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, 2003 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
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
111 West 57th Street, New York, New York 10019
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 582-0900
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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 30, 2003 was $70,370,536 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 10, 2004 the registrant had 13,798,845 shares of common stock,
par value $.01 per share, outstanding.
TABLE OF CONTENTS
Page
PART I
Item 1. Business........................................................ 1
Item 2. Properties...................................................... 23
Item 3. Legal Proceedings............................................... 23
Item 4. Submission of Matters to a Vote of Security Holders............. 23
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............................62
Item 9a. Controls and Procedures..........................................62
PART III
Item 10. Directors and Executive Officers of the Company..................63
Item 11. Executive Compensation...........................................63
Item 12. Security Ownership of Certain Beneficial Owners and Management...63
Item 13. Certain Relationships and Related Transactions...................63
Item 14. Principal Accountant Fees and Services...........................63
PART IV
Item 15. Exhibits, Consolidated Financial Statement, Schedules and
Reports on Form 8-K............................................64
Signatures.................................................................66
Exhibit Index..............................................................68
PART I
Item 1. Business
Harris & Harris Group, Inc. (the "Company," "us," "our," and
"we") is a venture capital company specializing in tiny
technology that operates as a non-diversified business
development company ("BDC") under the Investment Company Act of
1940, which we refer to as the 1940 Act. For tax purposes, we
operate as a regulated investment company ("RIC") under
Subchapter M of the Internal Revenue Code of 1986, which we refer
to as the Code. Our investment objective is to achieve long-term
capital appreciation, rather than current income, by making
venture capital investments in early-stage companies. Our
approach is comprised of a patient examination of available early
stage opportunities, thorough due diligence and close involvement
with management. As a venture capital company, we invest in and
provide managerial assistance to our portfolio companies which,
in our opinion, have significant potential for growth. We are
managed by our Board of Directors and officers and have no
investment advisor.
We make initial venture capital investments exclusively in
"tiny technology," which we define as microsystems,
microelectromechanical systems (which we refer to as MEMS) and
nanotechnology. We consider a company to be a tiny technology
company if the company employs or intends to employ technology
that we consider to be at the microscale or smaller and that is
material to its business plan. Our portfolio includes non-tiny
technology investments made prior to 2001, and we may make
follow-on investments in either tiny or non-tiny technology
companies. By making these investments, we seek to provide our
shareholders with an increasingly specific focus on tiny
technology through a portfolio of venture capital investments
that address a variety of markets and products. This investment
policy is not a fundamental policy and accordingly may be changed
without shareholder approval, although we intend to give
shareholders at least 60 days prior notice of any change in our
policy.
Tiny technology is multidisciplinary and widely applicable,
and it incorporates technology that is significantly smaller than
is currently in general use. Microsystems are measured in
micrometers, which are units of measurement in millionths of a
meter. Nanotechnology is measured in nanometers, which are units
of measurement in billionths of a meter. Because it is a new
field, tiny technology has significant scientific, engineering
and commercialization risks.
Our website is www.TinyTechVC.com. We make available free
of charge through our website: our annual report on Form 10-K;
our quarterly reports on Form 10-Q; our 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.
1
Neither our investments, nor an investment in us, is
intended to constitute a balanced investment program. We expect
to be risk seeking rather than risk averse in our investment
approach. To such end, we reserve the fullest possible freedom
of action, subject to our certificate of incorporation,
applicable law and regulations, and policy statements contained
herein. There is no assurance that our investment objective will
be achieved.
We expect to invest a substantial or major portion of our
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.
We expect to make speculative investments with limited
marketability and a greater risk of investment loss than less
speculative issues. Although we now restrict our initial
investments to tiny technology, such technology is enabling
technology applicable to a wide range of fields and businesses,
and we do not seek to invest in any particular industries or
categories of investments. Our securities investments may consist
of private, public or governmental issuers of any type. Subject
to the diversification requirements pertaining to a RIC, we may
commit all of our assets to only a few investments.
Achievement of our investment objectives is basically
dependent upon the judgment of a team of four professional, full-
time members of management who are designated as Managing
Directors, Charles E. Harris, Mel P. Melsheimer, Douglas W.
