," are subject to special risks,
including a greater risk of loss of principal and non-payment of
interest. Generally, lower-rated securities offer a higher return
potential than higher-rated securities but involve greater
volatility of price and greater risk of loss of income and
principal, including the possibility of default or bankruptcy of
the issuers of such securities. Lower-rated securities and
comparable non-rated securities will likely have large
uncertainties or major risk exposure to adverse conditions and are
predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of
the obligation. The occurrence of adverse conditions and
uncertainties to issuers of lower-rated securities would likely
reduce the value of lower-rated securities held by the Company,
with a commensurate effect on the value of its shares.
The markets in which lower-rated securities or
comparable non-rated securities are traded generally are more
limited than those in which higher-rated securities are traded.
The existence of limited markets for these securities may restrict
the Company's ability to obtain accurate market quotations for the
purposes of valuing lower-rated or non-rated securities and
calculating net asset value or to sell securities at their fair
value. The public market for lower-rated securities and comparable
non-rated securities is relatively new and has not fully weathered
a major economic recession. Any such economic downturn could
adversely affect the ability of issuers of lower-rated securities
to repay principal and pay interest thereon. The market values of
certain lower-rated and non-rated securities also tend to be more
sensitive to individual corporate developments and changes in
economic conditions than higher-rated securities. In addition,
lower-rated securities and comparable non-rated securities
6
generally present a higher degree of credit risk. Issuers of
lower-rated securities and comparable non-rated securities are
often highly leveraged and may not have more traditional methods of
financing available to them so that their ability to service their
debt obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of loss
due to default by such issuers is significantly greater because
lower-rated securities and comparable non-rated securities
generally are unsecured and frequently are subordinated to the
prior payment of senior indebtedness. The Company may incur
additional expenses to the extent that it is required to seek
recovery upon a default in the payment of principal or interest on
its portfolio holdings.
The market value of investments in debt securities
that carry no equity participation usually reflects yields
generally available on securities of similar quality and type at
the time purchased. When interest rates decline, the market value
of a debt portfolio already invested at higher yields can be
expected to rise if such securities are protected against early
call. Similarly, when interest rates increase, the market value of
a debt portfolio already invested at lower yields can be expected
to decline. Deterioration in credit quality also generally causes a
decline in market value of the security, while an improvement in
credit quality generally leads to increased value.
Foreign Securities
The Company may make investments in securities of
issuers whose principal operations are conducted outside the United
States, and whose earnings and securities are stated in foreign
currency.
Compared to otherwise comparable investments in
securities of U.S. issuers, currency exchange risk of securities of
foreign issuers is a significant variable. The value of such
investments to the Company will vary with the relation of the
currency in which they are denominated to the U.S. dollar, as well
as with intrinsic elements of value such as credit risk, interest
rates and performance of the issuer. Investments in foreign
securities also involve risks relating to economic and political
developments, including nationalization, expropriation, currency
exchange freezes and local recession. Securities of many foreign
issuers are less liquid and more volatile than those of comparable
U.S. issuers. Interest and dividend income and capital gains on
the Company's foreign securities may be subject to withholding and
other taxes that may not be recoverable by the Company. The
Company may seek to hedge all or part of the currency risk of its
investments in foreign securities through the use of futures,
options and forward currency purchases or sales.
In pursuit of the Company's investment strategy, it
may employ one or more of the following strategies in order to
enhance investment results.
7
Borrowing And Margin Transactions
The Company may from time to time borrow money or obtain
credit by any lawful means from banks, lending institutions, other
entities or individuals, in negotiated transactions; and may issue,
publicly or privately, bonds, debentures or notes, in series or
otherwise, with such interest rates and other terms and provisions,
including conversion rights, on a secured or unsecured basis, for
any purpose of the Company, up to the maximum amounts and
percentages permitted for business development companies under
Sections 18 and 61 of the 1940 Act, or any successor statute or
law, as the same may be amended from time to time, or as amplified
or modified by rules adopted thereunder. The 1940 Act currently
prohibits the Company from borrowing any money or issuing any other
senior securities (other than preferred stock and other than
temporary borrowings of up to five percent of its assets), if
giving effect to such borrowing or issuance, the value of its total
assets would be less than 200 percent of the total liabilities of
the Company (other than liabilities not constituting senior
securities). The Company may pledge assets to secure any such
borrowings.
A primary purpose of the Company's borrowing power is
for leverage, to increase its ability to acquire investments.
Borrowings for leverage accentuate any increase or decrease in the
market value of its investments and thus its net asset value.
Since any decline in the net asset value of its investments will be
borne first by holders of common stock, the effect of leverage in a
declining market would be a greater decrease in net asset value
applicable to the common stock than if the Company were not
leveraged. Any such decrease would likely be reflected in a
decline in the market price of the common stock. To the extent the
income derived from assets acquired with borrowed funds exceeds the
interest and other expenses associated with such borrowing, the
Company's total income will be greater than if borrowings were not
used. Conversely, if the income from such assets is not sufficient
to cover the borrowing costs, the Company's total income will be
less than if borrowings were not used. If the Company's current
income is not sufficient to meet its borrowing costs (repayment of
principal and interest), it might have to liquidate certain of its
investments when it may be disadvantageous to do so. Borrowings by
the Company for the purpose of buying liquid equity securities will
be subject to the margin rules, which require excess liquid
collateral marked to market daily. If the Company is unable to
post sufficient collateral, the Company would be required to sell
securities to remain in compliance with the margin rules. Any such
sales might be at disadvantageous times or prices.
Portfolio Company Turnover
Changes with respect to portfolio companies will be
made as management considers necessary in seeking to achieve its
investment objective. The rate of portfolio turnover will not be
treated as a limiting or relevant factor when circumstances exist
which are considered by management to make portfolio changes
advisable.
Although the Company expects that many of its
investments will be relatively long-term in nature, changes in
particular portfolio holdings may be made whenever it is considered
8
that an investment no longer has substantial growth potential or
has reached its anticipated level of performance, or (especially
when cash is not otherwise available) that another investment
appears to have a relatively greater opportunity for capital
appreciation. General portfolio changes may also be made to
increase the Company's cash to position it in a defensive posture.
Portfolio changes will be made without regard to the length of
time an investment has been held, or whether a sale results in
profit or loss, or a purchase results in the reacquisition of an
investment which the Company may have only recently sold.
If management's evaluation of particular investments
or general conditions changes frequently, portfolio changes may be
expected to occur rapidly and with great frequency. The portfolio
turnover rate may vary greatly from year to year as well as during
a year and may also be affected by cash requirements.
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 financial and other
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.
Regulation
The Small Business Investment Incentive Act of 1980 added the
provisions of the 1940 Act applicable to BDCs, 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 BDCs, 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 making
significant managerial assistance available 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 Securities Exchange Act of
1934; (iii) operate for the purpose of investing in the securities
of certain types of portfolio companies, namely, early stage 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; and
(v) file a proper notice of election with the SEC.
9
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 portfolio company).
The Company will be periodically examined by the SEC for
compliance with the 1940 Act.
As with other companies regulated by the 1940 Act, a business
development company must adhere to certain substantive regulatory
requirements. A majority of the directors must be persons who are
not interested persons, as that terms is defined in the 1940 Act.
Additionally, the Company is required to provide and maintain a
bond issued by a reputable fidelity insurance company to protect
the business development company. Furthermore, as a business
development company, the Company is prohibited from protecting any
director or officer against any liability to the Company or the
Company's shareholders arising from willful malfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in
the conduct of such person's office.
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 portfolio companies 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). Under specific conditions, the Company
is also permitted by the 1940 Act to issue warrants.
Except under certain conditions, 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
10
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
its portfolio companies.
Sub-Chapter M Status
The Company has elected to be treated as a Regulated
Investment Company (a "RIC"), taxable under Sub-Chapter M of the
Internal Revenue Code (the "Code"), for federal income tax
purposes . In general, a RIC is not taxable on its income or gains
to the extent it distributes such income or gains to its
shareholders. 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 and similar sources (the "Income Source Rule"); (2)
quarterly meet certain investment asset diversification
requirements; and (3) annually distribute at least 90 percent of
its investment company taxable income as a dividend (the "Income
Distribution Rule"). Any taxable investment company income not
distributed will be subject to corporate level tax. Any taxable
investment company income distributed generally will be taxable to
shareholders as dividend income.
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 realized
net capital gains from investments, but any net capital gains not
distributed may be subject to corporate level tax. Any net capital
gains distributed generally will be taxable to shareholders as
long-term capital gains.
If necessary for liquidity purposes or to fund investment
opportunities, in lieu of actually distributing its realized 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 its shareholders under the "designated
undistributed capital gain" rules of the Code. In that case, the
"deemed dividend" generally will be taxable to the shareholders as
long-term capital gains, 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
11
by the shareholder to offset other taxes due in that year or to
generate a tax refund to the shareholder. (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.")
The following simplified examples illustrate the tax treatment
under Sub-Chapter M of the Code for the Company and its individual
shareholders with regard to three possible distribution
alternatives, assuming a net 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 cash 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.
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.
Although the Company may retain income and gains subject to
the limitations described above (including paying corporate level
tax on such amounts), the Company could be subject to an additional
four percent excise tax if it fails to distribute 98 percent of its
aggregate annual taxable income.
12
As noted above, in order to qualify as a RIC, the Company
quarterly must meet certain investment asset diversification
requirements. Because of the specialized nature of its investment
portfolio, the Company has been able to satisfy the diversification
requirements under Sub-Chapter M of the Code only as a result of
its receipt of certifications from the SEC under the Code with
respect to each taxable year beginning after 1998 that it was
"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" for such
year.
Although the Company received SEC certifications for 1999-
2001, there can be no assurance that the Company will receive such
certification for 2002 or subsequent years (to the extent it needs
additional certifications as a result of changes in its portfolio).
If the Company requires, but fails to obtain, the SEC
certification for a taxable year, the Company will fail to qualify
as a RIC for such year. The Company will also fail to qualify as a
RIC for a taxable year if it does not satisfy the Income Source
Rule or Income Distribution Rule for such year. In the event the
Company does not qualify as a RIC for any taxable year, it will be
subject to federal tax with respect to all of its taxable income,
whether or not distributed. In addition, all distributions from
the Company in that situation generally will be taxable as ordinary
dividends.
Although the Company generally intends to qualify as a RIC for
each taxable year, under certain circumstances the Company may
choose to take action with respect to one or more taxable years to
ensure that it would be taxed under Sub-Chapter C of the Code
(rather than Sub-Chapter M) for such year or years. The Company
will take such action only if it determines that the result of the
action will benefit the Company and its shareholders.
Prior to 1999, the Company was taxable under Sub-Chapter C of
the Code (a "C Corporation"). Under the Code, a C Corporation
that elects to be treated as a RIC for federal tax purposes is
taxable on the effective date of the election to the extent of any
gain built into its assets ("C Corporation Assets") on such date
("Built-In Gain"). However, a C Corporation may elect
alternatively to be taxable on such Built-In Gain as such gain is
realized during the 10-year period beginning on the effective date
of its RIC election (the "Inclusion Period"). The Company had
Built-In Gains at the time of its qualification as a RIC and
elected to be taxed on any Built-In Gain realized during the
Inclusion Period. Prior to 1999, the Company incurred ordinary and
capital losses from its operations. After the Company's election
of RIC status, those losses remained available to be carried
forward to subsequent taxable years. Recently issued Internal
Revenue Service regulations confirm that such losses may be used to
offset realized Built-In Gains and, to the extent so used, to
eliminate C Corporation taxation of such gains. The Company has
previously used loss carryforwards to offset Built-In Gains. As of
January 1, 2003, the Company had $501,640 of loss carryforwards
remaining and $4,663,457 of unrealized Built-In Gains.
13
Subsidiaries
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100
percent wholly owned subsidiary of the Company and is consolidated
in the Company's financial statements. Enterprises holds the lease
for the Company's 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, until December 31, 2002, owned a 20 percent
limited partnership interest in PHZ Capital Partners L.P., which
organizes and manages investment partnerships. The partners of
Harris Partners I, L.P. are Harris & Harris Enterprises, Inc. (sole
general partner) and Harris & Harris Group, Inc. (sole limited
partner).
Employees
The Company currently employs directly five full-time
employees, and Enterprises employs one additional full-time and one
part-time employee.
Risk Factors
Investing in the Company involves a number of significant risks
relating to the Company's business and investment objectives. In
addition to the risks set forth below, other risks that could
impact the Company's business and investment objectives include:
o the ongoing global economic downturn, coupled with the
war in Iraq;
o risks associated with the possible disruption of the
Company's operations due to terrorism; and
o other risks and uncertainties as may be detailed from time
to time in the Company public announcements or SEC
filings.
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
of common stock. The securities markets frequently experience
extreme price and volume fluctuations which affect market prices
for securities of companies generally and technology and very small
capitalization companies in particular. Because of the Company's
focus on the technology and very small capitalization sectors and
because it is a small capitalization company, its stock price is
especially likely to be affected by these market conditions.
General economic conditions, and general conditions in the life
sciences, nanotechnology, tiny technology, material sciences,
Internet and information technology and other high technology
industries, will also affect the Company's stock price. During the
first quarter of 2002, the Company decided to make its initial
equity investments in tiny-technology companies, including
14
nanotechnology, microsystems and microelectromechanical systems
(MEMS). Tiny technology investments are new and especially risky,
involving science and technology risks as well as commercialization
risks.
Investing in the Company's common stock may be inappropriate for
the investor's risk tolerance.
The Company's investments, in accordance with its investment
objective and principal strategies, result in a far above average
amount of risk and volatility and may well result in 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 investors for whom such risk is
inappropriate.
The Company operates in a highly competitive environment.