Jamison and Daniel V. Leff, and two directors who are also
consultants to us, Dr. Kelly S. Kirkpatrick and Lori D. Pressman.
They collectively have expertise in venture capital investing,
intellectual property and nanotechnology. Charles E. Harris is
our Chairman and Chief Executive Officer and a "control" person
as defined in the 1940 Act. 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 our
behalf.
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 we may invest. Investments may include the
following:
o Equity, equity-related securities (including warrants)
and debt with equity features from either private or
public issuers.
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.
2
Investments and Strategies
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The following is a summary description of the types of
assets in which we may invest, the investment strategies we may
utilize and the attendant risks associated with our investments
and strategies.
Equity, Equity-Related Securities and Debt with Equity
Features
We may invest in equity, equity-related securities and debt
with equity features. These securities include common stock,
preferred stock, debt instruments convertible into common or
preferred stock, limited partnership interests, other beneficial
ownership interests and warrants, options or other rights to
acquire any of the foregoing.
We may make investments in companies with operating
histories that are unprofitable or marginally profitable, that
have negative net worth or that are involved in bankruptcy or
reorganization proceedings. These investments would involve
businesses that management believes have turnaround potential
through the infusion of additional capital and management
assistance. In addition, we may make investments in connection
with the acquisition or divestiture of companies or divisions of
companies. There is a significantly greater risk of loss with
these types of securities than is the case with traditional
investment securities.
We may also invest in publicly traded securities of whatever
nature, including relatively small, emerging growth companies
that management believes have long-term growth possibilities.
Warrants, options and convertible or exchangeable securities
generally give the investor the right to acquire specified equity
securities of an issuer at a specified price during a specified
period or on a specified date. Warrants and options fluctuate in
value in relation to the value of the underlying security and the
remaining life of the warrant or option, while convertible or
exchangeable securities fluctuate in value both in relation to
the intrinsic value of the security without the conversion or
exchange feature and in relation to the value of the conversion
or exchange feature, which is like a warrant or option. When we
invest in these securities, we incur the risk that the option
feature will expire worthless, thereby either eliminating or
diminishing the value of our investment.
Investments in equity securities of private companies
involve securities that are restricted as to sale and cannot be
sold in the open market without registration under the Securities
Act of 1933 or pursuant to a specific exemption from these
registrations. Opportunities for sale are more limited than in
the case of marketable securities, although these investments may
be purchased at more advantageous prices and may offer attractive
investment opportunities. Even if one of our portfolio companies
completes an initial public offering, we are typically subject to
a lock-up agreement, and the stock price may decline
substantially before we are free to sell. Even if we have
registration rights to make our investments more marketable, a
considerable amount of time may elapse between a decision to sell
or register the securities for sale and the time when we are able
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to sell the securities. The prices obtainable upon sale may be
adversely affected by market conditions or negative conditions
affecting the issuer during the intervening time.
Venture Capital Investments
We expect to invest in development stage or start-up
businesses. Substantially all of our long-term investments are
in thinly capitalized, unproven, small companies focused on risky
technologies. These businesses also tend to lack management
depth, to have limited or no history of operations and to have
not attained profitability. Because of the speculative nature of
these investments, these securities have a significantly greater
risk of loss than traditional investment securities. Some of our
venture capital investments are likely to be complete losses or
unprofitable and some will never realize their potential.
We may own 100% of the securities of a start-up investment
for a period of time and may control the company for a
substantial period. Start-up companies are more vulnerable than
better capitalized companies to adverse business or economic
developments. Start-up businesses generally have limited product
lines, service niches, markets and/or financial resources.
Start-up companies are not well-known to the investing public and
are subject to potential bankruptcy, general movements in markets
and perceptions of potential growth.
In connection with our venture capital investments, we may
participate in providing a variety of services to our portfolio
companies, including the following:
o recruiting management;
o formulating operating strategies;
o formulating intellectual property strategies;;
o assisting in financial planning;
o providing management in the initial start-up stages; and
o establishing corporate goals.