The market for venture capital investments, including tiny
technology investments, is highly competitive. In addition to
finding attractive investment opportunities, in some cases, the
Company's status as a regulated business development company may
hinder its ability to participate in investment opportunities or to
protect the value of existing investments because of "pay to play"
provisions or other coercive provisions which have become more
common in venture capital investing since the general stock market
decline began in 2000, in which preferred protections such as
dilution protection may be forfeited or preferred stock may be
converted to common stock by failure to invest in subsequent rounds
of financing.
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 result, the sources of funding are
many, but attractive investment opportunities are too few. Hence,
the Company faces substantial competition in sourcing good
investment opportunities on terms of investment that are
commercially attractive. Further, 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 such disclosure requirements. The Company's
obligation to disclose such 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. Also, compliance with certain regulations applicable
to the Company's business may prevent or discourage the Company
from making follow-on investments that would be in the Company's
and its investors' best interest.
15
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
and regulations may change with unpredictable consequences. Any
change in the laws or regulations that govern the Company's
business could have an adverse impact on the Company or its
operations. Also, as business and financial practices continue to
evolve, they may render the regulations under which the Company
operates less appropriate and more burdensome than they were when
originally imposed.
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
Company utilizes outside consultants, including two of its
directors, Dr. Kelly S. Kirkpatrick and Lori D. Pressman, and
lawyers to assist the Company in conducting due diligence when
evaluating potential investments. The future success of the
Company depends to a significant extent on the continued service
and coordination of its senior management team, particularly
Charles E. Harris, the Company's 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
for its benefit any key man life insurance on any of its officers
or employees.
Investing in small, private companies involves a high degree of
risk and is highly speculative.
There are significant risks inherent in the Company's venture
capital business. The Company has invested a substantial portion
of its assets in privately held development stage or start-up
companies. These privately held 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. Tiny technology companies in
particular are unproven, with significant science and technology
risks as well as commercialization risks. The Company has in the
past relied, and continues to rely, upon proceeds from sales of
investments rather than investment income to defray a significant
portion of its operating expenses. Such sales are unpredictable
and may not occur.
16
The Company invests in securities that are illiquid and may not be
able to dispose of such securities when it is advantageous to do
so.
Most of the investments of the Company are or will be equity
securities acquired directly from small companies. The Company
makes many of its portfolio investments with the view of holding
them for a number of years. 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.
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, rapidly changing and especially
sensitive to adverse general economic conditions. Commercial
success is difficult to predict and the marketing efforts of the
Company's portfolio companies may not be successful.
Because there is generally no established market in which to value
the Company's investments, the Company's Investment and Valuation
Committee's determination of their values may differ materially
from the values that a ready market or third party would attribute
to these investments.
There is typically no public market for equity securities of
the small privately held companies in which the Company invests.
As a result, the valuation of most of the equity securities in the
Company's portfolio is subject to the good faith determination of
the Company's Investment and Valuation Committee within the
guidelines established by the 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 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. The Company adjusts quarterly the valuation of
its portfolio to reflect the Investment and Valuation Committee's
determination of the current fair value of each investment in its
portfolio. Any changes in estimated fair 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.")
17
Quarterly results may fluctuate and are not indicative of future
quarterly performance.
The Company's quarterly operating results could fluctuate as a
result of a number of factors. These factors include, among
others, variations in and the timing of the recognition of realized
and unrealized gains or losses, the degree to which the Company and
its portfolio companies encounter competition in their markets and
general economic and market 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.")
Loss of pass-through tax treatment would substantially reduce net
assets and income available for dividends.
The Company currently qualifies as a RIC under the Code for
effective pass-through tax treatment because, among other factors,
it meets certain diversification and distribution requirements
under the Code. The Company would cease to qualify for pass-
through tax treatment if it were unable to comply with these
requirements. 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 gain or income distributions. (See "Sub-
Chapter M Status" contained in Item 1. "Business.") The lack of
pass-through 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
would become subject to federal income tax as if it were an
ordinary C Corporation, which tax would result in a corresponding
reduction in the Company's net assets and the amount of income
available for distribution to the Company's stockholders. Loss of
RIC status could have an adverse effect on the price of the
Company's common stock.
During some periods, there are few opportunities to take early
stage companies public or sell them to established companies.
During some periods, there may be few opportunities to gain
liquidity or realize a gain on an otherwise successful investment,
as the market for initial public offerings may be moribund,
particularly for early stage, high technology companies. During
such periods or other periods, it may also be difficult to sell
such companies to established companies. The lack of exit
strategies during such periods also tends to have an adverse effect
on the ability of private equity companies to raise capital
privately. Thus, the Company's business and the Company's common
stock are unusually vulnerable to adverse economic and capital
markets conditions.
18
Because the Company must distribute income, the Company will
continue to need additional capital to fund its investments and
operating expenses.
The Company will continue to need capital to fund investments
and to pay for operating expenses. As a RIC, the Company annually
must distribute at least 90 percent of its investment company
taxable income as a dividend and may either distribute or retain
its realized net capital gains from investments. As a result, such
earnings may 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 as well as its
ability to make follow-on and new investments. The Company is not
permitted to establish reserves for taxes on unrealized capital
gains. 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.
Loss of status as a RIC could reduce the Company's net asset value
by forcing it to establish currently unestablished reserves for
taxes.
As a RIC, the Company generally does not pay federal income
taxes on its income that is distributed to its shareholders. It is
not permitted to establish reserves for taxes on its unrealized
capital gains. If the Company failed to qualify for RIC status, to
the extent that it had unrealized capital gains, it would have to
establish such reserves for taxes, which would reduce its net asset
value accordingly, net of a reduction in any reserve for employee
profit sharing. When the Company, as a RIC, decides to make a
deemed distribution of net realized capital gains and to retain
such net realized capital gains, it has to establish appropriate
reserves for taxes upon making such a decision and subsequently pay
such taxes.
Leveraging by the Company could result in making the Company's
total return to common shareholders more volatile.
Leverage entails two primary risks. The first risk is that
the use of leverage magnifies the impact on the common shareholders
of changes in net asset value. For example, a fund that uses 33%
leverage (that is, $50 of leverage per $100 of common equity) will
show a 1.5% increase or decline in net asset value for each 1%
increase or decline in the value of its total assets. The second
risk is that the cost of leverage will exceed the return on the
securities acquired with the proceeds of leverage, thereby
diminishing rather than enhancing the return to common
shareholders. If the Company were to utilize leverage, these two
risks would generally make its total return to common shareholders
more volatile. In addition, the Company might be required to sell
investments in order to meet dividend or interest payments on the
debt or preferred stock when it might be disadvantageous to do so.
As provided in the 1940 Act and subject to certain exceptions,
the Company can issue debt or preferred stock so long as its total
assets immediately after such issuance, less certain ordinary
course liabilities, exceed 200% of the amount of the debt
19
outstanding and exceed 200% of the sum of the amount of the
preferred stock and debt outstanding. Such debt or preferred stock
may be convertible in accordance with SEC guidelines which may
permit the Company to obtain leverage at attractive rates. A
leveraged capital structure creates certain special risks and
potential benefits not associated with unleveraged funds having
similar investment objectives and policies. Any investment income
or gains from the capital represented by preferred shares or debt
which is in excess of the dividends payable thereon will cause the
total return of the common shares to be higher than would otherwise
be the case. Conversely, if the investment performance of the
capital represented by preferred shares or debt fails to cover the
dividends payable thereon, the total return of the common shares
would be less or, in the case of negative returns, would result in
higher negative returns to a greater extent than would otherwise be
the case. The requirement under the 1940 Act to pay in full
dividends on preferred shares or interest on debt before any
dividends may be paid on the common shares means that dividends on
the common shares from earnings may be reduced or eliminated.
Although an inability to pay dividends on the common shares could
conceivably result in the Company ceasing to qualify as a RIC under
the Code, which would be materially adverse to the holders of the
common shares, such inability could be avoided through the use of
mandatory redemption requirements designed to ensure that the
Company maintains the necessary asset coverage.
Unfavorable economic and capital markets conditions could result in
financial losses for the Company as well as impair its ability to
engage in liquidity events.
Most of the companies in which the Company has made or will
make investments are susceptible to economic slowdowns or
recessions. An economic slowdown, capital markets conditions or
credit squeeze may affect the ability of a company to raise
additional capital from venture capital or other private equity
sources or to engage in a liquidity event such as an initial public
offering or merger. These conditions greatly increase the
probability of financial losses in the Company's portfolio.
Unfavorable economic and capital markets conditions also tend to
increase the Company's cost of capital and restrict the Company's
access to capital.
The Company's business of making private equity investments
and positioning them for liquidity events also may be adversely
affected by current and future market and economic conditions.
Significant changes in the public equity markets could have an
effect on the valuations of privately held companies and on the
potential for liquidity events involving such companies, and such
changes could adversely affect the amount and timing of gains that
may be realized on the Company's investments.
The Company invests in privately held companies that may complete
initial public offerings. These types of companies can be highly
volatile and have uncertain liquidity.
When companies in which the Company has invested as private
entities complete initial public offerings, they are by definition
unseasoned issues. Typically, they have relatively small
capitalizations. Thus, they can be expected to be highly volatile
and of uncertain liquidity. If they are perceived as suffering
from adverse news or developments and/or the capital markets are in
20
a negative phase, not only their market prices, but also their
liquidity can be expected to be affected negatively. Historically,
the Company has also invested in unseasoned publicly traded
companies with similar characteristics and thus with similar
exposure to potential negative volatility and illiquidity. In
addition, the imposition of decimalization on the stock exchanges,
particularly Nasdaq, may have reduced liquidity and increased
volatility and riskiness of small, thinly traded public companies
because it may have lessened the incentive for dealers to market
and make markets in smaller issues. In general, reforms of Nasdaq
intended to make it a more visible and efficient market may have
had the effect of making it unprofitable for dealers to make
markets in smaller issues, thereby decreasing the liquidity of such
issues.
21
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 is being sublet by 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
The Company is not a party to any legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
On October 15, 2002, the Company held its Annual Meeting of
Shareholders for the following purposes (1) to elect directors of
the Company; (2) to ratify, confirm and approve the Audit
Committee's selection of PricewaterhouseCoopers LLP as the
Company's independent accountant for its fiscal year ending
December 31, 2003; (3) to approve a proposal to authorize the
Company to offer rights to purchase shares of the Company's common
stock; and (4) to approve a proposal to authorize the amendment and
restatement of the Company's existing Employee Profit-Sharing Plan.
At the close of business on the record date (August 16, 2002), an
aggregate of 11,498,845 shares of common stock were issued and
outstanding.
All of the nominees at the October 15, 2002 Annual Meeting
were elected directors:
Nominees For Withheld
------------------------ ---------- --------
Dr. C. Wayne Bardin 10,420,875 73,139
Dr. Phillip A. Bauman 10,418,004 76,010
G. Morgan Browne 10,421,239 72,775
Dugald A. Fletcher 10,398,193 95,821
Charles E. Harris 10,420,519 73,495
Dr. Kelly S. Kirkpatrick 10,408,654 85,360
Glenn E. Mayer 10,393,401 100,613
Lori D. Pressman 10,415,667 78,347
James E. Roberts 10,399,622 94,392
With respect to proposal number two, described as a proposal
"to ratify, confirm and approve the Audit Committee's selection of
PricewaterhouseCoopers LLP" as the Company's independent
accountant for its fiscal year ending December 31, 2003, the
affirmative votes cast were 10,390,522, the negative votes cast
were 39,402 and those abstaining were 64,090.
With respect to proposal number three, described as a
proposal "to authorize the Company to offer rights to purchase
shares of the Company's common stock at an exercise price that, at
22
the time such rights are issued, will not be less than the greater
of the market value of the Company's common stock or the net asset
value of the Company's common stock. Such rights may be part of
or accompanied by other securities of the Company (such as
convertible preferred stock or convertible debt)." The
affirmative votes cast were 5,919,699, the negative votes cast
were 290,295 and those abstaining were 113,546.
With respect to proposal number four, described as a proposal
"to authorize the amendment and restatement of the Company's
existing Employee Profit-Sharing Plan," the affirmative votes cast
were 10,041,081, the negative votes cast were 317,023 and those
abstaining were 135,910.
23
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.
Annette Hogan) 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 "TINY." 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.
2002 Quarter Ending Low High
March 31 $1.80 $5.50
June 30 $2.74 $5.10
September 30 $2.00 $2.99
December 31 $1.85 $2.49
2001 Quarter Ending Low High
March 31 $2.063 $4.25
June 30 $2.01 $3.29
September 30 $1.60 $2.86
December 31 $1.55 $2.33
Dividends
On January 22, 2002, the Company announced a deemed dividend
of $0.0875 per share for 2001 for a total of $775,620, and in 2002
the Company paid federal income taxes on behalf of shareholders of
$0.030625 per share for a total of $271,467. The Company paid the
tax at the corporate rate on the distribution, and the shareholders
received a tax credit equal to their proportionate share of the tax
paid.
The Company did not pay a cash dividend or declare a deemed
dividend for 2002.
24
Recent Sales of Unregistered Securities
The Company did not sell any equity securities during 2002
that were not registered under the Securities Act of 1933.
Shareholders
As of February 10, 2003, there were approximately 150 holders
of record of the Company's common stock which, the Company has been
informed, hold the Company's common stock for approximately 5,335
beneficial owners.
25
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:
2002 2001 2000 1999(1) 1998(1)
Total assets $35,951,969 $39,682,367 $43,343,423 $65,320,768 $25,358,859
Total liabilities $ 8,695,923 $15,347,597 $11,509,948 $11,685,963 $ 2,802,150
Net assets $27,256,046 $24,334,770 $31,833,475 $53,634,805 $22,556,709
Net asset value
per outstanding
share $ 2.37 $ 2.75 $ 3.51 $ 5.80 $ 2.13
Cash dividends
paid $ 0.00 $ 0.00 $ 0.02 $ 0.35 $ 0.75
Shares
outstanding 11,498,845 8,864,231 9,064,231 9,240,831 10,591,232
Operating Data for year ended December 31:
2002 2001 2000 1999 1998
Total investment
income $ 253,461 $ 510,661 $ 687,050 $ 287,684 $ 585,486
Total expenses(2) $ 2,124,549 $ 1,035,221 $(2,623,200) $ 9,924,020 $ 3,634,786
Net operating
income (loss) $(1,871,088) $ (524,560) $ 3,310,250 $(9,636,336) $(2,815,112)
Net realized gain
(loss) on
investments $ 2,390,302 $ 1,276,366 $18,963,832 $ 8,615,670 $(1,718,528)
Net realized
income (loss) $ 519,214 $ 751,806 $22,274,082 $(1,020,666) $(4,533,640)
Net (decrease)
increase in
unrealized
appreciation
on investments $ (3,241,408)$(7,641,044)$(37,781,289) $38,102,047 $ 1,655,830
Net (decrease)
increase in net
assets resulting
from operations $ (2,722,194)$(6,889,238)$(15,507,207) $37,081,381 $(2,877,810)
(Decrease)
increase in net
assets resulting
from operations
per outstanding
share $ (0.24)$ (0.78) $ (1.71) $ 4.01 $ (0.27)
(1) Certain reclassifications have been made to the December 31, 1998 and
December 31, 1999 financial statements to conform to the December 31, 2000
presentation. Note: See "Reclassifications" in Note 2 of Notes to Consolidated
Financials.
(2) Included in total expenses are the following profit-sharing (reversals)
accruals: ($163,049) in 2002; ($984,021) in 2001; ($4,812,675) in 2000;
$8,110,908 in 1999; $899,751 in 1998.
26
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 the Company's 2002 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 income (loss) from 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 income (loss) from investments" and "Net
(decrease) increase in unrealized appreciation on investments" are
directly related. When a security is sold to realize income
(loss), net unrealized appreciation decreases (increases) and net
realized income increases (decreases).
27
Business and Capital Markets Conditions
General business and capital markets conditions in 2002 and
2003 have been quite adverse for the venture-capital industry.
Conditions for the telecommunications-related investments have
been especially harsh. As a result, there have been few
opportunities to take venture-capital backed companies public or
sell them to established companies. It has also been difficult to
finance them privately. In addition, it has been difficult for
venture-capital firms themselves to raise capital. Under these
adverse conditions, the Company was fortunate to be able to raise
capital in a rights offering and to effect the profitable
liquidation of its interest in PHZ Capital Partners L.P.
Financial Condition
At December 31, 2002 as compared with December 31, 2001, the
Company's total assets decreased by $3,730,398 or 9.4 percent to
$35,951,969 and its net assets increased by $2,921,276 or 12.0
percent to $27,256,046.
Net asset value per share ("NAV") was $2.37 at December 31,
2002, versus $2.75 at December 31, 2001.
At December 31, 2001 as compared with December 31, 2000, the
Company's total assets decreased by $3,661,056 or 8.4 percent to
$39,682,367 and its net assets decreased by $7,498,705 or 23.6
percent to $24,334,770.
Net asset value per share ("NAV") was $2.75 at December 31,
2001 versus $3.51 at December 31, 2000. NAV was reduced by $0.02
in 2000 by the cash dividend paid by the Company.
Among the significant developments during the year ended
December 31, 2002 were: (1) payment of $271,467 in federal income
taxes as a result of the Company's deemed dividend distribution;
(2) decline in the value of the Company's investment in Continuum
Photonics, Inc. of $481,011; (3) decline in the value of the
Company's investment in Experion Systems, Inc. of $580,706; (4)
decline in the value of the Company's investment in Kriton Medical,
Inc. of $1,000,001; (5) decline in the value of the Company's
investment in NanoOpto Corporation of $596,600; (6) decline in the
value of the Company's investment in NeoPhotonics Corporation of
$569,560; (7) decline in the value of the Company's investment in
NeuroMetrix, Inc. of $1,986,081; (8) decrease in bank loan payable
of $12,495,777; (9) net proceeds of $5,643,470 from a rights
offering; and (10) receipt of $5,700,000 and recorded receivable of
$786,492 related to the liquidation of the Company's investment in
PHZ Capital Partners L.P.
Among the significant developments during the year ended
December 31, 2001 were: (1) payment of $5,709,884 in federal income
taxes as a result of the Company's deemed dividend distribution;
(2) decline in the value of the Company's holdings in Experion
Systems, Inc. of $480,000; (3) decline in the value of the
Company's holdings in Informio, Inc. of $353,221; (4) decline in
the value of the Company's holdings in Questech
28
Corporation of $245,843; (5) writeoff of the value of the Company's
holdings in Schwoo, Inc of $1,248,827; (6) sales of the Company's
holdings in Nanophase Technologies Corporation, Genomica
Corporation, SciQuest.com, Inc. Essential.com and MedLogic Global
Corporation; and (7) payment of the 2000 realized gain profit-
sharing awards of $2,320,938.
As of March 31, 2001, in accordance with newly promulgated SEC
guidelines, the Company changed its valuation policy by no longer
discounting publicly held securities for liquidity considerations.
(See "Asset Valuation Policy Guidelines" in the "Footnote to
Consolidated Schedule of Investments" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
The Company's shares outstanding as of December 31, 2002 were
11,498,845, versus 8,864,231 at December 31, 2001, pursuant to the
issuance and exercise of transferable rights to its shareholders to
subscribe to new shares of the Company's common stock. Investors
subscribed to 2,634,614 new common shares resulting in net proceeds
of $5,643,470.
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 developing unproven technologies that lack
management depth and have little or no history of operations. At
December 31, 2002, $12,036,077 or 33.5 percent of the Company's
total assets (44.2 of the Company's net assets) consisted of non-
publicly traded securities at fair value, of which net unrealized
depreciation was $2,718,389. At December 31, 2001, $13,120,978 or
33.1 percent of the Company's total assets (53.9 percent of the
Company's net assets) consisted of non-publicly traded securities
at fair value, of which net unrealized appreciation was $1,215,444.
The value of the non-publicly traded securities decreased by
$1,084,901 from $13,120,978 at December 31, 2001 to $12,036,077 at
December 31, 2002, reflecting increases from new and additional
investments offset by investment write-downs and the liquidation of
investments. Increases from new and additional investments totaled
$7,195,988 (see summary table on page 29). Write-downs were taken
on the following investments: Continuum Photonics, Inc., $481,011;
Experion Systems, Inc., $580,706; Kriton Medical, Inc., $1,000,001;
NanoOpto Corporation, $596,600; NeoPhotonics Corporation, $569,560;
and NeuroMetrix, Inc., $1,986,081. The liquidations of Informio,
Inc. and the Company's interest in PHZ Capital Partners L.P.
resulted in decreases in non-publicly traded securities of
$2,921,002 and $151,380, respectively, which were their respective
values at December 31, 2001.
The Company's investments in the telecommunications equipment
industry, Continuum Photonics, Inc., NanoOpto Corporation and
NeoPhotonics Corporation, were written-down by the Company by
$1,647,171 during 2002. The valuation of such investments was
reduced to 3.59 percent of the Company's net assets at December 31,
2002. Global economic conditions and difficulties among carrier
companies, especially competitive local exchange carriers, have
continued to take an unprecedented toll on the
29
telecommunications industry. The resulting impact on the optical
components sector has been severe. Continuing declines in major
system installations and capital expenditure budgets have continued
to limit sales by component companies.
A summary of the Company's investment portfolio is as
follows:
December 31, 2002 December 31, 2001
Investments, at cost $30,206,935 $37,714,285
Unrealized (depreciation)
appreciation (2,720,113) 1,216,420
----------- -----------
Investments, at fair value $27,486,822 $38,930,705
=========== ===========
__________________
The accumulated unrealized (depreciation) appreciation on
investments net of deferred taxes is ($3,389,458) at December 31,
2002 versus ($148,049) at December 31, 2001.
Following an initial investment in a private company, the
Company may make additional investments in such portfolio company
in order to: (1) increase or maintain in whole or in part 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 portfolio company and
the Company's initial investment or may result in a missed
opportunity for the Company to maintain or 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 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 or would preserve rights pursuant
to "pay to play" provisions.
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, 2002:
New Investments: Amount
--------------- ------
Agile Materials & Technologies, Inc. $1,000,000
Continuum Photonics, Inc. 1,000,000
Nanopharma Corp. 700,000
NanoOpto Corporation 625,000
Nanotechnologies, Inc. 750,000
NeoPhotonics Corporation 1,000,000
Optiva, Inc. 1,250,000
Additional Investments:
----------------------
Experion Systems, Inc. 517,706
NeuroMetrix, Inc. 353,282
----------
Total $7,195,988
==========
30
Results of Operations
Investment Income and Expenses:
The Company had net operating (loss) income of ($1,871,088)
in 2002, ($524,560) in 2001 and $3,310,250 in 2000. The net
operating (loss) income for 2002, 2001 and 2000 reflected a
decrease in the employee profit-sharing accrual that resulted in a
reversal of expenses of $163,049 in 2002, $984,021 in 2001 and
$4,812,675 in 2000. When unrealized appreciation as of a certain
date subsequently decreases or increases, the profit-sharing
accrual decreases or increases accordingly, resulting in a decrease
or increase to expenses.
The Company's principal objective is to achieve capital
appreciation. Therefore, a significant portion of the investment
portfolio is structured to maximize the potential for capital
appreciation and provides little or no current yield in the form of
dividends or interest. The Company does earn interest income from
fixed-income securities, including U.S. Government and Agency
Obligations. The amount of interest income earned varies with the
average balance of the Company's fixed-income portfolio and the
average yield on this portfolio.
The Company had total investment income of $253,461 in 2002 ,
$510,661 in 2001 and $687,050 in 2000. Total investment income is
comprised primarily of interest from fixed-income securities, loans
and debt securities of portfolio companies and other income.
The Company had interest income, primarily from fixed-income
securities, of $184,050 in 2002, $422,196 in 2001 and $554,233 in
2000. The decrease in interest income from 2002 to 2001 of
$238,146 or 56.4 percent reflects primarily the continual decline
in interest rates during 2002.
The Company had interest income from portfolio companies of $0
in 2002, $9,616 in 2001 and $64,950 in 2000. The decrease from
2001 to 2002 of $9,616 or 100.0 percent and from 2000 to 2001 of
$55,334 or 85.2 percent is owing to the reduction in the amount of
outstanding loans during the periods. The amount of outstanding
loans to portfolio companies varies. Typically, loans made to
portfolio companies are bridge loans and are converted into equity
at the next financing.
The Company had other income of $69,411 in 2002, $77,849 in
2001 and $65,867 in 2000. The other income primarily represents
rental income for subleasing office space to an unaffiliated party.
Operating expenses were $2,124,549 in 2002, $1,035,221 in 2001
and ($2,623,200) in 2000. The operating expenses for the year
ended December 31, 2002 reflect a reversal of a prior expense
accrual in the employee profit-sharing plan of $163,049. Salaries
and benefits increased by $85,289 or 8.2 percent primarily owing to
an increase in the retirement medical benefit expense of $29,272,
and the expense of a new employee, starting in September 2002.
Professional fees increased by $83,135 or 31.8 percent, primarily
31
as a result of expenses associated with new investments and
preparation of the Company's proxy statement. Directors' fees and
expenses increased $64,635 or 71.8 percent, as a result of special
board meetings; audit committee meetings regarding the appointment
of PricewaterhouseCoopers LLP as independent accountants for the
Company for the year ending December 31, 2002; nominating committee
meetings resulting in the appointment of three additional members
of the Board of Directors; and additional expenses associated with
the new members. Depreciation expense increased by $3,706 or 13.8
percent owing to an upgrading of the Company's computers and
software.
The operating expenses for the year ended December 31, 2001
reflect a reversal of a prior expense accrual in the employee
profit-sharing plan of $984,021 owing to decreases in unrealized
appreciation of investments for the current year. Salaries and
benefits increased by $8,326 or one percent. Administration and
operations increased by $20,880 or 5.4 percent, and professional
fees decreased by $49,019 or 15.8 percent in 2001. The remaining
expenses are related to office and rent expenses and director
compensation.
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, 2002, 2001 and
2000, the Company sold various investments and received
distributions, resulting in net realized income from investments
of $3,284,737, $1,394,781 and $19,065,267, respectively.
During 2002, the Company recorded realized income from
investments of $3,284,737, consisting primarily of realized income
of $4,776,360 from the liquidation of its partnership interest in
PHZ Capital Partners L.P. The Company also recorded realized
income of $120,133 from the Nanophase Technologies Litigation
Settlement Fund offset by realized losses of $350,583 and
$1,248,825 from the liquidation of Informio, Inc. and sale of
Schwoo, Inc., respectively. As a result of the income and losses
realized during 2002, unrealized appreciation increased by
$1,279,840.
During 2001, the Company recorded realized income from
investments of $1,394,781, consisting primarily of realized income
(losses) from sales of Nanophase Technologies Corporation,
$2,762,696; Genomica Corporation, $1,022,905; Essential.com, Inc.
($1,349,512); shares of SciQuest.com, Inc. purchased in the open
market, ($1,258,679); and MedLogic Global Corporation,
($1,033,765). The Company also recorded realized income of
$1,266,729 from its partnership interest in PHZ Capital Partners
L.P. As a result of the income and losses realized during 2001,
unrealized appreciation increased by $3,948,271.
32
During 2000, the Company recorded realized income from
investments of $19,065,267, consisting primarily of realized
income (losses) from sales of Alliance Pharmaceutical, $9,693,446;
the Company's private-equity investments in SciQuest.com, Inc.,
$7,407,377; Kana Communications, $1,054,818; and Nanophase
Technologies Corporation, $241,025. The Company also recorded
income of $528,021 from its partnership interest in PHZ Capital
Partners L.P. and $147,528 on the realization of the reserve
relating to monies placed in escrow in connection with the sale of
NBX Corporation to 3Com Corporation. (See Note 7 to Consolidated
Financial Statements.) The Company received in full the escrowed
funds on March 6, 2000. As a result of the income and losses
realized during 2000, unrealized appreciation decreased by
$21,400,036.