We may assist in raising additional capital for these
companies from other potential investors and may subordinate our
own investment to that of other investors. We may also find it
necessary or appropriate to provide additional capital of our
own. We may introduce these companies to potential joint venture
partners, suppliers and customers. In addition, we may assist in
establishing relationships with investment bankers and other
professionals. We may also assist with mergers and acquisitions.
We do not derive income from these companies for the performance
of any of the above services.
We may control, be represented on or have observer rights on
the board of directors of a portfolio company by one or more of
our officers or directors, who may also serve as officers of the
portfolio company. We indemnify our officers and directors for
serving on the boards of directors or as officers of portfolio
companies, which exposes us to additional risks. Particularly
during the early stages of an investment, we may in effect be
conducting the operations of the portfolio company. As a venture
company emerges from the developmental stage with greater
management depth and experience, we expect that our role in the
4
portfolio company's operations will diminish. Our goal is to
assist each company in establishing its own independent
capitalization, management and board of directors. We expect to
be able to reduce our involvement in those start-up companies
which become successful.
Debt Obligations
We may hold debt securities for income and as a reserve
pending more speculative investments. Debt obligations may
include U.S. government and government agency securities,
commercial paper, bankers' acceptances, receivables or other
asset-based financing, notes, bonds, debentures, or other debt
obligations of any nature and repurchase agreements related to
these securities. These obligations may have varying terms with
respect to security or credit support, subordination, purchase
price, interest payments and maturity from private, public or
governmental issuers of any type located anywhere in the world.
We may invest in debt obligations of companies with operating
histories that are unprofitable or marginally profitable, that
have negative net worth or are involved in bankruptcy or
reorganization proceedings, or that are start-up or development
stage entities. In addition, we may participate in the
acquisition or divestiture of companies or divisions of companies
through issuance or receipt of debt obligations.
It is likely that our investments in debt obligations will
be of varying quality, including non-rated, highly speculative
debt investments with limited marketability. Investments in
lower-rated and non-rated securities, commonly referred to as
"junk bonds," are subject to special risks, including a greater
risk of loss of principal and non-payment of interest.
Generally, lower-rated securities offer a higher return potential
than higher-rated securities but involve greater volatility of
price and greater risk of loss of income and principal, including
the possibility of default or bankruptcy of the issuers of these
securities. Lower-rated securities and comparable non-rated
securities will likely have large uncertainties or major risk
exposure to adverse conditions and are predominantly speculative
with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligation. The
occurrence of adverse conditions and uncertainties to issuers of
lower-rated securities would likely reduce the value of lower-
rated securities held by us, with a commensurate effect on the
value of our shares.
The markets in which lower-rated securities or comparable
non-rated securities are traded generally are more limited than
those in which higher-rated securities are traded. The existence
of limited markets for these securities may restrict our ability
to obtain accurate market quotations for the purposes of valuing
lower-rated or non-rated securities and calculating net asset
value or to sell securities at their fair value. Any economic
downturn could adversely affect the ability of issuers' lower-
rated securities to repay principal and pay interest thereon.
The market values of lower-rated and non-rated securities also
tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-rated securities.
In addition, lower-rated securities and comparable non-rated
securities generally present a higher degree of credit risk.
Issuers of lower-rated securities and comparable non-rated
securities are often highly leveraged and may not have more
traditional methods of financing available to them, so that their
ability to service their debt obligations during an economic
downturn or during sustained periods of rising interest rates may
5
be impaired. The risk of loss owing to default by these issuers
is significantly greater because lower-rated securities and
comparable non-rated securities generally are unsecured and
frequently are subordinated to the prior payment of senior
indebtedness. We may incur additional expenses to the extent
that we are required to seek recovery upon a default in the
payment of principal or interest on our portfolio holdings.
The market value of investments in debt securities that
carry no equity participation usually reflects yields generally
available on securities of similar quality and type at the time
purchased. When interest rates decline, the market value of a
debt portfolio already invested at higher yields can be expected
to rise if the securities are protected against early call.
Similarly, when interest rates increase, the market value of a
debt portfolio already invested at lower yields can be expected
to decline. Deterioration in credit quality also generally
causes a decline in market value of the security, while an
improvement in credit quality generally leads to increased value.