Unrealized Appreciation and Depreciation of Portfolio Securities
The Company's Investment and Valuation Committee values the
portfolio securities on a quarterly basis pursuant to the
Company's Asset Valuation guidelines established by the Board of
Directors in accordance with the 1940 Act. (See "Footnote to
Consolidated Schedule of Investments" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
In 2002, net unrealized depreciation on investments increased
by $3,936,533 or 323.6 percent from $1,216,420 to ($2,720,113),
primarily as a result in the declines in the valuations of the
Company's holdings in Continuum Photonics, Inc., Experion Systems,
Inc., Kriton Medical, Inc., NanoOpto Corporation, NeoPhotonics
Corporation and NeuroMetrix of $481,011, $580,706, $1,000,001,
$596,600, $569,560 and $1,986,081, respectively. This decrease
was offset by an increase in unrealized appreciation of $353,221
and $1,248,827 as a result of the realization of the loss on the
sale of the Company's positions in Informio, Inc. and Schwoo, Inc.
In addition, unrealized appreciation decreased $322,208 as a
result of the realization of income from the Company's investment
in PHZ Capital Partners, L.P., which had been recorded as
unrealized income.
In 2001, net unrealized appreciation on investments decreased
by $7,731,508 or 86.4 percent from $8,947,928 to $1,216,420,
primarily as a result of declines in the valuations of the
Company's holdings of Nanophase, Genomica, Essential.com, Experion
Systems, and Schwoo of $5,499,664, $1,540,375, $854,467, $480,000
and $1,248,827, respectively. This decrease was offset by an
increase in unrealized appreciation of $1,528,082 and $1,033,775
as a result of the realization of the loss on the sale of the
Company's positions in SciQuest.com and MedLogic.
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 valuations 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
33
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.")
Cash Flow
Cash flow provided by operating activities for the year ended
December 31, 2002 was $1,923,048 primarily as a result of the
following changes from December 31, 2001 to December 31, 2002:
payable to broker for unsettled trade increased by $5,969,725,
funds held in escrow increased by $750,000 and receivable from a
partnership liquidation increased by $786,492. In addition, net
realized and unrealized loss on investments was $651,797 and the
net decrease in net assets resulting from operations was
$2,722,194.
Cash provided by investing activities for the year ended
December 31, 2002 was $10,751,980, reflecting the decrease in the
Company's investment in United States Treasury Bills of
$10,358,006 and the proceeds from the liquidation of investments
of $7,631,100 offset by investments in private placements of
$7,195,988.
Cash used in financing activities for the year ended December
31, 2002 was $6,842,807, reflecting the payment of the outstanding
balance on the asset line of credit of $12,495,777 offset by the
net proceeds from the rights offering of $5,643,470.
Liquidity and Capital Resources
The Company's net primary sources of liquidity are cash,
receivables and freely marketable securities, net of short-term
indebtedness. The Company's secondary sources of liquidity are
restricted securities of companies that are publicly traded. At
December 31, 2002, December 31, 2001 and December 31, 2000, the
Company's net primary liquidity was $16,508,057, $13,459,654 and
$23,039,736, respectively. On the corresponding dates, the
Company's secondary liquidity was $0, $0 and $3,040,679. The
Company's tertiary source of liquidity has been its holding in PHZ
Capital Partners L.P., from which the Company received cash
distributions in 2002, 2001 and 2000 of $6,588,661, $172,068 and
$280,326, respectively. The Company liquidated its 20 percent
interest in PHZ, effective December 31, 2002, for $5,700,000 on
December 31, 2002 and a final distribution of $786,492 on January
16, 2003. The final distribution of $786,492 is included in net
primary liquidity as a receivable at December 31, 2002.
The increase in the Company's primary source of liquidity from
December 31, 2001 to December 31, 2002 is the net result of: (1)
payment of federal income taxes of $307,585; (2) investment in
Nanopharma Corp. of $700,000; (3) investment in NanoOpto
Corporation of $625,000; (4) investment in NeoPhotonics Corporation
of $1,000,000; (5) investment in Experion Systems, Inc. of
$517,706; (6) investment in Continuum Photonics, Inc. of
$1,000,000; (7) investment in Nanotechnologies, Inc. of $750,000;
(8) investment in Optiva, Inc. of $1,250,000; (9) investment in
Agile Materials & Technologies, Inc. of $1,000,000; (10) investment
in NeuroMetrix, Inc. of $353,282; and (11) use of funds for
operating expenses; offset by raising of $5,643,470 net of expenses
from the rights offering.
34
From December 31, 2001 to December 31, 2002, restricted funds
increased by $274,924 or 57.0 percent, owing to the Company's 2002
contribution of $147,478 to the Supplemental Executive Retirement
Plan, or SERP account, and net changes in the account from income
earned and changes in investments valuations.
From December 31, 2001 to December 31, 2002, the Company's
liability for accrued profit sharing decreased by $163,049 to
$15,233 to reflect the estimated amount to be paid out under the
Plan. Current income tax liability increased by $602,588 to
$857,656, owing primarily to income recorded in association with
the liquidation of the Company's interest in PHZ Capital Partners
L.P.
On November 19, 2001, the Company established an asset
account line of credit of up to $12,700,000. The asset account
line of credit is secured by the Company's government agency
securities. Under the asset account line of credit, the Company
may borrow up to 95 percent of the current value of its government
agency securities. The Company's outstanding balance under the
asset line of credit at December 31, 2002 and December 31, 2001
was $0 and $12,495,777, respectively. The asset line of credit
bears interest at a rate of the Broker Call Rate plus 50 basis
points.
The Company's net primary sources of liquidity are more than
adequate to cover the Company's gross cash operating expenses over
the next 12 months. Such gross cash operating expenses totaled
$2,256,991, $1,992,341 and $2,051,086 in 2002, 2001 and 2000,
respectively.
Critical Accounting Policies
Critical accounting policies are those that are both
important to the presentation of the Company's financial condition
and results of operations and require management's most difficult,
complex or subjective judgments. The Company's critical
accounting policies are those applicable to the valuation of
investments.
Valuation of Portfolio Investments
As a business development company, the Company invests
primarily in illiquid securities including debt and equity
securities of private companies. The investments are generally
subject to restrictions on resale and generally have no
established trading market. The Company values substantially all
of its investments at fair value as determined in good faith by
the Company's Investment and Valuation Committee. The Investment
and Valuation Committee, comprised of a least three or more
independent Board members, reviews and approves the valuation of
the Company's investments within the guidelines established by the
Board of Directors. Fair value is generally defined as the amount
that an investment could be sold for in an orderly disposition
over a reasonable time. Generally, to increase objectivity in
valuing 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. Where there
35
is an established public market for the class of the company's
securities held by the Company, public market value will be used.
The Company discounts market value for securities that are subject
to significant legal and contractual restrictions.
Recent Developments -- Portfolio Companies
On January 16, 2003, the Company received $786,492 as final
payment in the liquidation of the Company's investment in PHZ
Capital Partners L.P.
On February 3, 2003, the Company announced that it had
invested $750,000 in a convertible preferred security of Nanogram
Devices Corporation. Nanogram Devices has developed and is
commercializing specialized power sources for medical devices and
other medical equipment based on its patented, laser-based
nanomaterials synthesis technology.
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.")
Since 1998, the Company has received SEC certification for
the Company's qualification for RIC treatment. Although the SEC
certification for 1999-2001 was issued, there can be no assurance
that the Company will receive such certification for 2002 or
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 January 22, 2002, the Company announced that its Board of
Directors had declared a deemed dividend for 2001 of $0.0875 per
share, for a total of $775,620, and paid corporate taxes on behalf
of shareholders of $0.030625 per share, for a total of $271,467.
36
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk
The Company's business activities are highly risky. 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 developing new 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
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. Even when the Company's private equity
investments complete initial public offerings (IPOs), the Company
is normally subject to lock-up agreements for a period of time.
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."
37
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 Accountants......................... 39
Consolidated Financial Statements
- ---------------------------------
Consolidated Statements of Assets and Liabilities
as of December 31, 2002 and 2001....................... 40
Consolidated Statements of Operations for the
years ended December 31, 2002, 2001, 2000.............. 41
Consolidated Statements of Cash Flows for the
years ended December 31, 2002, 2001 and 2000............ 42
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2002, 2001 and 2000............ 43
Consolidated Schedule of Investments as of
December 31, 2002.......................................44-47
Footnote to Consolidated Schedule of Investments..........48-50
Notes to Consolidated Financial Statements................51-59
Financial Highlights for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998............ 60
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.
38
- -------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- -------------------------------------------------------------------
Report of Independent Accountants
To the Board of Directors and Shareholders of
Harris & Harris Group, Inc.
In our opinion, the accompanying consolidated statement of assets
and liabilities, including the consolidated schedule of
investments, and the related consolidated statements of
operations, of cash flows, of changes in net assets and of
financial highlights present fairly, in all material respects, the
financial position of Harris & Harris Group, Inc. (the "Company")
at December 31, 2002, and the results of its operations, its cash
flows, the changes in its net assets and the financial highlights
for the year then ended, in conformity with accounting principles
generally accepted in the United States of America. These
financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit
of these financial statements in accordance with auditing
standards generally accepted in the United States of America,
which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audit, which included confirmation of securities at December 31,
2002 by correspondence with the custodian, provides a reasonable
basis for our opinion. The financial statements of the Company as
of December 31, 2001 and 2000, and for the years then ended were
audited by other auditors who have ceased operations. Those
auditors expressed an unqualified opinion on those financial
statements in their report dated March 21, 2002.
As more fully disclosed in Note 2, the financial statements
include investments valued at $12,036,077 (44.16% of net assets)
at December 31, 2002, the fair values of which have been estimated
by the Board of Directors in the absence of readily ascertainable
market values. Those estimated values may differ significantly
from the values that would have been used had a ready market for
the investments existed, and the differences could be material.
/s/ PricewaterhouseCoopers, LLP
- -------------------------------
March 18, 2003
New York, N.Y.
39
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
December 31, 2002 December 31, 2001
Investments, at value (Cost:
$30,206,935 at 12/31/02,
$37,714,285 at 12/31/01).....$ 27,486,822 $ 38,930,705
Cash and cash equivalents...... 5,967,356 135,135
Restricted funds (Note 5)...... 756,944 482,020
Funds in escrow ............... 750,000 0
Receivable from portfolio
company...................... 786,492 0
Interest receivable............ 189 82
Prepaid expenses............... 96,631 14,833
Note receivable ($987, net of
reserve of $987 at 12/31/02). 0 10,487
Other assets................... 107,535 109,105
------------- -------------
Total assets................... 35,951,969 $ 39,682,367
============= =============
LIABILITIES & NET ASSETS
Accounts payable and accrued
liabilities..................$ 1,451,568 $ 1,039,350
Payable to broker for
unsettled trade.............. 5,696,725 0
Bank loan payable (Note 8)..... 0 12,495,777
Accrued profit sharing
(Note 3)..................... 15,233 178,282
Deferred rent.................. 5,397 14,650
Current income tax liability... 857,656 255,068
Deferred income tax liability
(Note 6)..................... 669,344 1,364,470
------------- -------------
Total liabilities.............. 8,695,923 15,347,597
------------- -------------
Commitments and contingencies
(Note 7)
Net assets.....................$ 27,256,046 $ 24,334,770
============= =============
Net assets are comprised of:
Preferred stock, $0.10 par
value, 2,000,000 shares
authorized; none issued......$ 0 $ 0
Common stock, $0.01 par value,
25,000,000 shares authorized;
13,327,585 issued at 12/31/02
and 10,692,971 issued at
12/31/01..................... 133,276 106,930
Additional paid in capital
(Note 4)..................... 32,845,872 27,228,748
Additional paid in capital -
common stock warrants........ 109,641 109,641
Accumulated net realized gain
(loss)....................... 1,137,820 618,606
Accumulated unrealized
appreciation of investments,
net of deferred tax liability
of $844,918 at 12/31/02 and
$1,540,044 at 12/31/01....... (3,565,032) (323,624)
Treasury stock, at cost
(1,828,740 shares at 12/31/02
and 12/31/01)................ (3,405,531) (3,405,531)
------------- -------------
Net assets.....................$ 27,256,046 $ 24,334,770
============= =============
Shares outstanding............. 11,498,845 8,864,231
============= =============
Net asset value per
outstanding share............$ 2.37 $ 2.75
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
40
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Investment income:
Interest from:
Fixed-income
securities..............$ 184,050 $ 422,196 $ 554,233
Portfolio companies...... 0 9,616 64,950
Dividend income........... 0 1,000 2,000
Other income.............. 69,411 77,849 65,867
----------- ------------ ------------
Total investment income.. 253,461 510,661 687,050
----------- ------------ ------------
Expenses:
Profit-sharing (reversal)
accrual (Note 3)......... (163,049) (984,021) (4,812,675)
Salaries and benefits..... 1,130,352 1,045,063 1,036,737
Professional fees......... 344,717 261,582 310,601
Administration and
operations............... 433,569 406,488 385,608
Rent...................... 173,291 166,312 166,816
Directors' fees and
expenses................. 154,682 90,047 100,469
Depreciation.............. 30,607 26,901 28,748
Custodian fees............ 9,604 14,518 14,355
Interest expense (Note 4). 10,776 8,331 146,141
----------- ------------ ------------
Total expenses........... 2,124,549 1,035,221 (2,623,200)
----------- ------------ ------------
Operating (loss) income
before income taxes....... (1,871,088) (524,560) 3,310,250
Income tax benefit
(Note 6).................. 0 0 0
----------- ------------ ------------
Net operating (loss)
income.................... (1,871,088) (524,560) 3,310,250
Net realized income (loss)
from investments:
Realized income from
investments.............. 3,284,737 1,394,781 19,065,267
----------- ------------ ------------
Total realized income... 3,284,737 1,394,781 19,065,267
Income tax expense
(Note 6)................. (894,435) (118,415) (101,435)
----------- ------------ ------------
Net realized income
from investments......... 2,390,302 1,276,366 18,963,832
----------- ------------ ------------
Net realized income........ 519,214 751,806 22,274,082
Net decrease in unrealized
appreciation on investments:
Increase as a result of
investment sales......... 1,602,048 4,802,738 0
Decrease as a result of
investment sales......... (322,208) (854,467) (21,400,036)
Increase on investments
held..................... 285 3,232,919 26,741,283
Decrease on investments
held..................... (5,216,659) (14,912,698) (43,275,840)
----------- ------------ ------------
Change in unrealized
appreciation on
investments............. (3,936,534) (7,731,508) (37,934,593)
Income tax benefit
(Note 6)................. 695,126 90,464 153,304
----------- ------------ ------------
Net decrease in
unrealized appreciation
on investments........... (3,241,408) (7,641,044) (37,781,289)
----------- ------------ ------------
Net decrease in net assets
resulting from operations:
Total.....................$(2,722,194) $ (6,889,238) $(15,507,207)
=========== ============ ============
Per outstanding share.....$ (0.24) $ (0.78) $ (1.71)
=========== ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
41
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Cash flows used in
operating activities:
Net (decrease) increase
in net assets resulting
from operations..........$ (2,722,194) $ (6,889,238) $(15,507,207)
Adjustments to reconcile
net (decrease) increase
in net assets resulting
from operations to net
cash used in operating
activities:
Net realized and
unrealized loss
(income) on investments. 651,797 5,950,398 18,869,326
Deferred income taxes.... (695,126) 90,464 (153,304)
Depreciation............. 30,607 26,901 28,748
Other.................... 0 2,010 109,641
Interest received in
stock................... 0 0 (27,009)
Changes in assets and liabilities:
Restricted funds......... (274,924) (216,837) (265,183)
Receivable from
investment company...... (786,492) 0 0
Funds in escrow.......... (750,000) 0 1,327,748
Interest receivable...... (107) 30,000 14,107
Prepaid expenses......... (81,798) 67,782 (8,287)
Notes receivable......... 10,487 401 0
Other assets............. 1,570 23,667 18,384
Accounts payable and
accrued liabilities..... 412,217 267,587 71,197
Payable to broker for
unsettled trade......... 5,696,725 (115,005) 115,005
Accrued profit sharing... (163,049) (3,304,959) (5,951,226)
Deferred rent............ (9,253) (9,253) (9,253)
Current income tax
liability............... 602,588 (5,496,498) 62,670
------------ ------------ ------------
Net cash provided by
(used in) operating
activities.............. 1,923,048 (9,572,580) (1,304,643)
Cash provided by investing
activities:
Net (purchase) sale of
short-term investments
and marketable
securities.............. 10,358,006 (10,263,667) (14,480,590)
Investment in private
placements and loans.... (7,195,988) (1,818,826) (6,417,500)
Proceeds from sale of
investments............. 7,631,100 9,385,615 23,022,868
Purchase of fixed assets. (41,138) (6,508) (6,974)
------------ ------------ ------------
Net cash provided by
(used in) investing
activities.............. 10,751,980 (2,703,386) 2,117,804
Cash flows used in financing activities:
Payment of dividend...... 0 0 (184,817)
Purchase of treasury
stock (Note 4).......... 0 (338,000) (530,051)
Proceeds from note
payable................. 0 12,495,777 3,000,000
Payment of note payable
(Note 4)................ (12,495,777) 0 (3,000,000)
Proceeds from rights
offering, net (Note 4).. 5,643,470 0 0
Collection on notes
receivable.............. 9,500 0 21,775
------------ ----------- ------------
Net cash (used in)
provided by financing
activities.............. (6,842,807) 12,157,777 (693,093)
------------ ----------- ------------
Net increase (decrease)
in cash and cash equivalents:
Cash and cash
equivalents at
beginning of the year... 135,135 253,324 133,256
Cash and cash
equivalents at end of
the year................ 5,967,356 135,135 253,324
------------ ----------- ------------
Net increase (decrease)
in cash and cash
equivalents.............$ 5,832,221 $ (118,189) $ 120,068
============ =========== ============
Supplemental disclosures
of cash flow information:
Income taxes paid........$ 307,585 $ 5,795,916 $ 117,134
Interest paid............$ 19,106 $ 0 $ 36,500
The accompanying notes are an integral part of these
consolidated financial statements.
42
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
Changes in net assets
from operations:
Net operating (loss) income..$(1,871,088) $ (524,560) $ 3,310,250
Net realized income on
investments................. 2,390,302 1,276,366 18,963,832
Net increase (decrease) in
unrealized appreciation on
investmentsas a result of
sales....................... 1,279,840 4,038,735 (21,246,732)
Net decrease in unrealized
appreciation on investments
held....................... (4,521,248) (11,679,779) (16,534,557)
----------- ------------ ------------
Net decrease in net assets
resulting from operations... (2,722,194) (6,889,238) (15,507,207)
Changes in net assets from
capital stock transactions:
Payment of dividend.......... 0 0 (184,817)
Purchase of treasury stock... 0 (338,000) (530,051)
Proceeds from sale of stock.. 26,346 0 0
Additional paid in capital
on common stock issued...... 5,617,124 0 0
Deemed dividend shareholder
tax credit.................. 0 (271,467) (5,688,896)
Additional paid in capital
warrants.................... 0 0 109,641
----------- ------------ ------------
Net increase (decrease) in
net assets resulting from
capital stock transactions.. 5,643,470 (609,467) (6,294,123)
----------- ------------ ------------
Net increase (decrease)
in net assets............... 2,921,276 (7,498,705) (21,801,330)
----------- ------------ ------------
Net Assets:
Beginning of the year........ 24,334,770 31,833,475 53,634,805
----------- ------------ ------------
End of the year..............$27,256,046 $ 24,334,770 $ 31,833,475
=========== ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
43
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
(Audited)
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated Companies
(8)(9)(10) -- 10.0% of total investments
Private Placement Portfolio (Illiquid) -- 10.0% of total investments
AlphaSimplex Group, LLC (2) --
Investment advisory firm headed
by Dr. Andrew W. Lo, holder of
the Harris & Harris Group Chair
at MIT
Limited Liability Company interest......(D) -- $ 6,235
Continuum Photonics, Inc. (1)(2)(4)(6)
-- Develops optical networking
components by merging cutting-edge
materials, MEMS and electronics
technologies -- 3.73% of fully
diluted equity
Series B Convertible Preferred Stock....(D) 2,000,000 518,989
Exponential Business Development Company
(1)(2)(5) -- Venture capital partnership
focused on early stage companies
Limited partnership interest............(A) -- 25,000
Kriton Medical, Inc. (1)(2)(6) --
Develops ventricular assist devices
-- 1.73% of fully diluted equity
Series B Convertible Preferred Stock....(D) 476,191 0
NanoOpto Corporation (1)(2)(4)(6) --
Develops high performance, integrated
optical communications sub-components
on a chip by utilizing patented nano-
manufacturing technology -- 1.45% of
fully diluted equity
Series A-1 Convertible Preferred Stock..(D) 267,857 28,400
Nantero, Inc. (1)(2)(5)(6) -- Develops
a high density nonvolatile random
access memory chip using nanotechnology
-- 4.15% of fully diluted equity
Series A Convertible Preferred Stock....(A) 345,070 489,999
NeoPhotonics Corporation (1)(2)(4)(6) --
Develops and manufactures planar
optical devices and components using
nanomaterials deposition technology
-- 1.76% of fully diluted equity
Series D Convertible Preferred Stock....(D) 1,498,802 430,440
Optiva, Inc. (1)(2)(4)(5)(6) -- Develops
and commercializes nanomaterials for
advanced applications -- 1.99% of
fully diluted equity
Series C Convertible Preferred Stock....(B) 1,249,999 1,250,000
----------
Total Private Placement Portfolio (cost: $5,395,166).............$2,749,063
----------
Total Investments in Unaffiliated Companies (cost: $5,395,166)...$2,749,063
----------
The accompanying notes are an integral part of
this consolidated schedule.
44
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
(Audited)
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled Affiliated
Companies (8)(9)(11) -- 33.8% of total investments
Private Placement Portfolio (Illiquid) -- 33.8% of total investments
Agile Materials & Technologies, Inc.
(1)(2)(4)(5)(6) -- Develops and
sells variable integrated passive
electronic equipment components--
8.21% of fully diluted equity
Series A Convertible Preferred Stock.....(A) 3,732,736 $ 1,000,000
Experion Systems, Inc. (1)(2)(7) --
Develops and sells software to
credit unions -- 12.45% of fully
diluted equity
Series A Convertible Preferred Stock.....(B) 294,118
Series B Convertible Preferred Stock.....(B) 35,294
Series C Convertible Preferred Stock.....(B) 222,184 $ 1,037,000
Nanopharma Corp. (1)(2)(4)(5)(6) --
Develops advanced nanoscopic drug
delivery vehicles and systems --
14.69% of fully diluted equity
Series A Convertible Preferred Stock.....(A) 684,516 700,000
Nanotechnologies, Inc. (1)(2)(4)(5)(6) --
Develops high-performance nanoscale
materials for industry -- 6.48% of
fully diluted equity
Series B Convertible Preferred Stock.....(A) 1,538,837 750,000
NeuroMetrix, Inc. (1)(2) -- Develops and
sells medical devices for monitoring
neuromuscular disorders -- 12.10% of
fully diluted equity
Series A Convertible Preferred Stock.....(B) 875,000
Series B Convertible Preferred Stock.....(B) 625,000
Series C-2 Convertible Preferred Stock...(B) 1,148,100
Series E Convertible Preferred Stock.....(B) 499,996
Series E-1 Convertible Preferred Stock...(B) 235,521 5,075,426
Questech Corporation (1)(2)(5) --
Manufactures and markets proprietary
metal decorative tiles -- 6.68% of
fully diluted equity
Common Stock.............................(B) 646,954
Warrants at $5.00 expiring 11/15/04......(B) 1,966
Warrants at $1.50 expiring 11/16/05......(B) 1,250
Warrants at $1.50 expiring 12/14/06......(B) 8,500
Warrants at $1.50 expiring 11/21/07......(B) 3,750 724,588
-----------
Total Private Placement Portfolio (cost: $9,359,300)............$ 9,287,014
-----------
Total Investments in Non-Controlled Affiliated Companies
(cost: $9,359,300)..............................................$ 9,287,014
-----------
The accompanying notes are an integral part of
this consolidated schedule.
45
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
(Audited)
Method of Shares/
Valuation (3) Principal Value
U.S. Government and Agency Obligations -- 56.2% of total investments
U.S. Treasury Bills --
due date 01/16/03......................(K) $4,045,000 $ 1,044,488
U.S. Treasury Bills --
due date 01/23/03......................(K) 9,470,000 9,463,237
U.S. Treasury Bills --
due date 02/13/03......................(K) 4,950,000 4,943,020
-----------
Total Investments in U.S. Government (cost: $15,452,469)........$15,450,745
-----------
Total Investments -- 100% (cost: $30,206,935)...................$27,486,822
===========
46
The accompanying notes are an integral part of
this consolidated schedule.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2002
(Audited)
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments
that have not paid dividends within the last 12 months are
considered to be non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the
Asset Valuation Policy Guidelines.
(4) Initial investment was made during 2002.
(5) No changes in valuation occurred in these investments during the
12 months ended December 31, 2002.
(6) These investments are development stage companies. A development
stage company is defined as a company that is devoting
substantially all of its efforts to establishing a new business,
and either it has not yet commenced its planned principal
operations or it has commenced such operations but has not
realized significant revenue from them.
(7) Previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in
which the Company owns less than five percent of the portfolio
company. Investments in non-controlled affiliated companies
consist of investments in which the Company owns more than five
percent but less than 25 percent of the portfolio company.
Investments in controlled affiliated companies consist of
investments in which the Company owns more than 25 percent of the
portfolio company.
(9) The percentage ownership of each portfolio company disclosed in
the Consolidated Schedule of Investments expresses the potential
equity interest in each such portfolio company. The calculated
percentage represents the amount of the issuer's equity
securities the Company owns or can acquire as a percentage of the
issuer's total outstanding equity securities plus equity
securities reserved for issued and outstanding warrants,
convertible securities and all authorized stock options, both
granted and ungranted.
(10) The aggregate cost for federal income tax purposes of
investments in unaffiliated companies is $5,395,166. The gross
unrealized appreciation based on the tax cost for these
securities is $1,069. The gross unrealized depreciation based on
the tax cost for these securities is $2,647,172.
(11) The aggregate cost for federal income tax purposes of
investments in non-controlled affiliated companies is $9,359,300.
The gross unrealized appreciation based on the tax cost for these
securities is $2,414,044. The gross unrealized depreciation
based on the tax cost for these securities is $2,486,330.
The accompanying notes are an integral part of
this consolidated schedule.
47
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
ASSET VALUATION POLICY GUIDELINES
The Company's investments can be classified into five broad
categories for valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH
AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires
periodic valuation of each investment in the Company's portfolio
to determine net asset value. Under the 1940 Act, unrestricted
securities with readily available market quotations are to be
valued at the current market value; all other assets must be
valued at "fair value" as determined in good faith by or under the
direction of the Board of Directors.
The Company's Board of Directors is responsible for (1)
determining overall valuation guidelines and (2) ensuring the
valuation of investments within the prescribed guidelines.