Foreign Securities
We may make investments in securities of issuers whose
principal operations are conducted outside the United States, and
whose earnings and securities are stated in foreign currency. In
order to maintain our status as a business development company,
our investments in the stocks of companies organized outside the
U.S. would be limited to 30% of our assets, because we must
invest at least 70% of our assets in "qualifying assets" and
foreign companies are not "qualifying assets." We do not
anticipate investing a significant portion of our assets in
foreign companies.
Compared to otherwise comparable investments in securities
of U.S. issuers, currency exchange risk of securities of foreign
issuers is a significant variable. The value of these
investments to us will vary with the relation of the currency in
which they are denominated to the U.S. dollar, as well as with
intrinsic elements of value such as credit risk, interest rates
and performance of the issuer. Investments in foreign securities
also involve risks relating to economic and political
developments, including nationalization, expropriation, currency
exchange freezes and local recession. Securities of many foreign
issuers are less liquid and more volatile than those of
comparable U.S. issuers. Interest and dividend income and
capital gains on our foreign securities may be subject to
withholding and other taxes that may not be recoverable by us.
We may seek to hedge all or part of the currency risk of our
investments in foreign securities through the use of futures,
options and forward currency purchases or sales.
Intellectual Property
We believe there is a role for organizations that can assist
in technology transfer. Scientists and institutions that develop
and patent intellectual property perceive the need for and
rewards of entrepreneurial commercialization of their inventions.
6
Our form of investment may be:
o funding research and development in the development of a
technology;
o obtaining licensing rights to intellectual property or
patents;
o acquiring intellectual property or patents; or
o forming and funding companies or joint ventures to
commercialize further intellectual property.
Income from our investments in intellectual property or its
development may take the form of participation in licensing or
royalty income, fee income, or some other form of remuneration.
Investment in developmental intellectual property rights involves
a high degree of risk that can result in the loss of our entire
investment as well as additional risks including uncertainties as
to the valuation of an investment and potential difficulty in
liquidating an investment. Further, investments in intellectual
property generally require investor patience as investment return
may be realized only after or over a long period. At some point
during the commercialization of a technology, our investment may
be transformed into ownership of securities of a development
stage or start-up company as discussed under "Venture Capital
Investments" above.
Other Strategies
In pursuit of our investment strategy, we may employ one or
more of the following strategies in order to enhance investment
results.
Borrowing and Margin Transactions
We may from time to time borrow money or obtain credit by
any lawful means from banks, lending institutions, other entities
or individuals, in negotiated transactions. We may issue,
publicly or privately, bonds, debentures or notes, in series or
otherwise, with interest rates and other terms and provisions,
including conversion rights, on a secured or unsecured basis, for
any purpose, up to the maximum amounts and percentages permitted
for closed-end investment companies under the 1940 Act. The 1940
Act currently prohibits us from borrowing any money or issuing
any other senior securities (other than preferred stock and other
than temporary borrowings of up to 5% of our assets), if in
giving effect to the borrowing or issuance, the value of our
total assets would be less than 200% of our total liabilities
(other than liabilities not constituting senior securities). We
may pledge assets to secure any borrowings. We currently have no
leverage and have no current intention to issue preferred stock.
A primary purpose of our borrowing power is for leverage, to
increase our ability to acquire investments both by acquiring
larger positions and by acquiring more positions. Borrowings for
leverage accentuate any increase or decrease in the market value
of our investments and thus our net asset value. Because any
decline in the net asset value of our investments will be borne
first by holders of common stock, the effect of leverage in a
declining market would be a greater decrease in net asset value
applicable to the common stock than if we were not leveraged. Any
decrease would likely be reflected in a decline in the market
price of our common stock. To the extent the income derived from
7
assets acquired with borrowed funds exceeds the interest and
other expenses associated with borrowing, our total income will
be greater than if borrowings were not used. Conversely, if the
income from assets is not sufficient to cover the borrowing
costs, our total income will be less than if borrowings were not
used. If our current income is not sufficient to meet our
borrowing costs (repayment of principal and interest), we might
have to liquidate our investments when it may be disadvantageous
to do so. Our borrowings for the purpose of buying most liquid
equity securities will be subject to the margin rules, which
require excess liquid collateral marked to market daily. If we
are unable to post sufficient collateral, we will be required to
sell securities to remain in compliance with the margin rules.