The Company's Investment and Valuation Committee, comprised of
at least three or more independent Board members, is responsible
for reviewing and approving the valuation of the Company's assets
within the guidelines established by the Board of Directors.
Fair value is generally defined as the amount that an
investment could be sold for in an orderly disposition over a
reasonable time. Generally, to increase objectivity in valuing the
assets of the Company, external measures of value, such as public
markets or third-party transactions, are utilized whenever
possible. Valuation is not based on long-term work-out value, nor
immediate liquidation value, nor incremental value for potential
changes that may take place in the future.
The values assigned to these investments are based on
available information and do not necessarily represent amounts that
might ultimately be realized, as such amounts depend on future
circumstances and cannot reasonably be determined until the
individual investments are actually liquidated.
The Company's valuation policy with respect to the five broad
investment categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one
or more of the following basic methods of valuation:
A. Cost: The cost method is based on the original cost to
the Company. This method is generally used in the early stages of
a company's development until significant positive or negative
events occur subsequent to the date of the original investment that
dictate a change to another valuation method. Some
48
examples of such events are: (1) a major recapitalization; (2) a
major refinancing; (3) a significant third-party transaction; (4)
the development of a meaningful public market for the company's
common stock; and (5) significant positive or negative changes in
the company's business.
B. Private Market: The private market method uses actual
third-party transactions in the company's securities as a basis for
valuation, using actual, executed, historical transactions in the
company's securities by responsible third parties. The private
market method may also use, where applicable, unconditional firm
offers by responsible third parties as a basis for valuation.
C. Public Market: The public market method is used when
there is an established public market for the class of the
company's securities held by the Company. The Company discounts
market value for securities that are subject to significant legal
and contractual restrictions. Other securities, for which market
quotations are readily available, are carried at market value as of
the time of valuation.
Market value for securities traded on securities exchanges or
on the Nasdaq National Market is the last reported sales price on
the day of valuation. For other securities traded in the over-the-
counter market and listed securities for which no sale was reported
on that day, market value is the mean of the closing bid price and
asked price on that day.
This method is the preferred method of valuation when there is
an established public market for a company's securities, as that
market provides the most objective basis for valuation.
D. Analytical Method: The analytical method is generally
used to value an investment position when there is no established
public or private market in the company's securities or when the
factual information available to the Company dictates that an
investment should no longer be valued under either the cost or
private market method. This valuation method is inherently
imprecise and ultimately the result of reconciling the judgments of
the Company's Investment and Valuation Committee members, based on
the data available to them. The resulting valuation, although
stated as a precise number, is necessarily within a range of values
that vary depending upon the significance attributed to the various
factors being considered. Some of the factors considered may
include the financial condition and operating results of the
company, the long-term potential of the business of the company,
the values of similar securities issued by companies in similar
businesses, the proportion of the company's securities owned by the
Company and the nature of any rights to require the company to
register restricted securities under applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following
basic methods of valuation:
E. Cost: The cost method is based on the original cost to
the Company. Such method is generally used in the early stages of
commercializing or developing intellectual property or patents or
research and development in technology or product development until
significant positive or adverse events occur subsequent to the date
of the original investment that dictate a change to another
valuation method.
F. Private Market: The private market method uses actual
third-party investments in intellectual property or patents or
research and development in technology or product development as a
basis for valuation, using actual executed historical transactions
by responsible third parties. The private market method may also
use, where applicable, unconditional firm offers by responsible
third parties as a basis for valuation.
49
G. Analytical Method: The analytical method is used to value
an investment after analysis of the best available outside
information where the factual information available to the Company
dictates that an investment should no longer be valued under either
the cost or private market method. This valuation method is
inherently imprecise and ultimately the result of reconciling the
judgments of the Company's Investment and Valuation Committee
members. The resulting valuation, although stated as a precise
number, is necessarily within a range of values that vary depending
upon the significance attributed to the various factors being
considered. Some of the factors considered may include the results
of research and development, product development progress,
commercial prospects, term of patent and projected markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are
readily available are carried at market value as of the time of
valuation using the most recent bid quotations when available.
Securities for which market quotations are not readily
available are carried at fair value using one or more of the
following basic methods of valuation:
I. Fixed-Income Securities are valued by independent pricing
services that provide market quotations based primarily on
quotations from dealers and brokers, market transactions, and other
sources.
J. Other Fixed-Income Securities that are not readily
marketable are valued at fair value by the Investment and Valuation
Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
K. Short-Term Fixed-Income Investments are valued at market
value at the time of valuation. Short-term debt with remaining
maturity of 60 days or less is valued at amortized cost.
ALL OTHER INVESTMENTS
L. All Other Investments are reported at fair value as
determined in good faith by the Investment and Valuation
Committee.
The reported values of securities for which market quotations
are not readily available and for other assets reflect the
Investment and Valuation Committee's judgment of fair values as of
the valuation date using the outlined basic methods of valuation.
They do not necessarily represent an amount of money that would
be realized if the securities had to be sold in an immediate
liquidation. Thus valuations as of any particular date are not
necessarily indicative of amounts that may ultimately be realized
as a result of future sales or other dispositions of investments
held.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE COMPANY
Harris & Harris Group, Inc. (the "Company") is a venture
capital investment company operating as a business development
company ("BDC") under the Investment Company Act of 1940 ("1940
Act"). A BDC is a specialized type of investment company under the
1940 Act. The Company operates as an internally managed investment
company whereby its officers and employees, under the general
supervision of its Board of Directors, conduct its operations.
The Company elected to become a BDC on July 26, 1995, after
receiving the necessary approvals. From September 30, 1992 until
the election of BDC status, the Company operated as a closed-end,
non-diversified, investment company under the 1940 Act. Upon
commencement of operations as an investment company, the Company
revalued all of its assets and liabilities at fair value as defined
in the 1940 Act. Prior to such time, the Company was registered
and filed under the reporting requirements of the Securities and
Exchange Act of 1934 as an operating company and, while an
operating company, operated directly and through subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100
percent wholly owned subsidiary of the Company. Enterprises holds
the lease for the office space, which it subleases to the Company
and an unaffiliated party; operates a financial relations and
consulting firm; is a partner in Harris Partners I, L.P. and is
taxed as a C corporation. Harris Partners I, L.P. is a limited
partnership and owned, until December 31, 2002, a 20 percent
limited partnership interest in PHZ Capital Partners L.P. The
partners of Harris Partners I, L.P. are Enterprises (sole general
partner) and Harris & Harris Group, Inc. (sole limited partner).
The Company filed for 1999 to elect treatment as a Regulated
Investment Company ("RIC") under Sub-Chapter M of the Internal
Revenue Code of 1986 (the "Code") and qualified for the same
treatment for 2000 and 2001. There can be no assurance that the
Company will qualify as a RIC for 2002 and subsequent years or that
if it does qualify, it will continue to qualify for subsequent
years. In addition, even if the Company were to qualify as a RIC
for a given year, the Company might take action in a subsequent
year to ensure that it would be taxed in that subsequent year as a
C Corporation, rather than as a RIC. As a RIC, the Company must,
among other factors, distribute at least 90 percent of its
investment company taxable income and may either distribute or
retain its realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies
followed in the preparation of the consolidated financial
statements:
Principles of Consolidation. The consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States for investment
companies and include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include
money market instruments with maturities of less than three months.
51
Portfolio Investment Valuations. Investments are stated at
"fair value" as defined in the 1940 Act and in the applicable
regulations of the Securities and Exchange Commission. All assets
are valued at fair value as determined in good faith by, or under
the direction of, the Board of Directors. (See "Asset Valuation
Policy Guidelines" in the "Footnote to Consolidated Schedule of
Investments.")
Securities Transactions. Securities transactions are
accounted for on the date the securities are purchased or sold
(trade date); dividend income is recorded on the ex-dividend date;
and interest income is accrued as earned. Realized gains and losses
on investment transactions are determined on specific
identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, the Company recorded
income taxes using the liability method in accordance with the
provision of Statement of Financial Accounting Standards No. 109.
Accordingly, deferred tax liabilities had been established to
reflect temporary differences between the recognition of income and
expenses for financial reporting and tax purposes, the most
significant difference of which relates to the Company's unrealized
appreciation on investments.
The December 31, 2002 consolidated financial statements
include a provision for deferred taxes on the remaining net built-
in gains as of December 31, 1998, net of the unutilized operating
and capital loss carryforwards incurred by the Company through
December 31, 1998.
The Company pays federal, state and local income taxes on
behalf of its wholly owned subsidiary, Harris & Harris Enterprises,
which is a C corporation. (See "Note 6 Income Taxes.")
Estimates by Management. The preparation of the consolidated
financial statements in conformity with accounting principles
generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities as of December 31, 2002 and 2001, and the
reported amounts of revenues and expenses for the three years ended
December 31, 2002. The most significant estimate relates to the
fair valuations of investments for the years ended December 31,
2002 and 2001. Actual results could differ from these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
On August 3, 1989, the shareholders of the Company approved
the 1988 Long Term Incentive Compensation Plan (the "1988 Plan").
The Company's 1988 Plan was cancelled as of December 31, 1997,
canceling all outstanding stock options and eliminating all
potential stock option grants. As a substitution for the 1988
Plan, the Company adopted an employee profit-sharing plan.
As of January 1, 1998, the Company implemented the Harris &
Harris Group, Inc. Employee Profit-Sharing Plan (the "1998 Plan")
that provided for profit sharing equal to 20 percent of the net
realized income of the Company as reflected on the Consolidated
Statements of Operations for such year, less the nonqualifying
gain, if any. The 1998 Plan was terminated by the Company as of
December 31, 1999, subject to the payment of any amounts owed on
the 1999 realized gains under the 1998 Plan.
In March 2000, the Company paid out 90 percent of the profit
sharing in the amount of $1,024,696 on the 1999 realized gains;
the remaining 10 percent or $113,855 was paid out in September
2000, upon the completion and filing of the Company's 1999 federal
tax return.
As of January 1, 2000, the Company implemented the Harris &
Harris Group, Inc. Employee Profit-Sharing Plan (the "Plan") that
provides for profit sharing by its officers and employees equal to
20 percent of the net realized income of the Company as reflected
on the consolidated statements of operations of the Company for
such year, less the nonqualifying gain, if any.
52
On April 26, 2000 the shareholders of the Company approved the
performance goals under the Plan in accordance with Section 162(m)
of the Internal Revenue Code of 1986 ("Code"), effective as of
January 1, 2000. The Code generally provides that a public company
such as the Company may not deduct compensation paid to its chief
executive officer or to any of its four most highly compensated
officers to the extent that the compensation paid to any such
officer/employee exceeds $1 million in any tax year, unless the
payment is made upon the attainment of objective performance goals
that are approved by the Company's shareholders.
Under the Plan, net realized income of the Company includes
investment income, realized gains and losses, and operating
expenses (including taxes paid or payable by the Company), but is
calculated without regard to dividends paid or distributions made
to shareholders, payments under the Plan, unrealized gains and
losses, and loss carry-overs from other years ("Qualifying
Income"). The portion of net after-tax realized gains attributable
to asset values as of September 30, 1997 is considered
nonqualifying gain, which reduces Qualifying Income.
As soon as practicable following the year-end audit, the
Committee will determine whether, and if so how much, Qualifying
Income exists for a plan year, and 90 percent of the Qualifying
Income will be paid out to Plan participants pursuant to the
distribution percentages set forth in the Plan. The remaining 10
percent will be paid out after the Company has filed its federal
tax return for that year in which Qualifying Income exists. At
December 31, 2002, the distribution amounts for each officer and
employee were as follows: Charles E. Harris, 13.790 percent; Mel P.
Melsheimer, 4.233 percent; Helene B. Shavin, 1.524 percent; and
Jacqueline M. Matthews, 0.453 percent. In one case, for a former
employee, who left the Company other than due to termination for
cause, any amount earned will be accrued and may subsequently be
paid to such participant.
On October 15, 2002 the shareholders of the Company approved
the performance goals under the 2002 Plan in accordance with
Section 162(m) of the Internal Revenue Code of 1986 ("Code"),
effective as of January 1, 2003. The Code generally provides that
a public company such as the Company may not deduct compensation
paid to its chief executive officer or to any of its four most
highly compensated officers to the extent that the compensation
paid to any such officer/employee exceeds $1 million in any tax
year, unless the payment is made upon the attainment of objective
performance goals that are approved by the Company's shareholders.
As of January 1, 2003, the Company implemented the Amended and
Restated Harris & Harris Group, Inc. Employee Profit-Sharing Plan
(the "2002" Plan").
Under the 2002 Plan, net realized income of the Company
includes investment income, realized qualifying gains and losses,
and operating expenses (including taxes paid or payable by the
Company), but is calculated without regard to dividends paid or
loss carry-overs from other years ("Qualifying Income").
Under the 2002 Plan, awards previously granted to the Plan's
four current Participants (Messrs. Harris and Melsheimer and Mss.
Shavin and Matthews, herein referred to as the "grandfathered
participants") will be reduced by 10% with respect to "Non-Tiny
Technology Investments" (as defined in the 2002 Plan) and by 25%
with respect to "Tiny Technology Investments" (as defined in the
2002 Plan) and will become permanent. These reduced awards are
herein referred to as "grandfathered participations." The amount
by which such awards are reduced will be allocable and reallocable
each year by the Compensation Committee ("Committee") among current
and new participants as awards under the 2002 Plan. The
grandfathered participations will be honored by the Company whether
or not the grandfathered participant is still employed by the
Company or is still alive (in the event of death, the grandfathered
participations will be paid to the grandfathered participant's
estate), unless the grandfathered participant is dismissed for
cause, in which case all awards, including the grandfathered
participations, will be immediately cancelled and forfeited. With
regard to new investments and follow-on investments made after the
53
date on which the first new employee begins participating in the
2002 Plan, both current and new participants will be required to be
employed by the Company at the end of a plan year in order to
participate in profit sharing on such investments with respect to
such year.
Notwithstanding any provisions of the 2002 Plan, in no event
may the aggregate amount of all awards payable for any Plan Year
during which the Company remains a "business development company"
within the meaning of 1940 Act be greater than 20 percent of the
Company's "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards as calculated
exceed such amount, the awards will be reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the
Committee at any time. Notwithstanding the foregoing, the
grandfathered participations may not be modified further. Nothing
in the 2002 Plan will preclude the Committee from naming additional
participants in the 2002 Plan or, except for grandfathered
participations, changing the Award Percentage of any Participant
(subject to the overall percentage limitations contained in the
2002 Plan). Under the 2002 Plan, the distribution amounts for non-
grandfathered investments for each officer and employee currently
are as follows: Charles E. Harris, 10.790 percent; Mel P.
Melsheimer, 4.233 percent; Douglas W. Jamison, 3.0 percent; Helene
B. Shavin, 1.524 percent; and Jacqueline M. Matthews, 0.453
percent.
The grandfathered participations are set forth below:
Grandfathered Participations
Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews .40770 .33975
Total 18.00000 15.00000
Accordingly, an additional 2.00% of Qualifying Income with
respect to grandfathered Non-Tiny Technology Investments, 5.00% of
Qualifying Income with respect to grandfathered Tiny Technology
Investments and the full 20.00% of Qualifying Income with respect
to new investments are available for allocation and reallocation
from year to year. Currently Douglas W. Jamison is allocated .80%
of the Non-Tiny Technology Grandfathered Participations and 2.00 %
of the Tiny Technology Grandfathered Participations.
During 2002, the Company decreased the profit-sharing accrual
by $163,049, bringing the cumulative accrual under the Plan to
$15,233 at December 31, 2002. The amounts payable under the Plan
for net realized income during the year ended December 31, 2002 are
$15,233. The Company will pay out 90 percent in March 2003 and the
remaining 10 percent upon the completion and filing of the
Company's 2002 federal tax return.
NOTE 4. CAPITAL TRANSACTIONS
In 1998, the Board of Directors approved that, effective
January 1, 1998, 50 percent of all Directors' fees be used to
purchase Company common stock from the Company. However, effective
March 1, 1999, the directors may purchase the Company's common
stock in the open market, rather than from the Company. During
1999, the Directors bought directly from the Company 5,816 shares.
54
On July 14, 1999, the Board of Directors announced a tender
offer to purchase up to 1,100,000 shares of its common stock for
cash at a price equal to $1.63 per share. A total of 1,080,569
shares were tendered for a total cost, including related expenses
of approximately $71,500, of $1,832,831. Of these shares,
1,075,269 were tendered by one shareholder, which tendered all of
its holdings.
On January 27, 2000, the Company placed privately, with an
unaffiliated investor, for $3 million in cash, a one-year, 12
percent note with one-year warrants to purchase 25,263 shares of
the Company's common stock at $11.8750 per share. Unless the note
was prepaid, six months after its issuance, the investor would have
received additional one-year warrants to purchase an additional
$300,000 worth of the Company's common stock at the then-current
market price. During March 2000, with part of the proceeds from
the sale of SciQuest.com stock, the Company prepaid the Note. The
Company incurred total interest costs of $146,141: $36,500 in
interest paid on the note and $109,641 on warrants. The warrants
expired unexercised.
On July 8, 2002, the Company filed a final prospectus under
Rule 497 of the Securities Act of 1933 with the SEC for the
issuance of transferable rights to its shareholders. The rights
allowed the shareholders to subscribe for a maximum of 2,954,743
new shares of the Company's common stock, of which 2,634,614 new
shares were subscribed for pursuant to the rights offering. The
actual amount of gross proceeds raised upon completion of the
offer was $5,927,882; net proceeds were $5,643,470, after expenses
of $284,412. The Company intends to invest, under normal
circumstances, directly or indirectly, the net proceeds of the
offer in accordance with its investment objectives and policies,
within the 12 months following the receipt of such proceeds,
depending on the available investment opportunities for the types
of investments in which the Company principally invests.
Since 1998, the Company has repurchased a total of 1,859,047
of its shares for a total of $3,496,388, including commissions and
expenses, at an average price of $1.88 per share. These treasury
shares were reduced by the purchases made by the Directors. On
July 23, 2002, because of the Company's strategic decision to
invest in tiny technology, the Board of Directors reaffirmed its
commitment not be authorize the purchase of additional shares of
stock in the foreseeable future.
On December 14, 2000, the Company declared a deemed dividend
of $1.78 per share for a total of $16,253,987, and in 2001, the
Company paid federal income taxes on behalf of shareholders of
$0.62 per share for a total of $5,688,896. The Company paid the
tax at the corporate rate on the distribution, and the shareholders
received a tax credit equal to their proportionate share of the tax
paid.
On January 22, 2002, the Company announced a deemed dividend
of $0.0875 per share for a total of $775,620, and in 2002 the
Company paid federal income taxes on behalf of shareholders of
$0.030625 per share for a total of $271,467. The Company paid the
tax at the corporate rate on the distribution, and the shareholders
received a tax credit equal to their proportionate share of the tax
paid.
The net of the total deemed dividends declared in 2000
($16,253,987) and 2001 ($775,620) and the taxes paid on behalf of
shareholders in 2000 ($5,688,896) and 2001 ($271,467) is considered
to be reinvested by the shareholders; therefore, during 2000 and
2001, additional paid in capital has increased by $10,565,091 and
$504,153, respectively.
The tax character of the 2000 and 2001 deemed dividends was
long-term capital gain.
As of December 31, 2002, there are no distributable earnings.
The difference between the book basis and tax basis components of
distributable earnings is attributed to Built-In Gains generated at
the time of the Company's qualification as a RIC (see Note 6.
"Income Taxes") and after tax earnings that are not required to be
distributed.
55
NOTE 5. EMPLOYEE BENEFITS
On October 19, 1999, Charles E. Harris signed an Employment
Agreement with the Company (disclosed in a Form 8-K filed on
October 27, 1999) (the "Employment Agreement"), which superseded an
employment agreement that was about to expire on December 31, 1999.
The Employment Agreement shall terminate on December 31, 2004
("Term") subject to either an earlier termination or an extension
in accordance with the terms; on January 1, 2000 and on each day
thereafter, the Term extends automatically by one day unless at any
time the Company or Mr. Harris, by written notice, decides not to
extend the Term, in which case the Term will expire five years from
the date of the written notice.
During the period of employment, Mr. Harris shall serve as the
Chairman and Chief Executive Officer of the Company; be responsible
for the general management of the affairs of the Company and all
its subsidiaries, reporting directly to the Board of Directors of
the Company; serve as a member of the Board for the period of which
he is and shall from time to time be elected or reelected; and
serve, if elected, as President of the Company and as an officer
and director of any subsidiary or affiliate of the Company.
Mr. Harris is to receive compensation under his Employment
Agreement in the form of base salary of $208,315 for 2000, with
automatic yearly adjustments to reflect inflation. In addition,
the Board may increase such salary, and consequently decrease it,
but not below the level provided for by the automatic adjustments
described above. Mr. Harris is also entitled to participate in the
Company's Profit-Sharing Plan as well as in all compensation or
employee benefit plans or programs, and to receive all benefits,
perquisites, and emoluments for which salaried employees are
eligible. Under the Employment Agreement, the Company is to
furnish Mr. Harris with certain perquisites which include a company
car, membership in certain clubs and up to a $5,000 annual
reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life
insurance for the benefit of his designated beneficiaries in the
amount of $2,000,000; provides reimbursement for uninsured medical
expenses, not to exceed $10,000 per annum, adjusted for inflation,
over the period of the contract; provides Mr. Harris and his spouse
with long-term care insurance; and disability insurance in the
amount of 100 percent of his base salary. These benefits are for
the term of the Employment Agreement.
The Employment Agreement provides for the Company to adopt a
supplemental executive retirement plan (the "SERP") for the benefit
of Mr. Harris. Under the SERP, the Company will cause an amount
equal to one-twelfth of Mr. Harris's current annual salary to be
credited each month (a "Monthly Credit") to a special account
maintained for this purpose on the books of the Company for the
benefit of Mr. Harris (the "SERP Account"). The amounts credited
to the SERP Account will be deemed invested or reinvested in such
mutual funds or U.S. Government securities as determined by Mr.
Harris. The SERP Account will be credited and debited to reflect
the deemed investment returns, losses and expenses attributed to
such deemed investments and reinvestments. Mr. Harris' benefit
under the SERP will equal the balance in the SERP Account and such
benefit will always be 100 percent vested (i.e., not forfeitable).
Mr. Harris will determine the form and timing of the distribution
of the balance in the SERP Account; provided, however, in the event
of the termination, the balance in the SERP Account will be
distributed to Mr. Harris or his beneficiary, as the case may be,
in a lump-sum payment within 30 days of such termination. The
Company will establish a rabbi trust for the purpose of
accumulating funds to satisfy the obligations incurred by the
Company under the SERP. The restricted funds for the SERP Plan
total $756,944 as of December 31, 2002. Mr. Harris' rights to
benefits pursuant to this SERP will be no greater than those of a
general creditor of the Company.
The Employment Agreement provides severance pay in the event
of termination without cause or by constructive discharge and also
provides for certain death benefits payable to the surviving spouse
equal to the executive's base salary for a period of two years.
56
In addition, Mr. Harris is entitled to receive severance pay
pursuant to the severance compensation agreement that he entered
into with the Company, effective August 15, 1990. The severance
compensation agreement provides that if, following a change in
control of the Company, as defined in the agreement, such
individual's employment is terminated by the Company without cause
or by the executive within one year of such change in control, the
individual shall be entitled to receive compensation in a lump sum
payment equal to 2.99 times the individual's average annualized
compensation and payment of other welfare benefits. If Mr. Harris'
termination is without cause or is a constructive discharge, the
amount payable under the Employment Agreement will be reduced by
the amounts paid pursuant to the severance compensation agreement.
As of January 1, 1989, the Company adopted an employee
benefits program covering substantially all employees of the
Company under a 401(k) Plan and Trust Agreement. As of January 1,
1999, the Company adopted the Harris & Harris Pension Plan and
Trust, a money purchase plan which would allow the Company to stay
compliant with the 401(k) top-heavy regulations and deduction
limitation regulations. In 2001, Congress enacted the Economic
Growth and Tax Relief Reconciliation Act of 2001 which has
increased the deduction limits for plans such as the 401(k) Plan.
This Act eliminates the need for the Company to maintain two
separate plans. Effective December 31, 2001, the Pension Plan
merged into the 401(k) Plan, with the 401(k) Plan being the
surviving plan. Contributions to the plan are at the discretion of
the Company. During 2002, contributions to the plan that have been
charged to salaries and benefits totaled approximately $51,500.
On June 30, 1994, the Company adopted a plan to provide
medical and health insurance for retirees, their spouses and
dependents who, at the time of their retirement, have ten years of
service with the Company and have attained 50 years of age or have
attained 45 years of age and have 15 years of service with the
Company. On February 10, 1997, the Company amended this plan to
include employees who "have seven full years of service and have
attained 58 years of age." The coverage is secondary to any
government provided or subsequent employer provided health
insurance plans. Based upon actuarial estimates, the Company
provided an original reserve of $176,520 that was charged to
operations for the period ending June 30, 1994. As of December 31,
2002 the Company had a reserve of $446,302 for the plan.
NOTE 6. INCOME TAXES
The Company elected Sub-Chapter M status for the year ended
December 31, 1999. On February 23, 1999, the Company declared a
cash dividend of $0.35 per share (for a total of $3,647,017),
thereby distributing part of the long-term capital gain generated
in 1999 by the sale of NBX Corporation to 3Com Corporation.
Approximately $143,261 of the long-term capital gain for 1999 was
not distributed during 1999. Accordingly, on September 20, 2000,
the Company declared a $0.02 dividend (for a total of $184,817).
For the year ended December 31, 1999, the Company incurred
approximately $20,000 in excise taxes.
Provided that a proper election is made, a corporation taxable
under Sub-Chapter C of the Internal Revenue Code (a "C
Corporation") that elects to qualify as a RIC continues to be
taxable as a C Corporation on any gains realized within 10 years of
its qualification as a RIC (the "Inclusion Period") from sales of
assets that were held by the corporation on the effective date of
the RIC election ("C Corporation Assets") to the extent of any
gain built into the assets on such date ("Built-In Gain"). (If
the corporation fails to make a proper election, it is taxable on
its Built-In Gain as of the effective date of its RIC election.)
The Company had Built-In Gains at the time of its qualification as
a RIC and made the election to be taxed on any Built-In Gain
realized during the Inclusion Period. Prior to 1999, the Company
incurred ordinary and capital losses from its operations. After
the Company's election of RIC status, those losses remained
available to be carried forward to subsequent taxable years. The
Company has previously used loss carryforwards to offset Built-In
Gains. As of January 1, 2003, the Company had $501,640 of loss
carryforwards remaining and $4,663,457 of unrealized Built-In
Gains.
57
Continued qualification as a RIC requires the Company to satisfy
certain investment asset diversification requirements in future
years. The Company's ability to satisfy those requirements may not
be controllable by the Company. (See "Sub-Chapter M Status"
contained in Item 1. "Business.") There can be no assurance that
the Company will qualify as a RIC in subsequent years.
To the extent that the Company retains capital gains, and
declares a deemed dividend to shareholders, the dividend is taxable
to the shareholders. The Company would pay tax, at the corporate
rate, on the distribution, and the shareholders would receive a tax
credit equal to their proportionate share of the tax paid. The
Company took advantage of this rule for 2000 and 2001. The Company's
financial statements for 2000 and 2001 include a tax liability of
$5,709,884 and $290,748, respectively. The taxes paid by the
Company's shareholders as a result of its deemed dividend declaration
for 2000 ($5,688,896) and 2001 ($271,467) are reflected as a
deduction to the additional paid-in capital in the Company's
Consolidated Statement of Assets and Liabilities rather than an
expense in the Consolidated Statement of Operations.
The Company also realized short-term capital gains of
approximately $2,111,865 in 2000, primarily on sales of shares of
Alliance Pharmaceutical Corp. The Company offset the realized short-
term gain with 2000 expenses and neither owed federal income taxes on
the gain nor was required to distribute any portion of this gain to
shareholders.
In 2002, the Company realized long-term capital losses of
$470,622 primarily from long-term capital gains of $1,008,653 from
the Company's liquidation of its partnership interest in PHZ Capital
Partners L.P. offset by losses on the sale of Schwoo, Inc. of
$1,248,825 and on the liquidation of Informio, Inc. of $350,583. The
Company also realized short-term capital gains of $732,936 primarily
from the liquidation of its partnership interest in PHZ Capital
Partners L.P. Realized short-term capital gains were reduced by
realized long-term capital losses resulting in net realized short-
term capital gains. The Company offset the net realized short-term
gains with 2002 expenses and neither owed federal income taxes on the
gain nor was required to distribute any portion of this gain to
shareholders.
For the years ended December 31, 2002, 2001 and 2000, the
Company's income tax (benefit) expense was allocated as follows:
2002 2001 2000
Investment operations $ 0 $ 0 $ 0
Realized income on
investments 894,435 118,415 101,435
Decrease in unrealized
appreciation on
investments (695,126) (90,464) (153,304)
--------- -------- ----------
Total income tax
(benefit) expense $ 199,309 $ 27,951 $ (51,869)
========= ========= ==========
The above tax (benefit) expense consists of the following:
2002 2001 2000
Current $ 894,435 $ 118,415 $ 101,435
Deferred -- Federal (695,126) (90,464) (153,304)
--------- --------- ----------
Total income tax
(benefit) expense $ 199,309 $ 27,951 $ (51,869)
========= ========= ==========
The Company's net deferred tax liability at December 31, 2002
and 2001 consists of the following:
2002 2001
Unrealized appreciation on investments $ 844,918 $1,540,044
Net operating and capital loss carryforward (175,574) (175,574)
--------- ----------
Net deferred income tax liability $ 669,344 $1,364,470
========= ==========
58
NOTE 7. COMMITMENTS AND CONTINGENCIES
During 1993, the Company signed a ten-year lease with sublet
provisions for office space. In 1995, this lease was amended to
include additional office space. During 1999, the Company sublet
this additional space to an unaffiliated party. Rent expense under
this lease for the year ended December 31, 2002 was $178,561.
Future minimum lease payments in 2003 are $101,946.
The Company had $750,000 of funds in escrow as of December 31,
2002, in anticipation of closing an investment in NanoGram Devices
Corporation. On February 3, 2003, the Company announced that it
had invested in a convertible preferred security of Nanogram
Devices Corporation.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
On November 19, 2001, the Company established an asset
account line of credit of up to $12,700,000. The asset account
line of credit is secured by the Company's government agency
securities. Under the asset account line of credit, the Company
may borrow up to 95 percent of the current value of its government
agency securities. The Company's outstanding balance under the
asset line of credit at December 31, 2001 and December 31, 2002
was $12,495,777 and $0, respectively. The asset line of credit
bears interest at a rate of the Broker Call Rate plus 50 basis
points.
NOTE 9. SUBSEQUENT EVENTS
On January 16, 2003, the Company received $786,492 as final
payment in the liquidation of the Company's investment in PHZ
Capital Partners L.P.
On February 3, 2003, the Company announced that it had
invested $750,000 in a convertible preferred security of Nanogram
Devices Corporation. Nanogram Devices has developed and is
commercializing specialized power sources for medical devices and
other medical equipment based on its patented, laser-based
nanomaterials synthesis technology.
On March 20, 2003, in order to begin planning for eventual
management succession, the Board of Directors voted to establish a
mandatory retirement plan for individuals who are employed by the
Company in a bona fide executive or high policy making position.
There are currently two such individuals, the Chairman and CEO, and
the President and COO. Under this plan, mandatory retirement will
take place effective December 31 of the year in which the eligible
individuals attain the age of 65. On an annual basis beginning in
the year in which the designated individual attains the age of 65,
a committee of the Board consisting of non-interested directors may
determine to postpone the mandatory retirement date for that
individual for one additional year for the benefit of the Company.
Pursuant to applicable age discrimination laws, the Company is
required to establish a pension benefit plan (the "Plan") for such
individuals. The Company's Chairman and CEO has offered, for the
benefit of the Company in connection with its establishment of the
Plan, to waive certain of his existing benefit rights, which is
expected to relieve the Company from having to provide for Plan
expense for him. Plan expense to cover the President and COO's
anticipated benefit under the Plan will total approximately a
currently estimated $450,000, which will be unfunded and will be
amortized over the fiscal periods through the year ended December
31, 2004.
59
FINANCIAL HIGHLIGHTS
Per share operating performance:
Year Ended Year Ended Year Ended Year Ended Year Ended
December December December December December
31, 2002 31, 2001 31, 2000 31, 1999 31, 1998
Net asset value, beginning
of period $ 2.75 $ 3.51 $ 5.80 $ 2.13 $ 3.15
Net operating income (loss) (0.19) (0.06) 0.37 (1.04) (0.26)
Net realized gain (loss) on
investments 0.24 0.14 2.09 0.93 (0.16)
Net (decrease) increase in unrealized
appreciation as a result of sales 0.13 0.45 (2.35) (0.46) 0.11
Net decrease (increase) in unrealized
appreciation on investments held (0.46) (1.30) (1.82) 4.58 0.05
Net decrease as a result of cash
dividend 0.00 0.00 (0.02) (0.35) (0.75)
Net decrease as a result of deemed
dividend 0.00 (0.03) (0.62) 0.00 0.00
Net increase (decrease) from capital
stock transactions (0.10) 0.04 0.06 0.01 (0.01)
----------- ----------- ----------- ------------- ----------
Net asset value, end of period* $ 2.37 $ 2.75 $ 3.51 $ 5.80 $ 2.13
=========== =========== =========== ============ ==========
Cash dividends paid per share $ 0.00 $ 0.00 $ 0.02 $ 0.35 $ 0.75
Deemed dividend per share $ 0.00 $ 0.0875 $ 1.78 $ 0.00 $ 0.00
Market value per share, end
of period $ 2.46 $ 1.90 $ 2.4375 $ 11.50 $ 1.50
Total income tax liability
per share $ 0.15 $ 0.18 $ 0.78 $ 0.16 $ 0.09
Ratio of expenses to average
net assets 8.3% 3.45% (6.21)% 34.08% 10.9%
Ratio of net operating gain
(loss) to average net assets (7.3)% (1.75)% 52.7% (3.50)% (10.4)%
Investment return based on:
Stock price 40.5% (22.1)% (78.8)% 666.7% (45.5)%
Net asset value (13.8)% (21.7)% (39.5)% 188.7% (8.3)%
Portfolio turnover 46.00% 9.00% 20.56% 53.54% 19.71%
Net assets, end of period $27,256,046 $24,334,770 $ 31,833,475 $ 53,634,805 $22,556,709
Number of shares outstanding 11,498,845 8,864,231 9,064,231 9,240,831 10,591,232
*Reflects the decline in net asset value as a result of the $0.02
dividend paid in 2000.
The accompanying notes are an integral part of this schedule.
60
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure
On February 26, 2002, the Company appointed the accounting
firm of PricewaterhouseCoopers LLP as independent accountants for
the Company for the fiscal year ending December 31, 2002. Arthur
Andersen LLP was dismissed effective upon completion of the
December 31, 2001 audit. The decision to change accountants was
approved by the Company's Audit Committee and was subject to
ratification by its stockholders.
In connection with its audits for the 2001 and 2000 fiscal
years, (1) there were no disagreements with Arthur Andersen on any
matter of accounting principle or practice, financial statement
disclosure, auditing scope or procedure, whereby such
disagreements, if not resolved to the satisfaction of Arthur
Andersen, would have caused them to make reference thereto in their
report on the financial statements for such years; and (2) there
have been no reportable events (as defined in Item 304(a)(1)(v) of
Regulation S-K).
The reports of Arthur Andersen on the financial statements of
the Company for 2001 and 2000 contained no adverse opinion or
disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principle.
The Company did not consult with PricewaterhouseCoopers LLP in
2001, 2000 or the interim period from January 1, 2002 to February
26, 2002 on either the application of accounting principles to a
specified transaction either completed or proposed or the type of
audit opinion PricewaterhouseCoopers LLP might issue on the
Company's financial statements.
The Company requested that Arthur Andersen furnish a letter
addressed to the Securities and Exchange Commission stating whether
or not Arthur Andersen agreed with the above statements. A copy of
such letter to the SEC, dated March 1, 2002, was filed as Exhibit
16.1 to the Form 8-K filed with the SEC on March 1, 2002.
61
PART III
Item 10. Directors and Executive Officers of the Company
The information set forth under the captions "Election of
Directors" on page 3, "Executive Officers" on page 12 and "Section
16(a) Beneficial Ownership Reporting Compliance" on page 20 in the
Company's Proxy Statement for Annual Meeting of Shareholders to be
held May 5, 2003, filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934 on or about March 25, 2003 (the
"2003 Proxy Statement") is herein incorporated by reference.
Item 11. Executive Compensation
The information set forth under the captions "Summary
Compensation Table" on page 13 and "Compensation of Directors" on
page 19 in the 2003 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 Certain Beneficial Owners" on pages 10 and 11 in the
2003 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, 2002.
Item 14. Controls and Procedures
(a) Within the 90-day period prior to the filing date of this
annual report, the Company's chief executive officer and chief
financial officer conducted an evaluation of the Company's
disclosure controls and procedures (as defined in Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934). Based upon this
evaluation, the Company's chief executive officer and chief
financial officer concluded that the Company's disclosure controls
and procedures are effective in timely alerting them of any
material information relating to the Company that is required to be
disclosed by the Company in the reports it files or submits under
the Securities Exchange Act of 1934.
(b) There have not been any significant changes in the
Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
62
PART IV
Item 15. Exhibits, Consolidated Financial Statements, Schedules
and Reports on Form 8-K
(a) The following documents are filed as a part of this report:
(1) Listed below are the financial statements which are filed
as part of this report:
o Consolidated Statements of Assets and Liabilities as of
December 31, 2002 and 2001;
o Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000;
o Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000;
o Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2002, 2001 and 2000;
o Consolidated Schedule of Investments as of December 31,
2002;
o Footnote to Consolidated Schedule of Investments;
o Notes to Consolidated Financial Statements; and
o Selected Per Share Data and Ratios for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998.
(2) No financial statement schedules are required to be filed
herewith because (i) such schedules are not required or (ii)
the information has been presented in the above financial
statements.
(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.
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.
63
10.1 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.
10.2 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.
10.3 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.
10.4 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.
10.5 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.
10.6 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.
10.7 Harris & Harris Group, Inc. Directors Stock Purchase Plan
2001.
10.8 Harris & Harris Group, Inc. Executive Mandatory Retirement
Plan.
10.9 Amendment No. 1 to Deferred Compensation Agreement.
11.0* Computation of Per Share Earnings is set forth under Item 8.
99.1* Certification of CEO and CFO pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
(b) Reports on Form 8-K. None
*Exhibits attached.
64
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.
Date: March 24, 2003 By:/s/ Charles E. Harris
---------------------
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 Board March 18, 2003
- --------------------- and Chief Executive Officer
Charles E. Harris
/s/ Mel P. Melsheimer President, Chief Operating March 18, 2003
- --------------------- Officer, Chief Financial Officer,
Mel P. Melsheimer Treasurer and Chief Compliance Officer
/s/ Helene B. Shavin Vice President and Controller March 18, 2003
- --------------------
Helene B. Shavin
/s/ Phillip A. Bauman Director March 13, 2003
- ---------------------
Phillip A. Bauman
65
/s/ G. Morgan Browne Director March 14, 2003
- --------------------
G. Morgan Browne
/s/ Dugald A. Fletcher Director March 13, 2003
- ----------------------
Dugald A. Fletcher
/s/Kelly S. Kirkpatrick Director March 18, 2003
- -----------------------
Kelly S. Kirkpatrick
/s/ Glenn E. Mayer Director March 14, 2003
- ------------------
Glenn E. Mayer
/s/ Lori D. Pressman Director March 21, 2003
- --------------------
Lori D. Pressman
/s/ Charles E. Ramsey Director March 19, 2003
- ---------------------
Charles E. Ramsey
/s/ James E. Roberts Director March 18, 2003
- --------------------
James E. Roberts
66
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Charles E. Harris, Chief Executive Officer of the Company,
certify that:
1. I have reviewed this annual report on Form 10-K of Harris &
Harris Group, Inc.:
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons fulfilling the equivalent
functions):
a. all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
By: /s/ Charles E. Harris
---------------------
Date: March 24, 2003 Charles E. Harris,
Chief Executive Officer
67
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Mel P. Melsheimer, Chief Financial Officer of the Company,
certify that:
7. I have reviewed this annual report on Form 10-K of Harris &
Harris Group, Inc.:
8. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
9. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
10. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
11. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons fulfilling the equivalent
functions):
a. all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
12. The registrant's other certifying officers and I have
indicated in this annual report whether there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
By: /s/ Mel P. Melsheimer
---------------------
Date: March 24, 2003 Mel P. Melsheimer,
Chief Financial Officer
68
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
10.8 Harris & Harris Group, Inc. Executive Mandatory Retirement
Plan.
10.9 Amendment No. 1 to Deferred Compensation Agreement.
11.0 Computation of Per Share Earnings is set forth under Item 8.
99.1 Certification of CEO and CFO pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
69