These sales might be at disadvantageous times or prices.
Repurchase of Shares
Our shareholders do not have the right to compel us to
redeem our shares. We may, however, purchase outstanding shares
of our common stock from time to time, subject to approval of our
board of directors and compliance with applicable corporate and
securities laws. The board of directors may authorize purchases
from time to time when they are deemed to be in the best
interests of our shareholders, but could do so only after
notification to shareholders. The board of directors may or may
not decide to undertake any purchases of our common stock.
Our repurchases of our common shares would decrease our
total assets and would therefore likely have the effect of
increasing our expense ratio. Subject to our investment
restrictions, we may borrow money to finance the repurchase of
our common stock in the open market pursuant to any tender offer.
Interest on any borrowings to finance share repurchase
transactions will reduce our net assets. If, because of market
fluctuations or other reasons, the value of our assets falls
below the required 1940 Act coverage requirements, we may have to
reduce our borrowed debt to the extent necessary to comply with
the requirement. To achieve a reduction, it is possible that we
may be required to sell portfolio securities at inopportune times
when it may be disadvantageous to do so. Since 1998, we have
repurchased a total of 1,828,740 shares of our common stock at a
total cost of $3,405,531, or $1.86 per share. Because we intend
to continue investing in tiny technology, our board of directors
does not currently intend to authorize the purchase of additional
shares of our common stock.
Portfolio Company Turnover
Changes with respect to portfolio companies will be made as
our management considers necessary in seeking to achieve our
investment objective. The rate of portfolio turnover will not be
treated as a limiting or relevant factor when circumstances exist
which are considered by management to make portfolio changes
advisable.
Although we expect that many of our investments will be
relatively long term in nature, we may make changes in our
particular portfolio holdings whenever it is considered that an
investment no longer has substantial growth potential or has
reached its anticipated level of performance, or (especially when
cash is not otherwise available) that another investment appears
to have a relatively greater opportunity for capital appreciation.
8
We may also make general portfolio changes to increase our cash
to position us in a defensive posture. We may make portfolio
changes without regard to the length of time we have held an
investment, or whether a sale results in profit or loss, or
whether a purchase results in the reacquisition of an
investment which we may have only recently sold.
The portfolio turnover rate may vary greatly from year to
year as well as during a year and may also be affected by cash
requirements.
Investment Restrictions
When we were a regulated investment company, pursuant to a
requirement under the 1940 Act, we provided that our investment
objective and the following investment restrictions were
fundamental and could not be changed without the approval of the
holders of a majority of our outstanding voting securities
(defined in the 1940 Act as the lesser of (a) more than 50% of
the outstanding shares or (b) 67% or more of the shares
represented at a meeting at which more than 50% of the
outstanding shares are represented). The provisions of the 1940
Act regarding fundamental investment restrictions and objectives
are not applicable to business development companies and
accordingly we believe that the following restrictions do not
apply to us although we have as a matter of fact conducted our
operations consistently with them. Satisfaction of these
restrictions was measured only at the time of a transaction, with
the result that later changes in percentage resulting from
changing market values, for example, would not be considered a
deviation from policy. Under these restrictions, prior to
becoming a business development company, we could not:
(1) invest more than 25% of the value of our total assets
in any one industry;
(2) issue senior securities other than:
(a) preferred stock not in excess of the excess of 50%
of our total assets over any senior securities
described in clause (b) below that are
outstanding,
(b) senior securities other than preferred stock
(including borrowing money, including on margin if
margin securities are owned and through entering
into reverse repurchase agreements, and providing
guaranties) not in excess of 33 1/3% of our total
assets, and
(c) borrowings of up to 5% of our total assets for
temporary purposes without regard to the amount of
senior securities outstanding under clauses (a)
and (b) above; provided, however, that our
obligations under interest rate swaps, when issued
and forward commitment transactions and similar
transactions are not treated as senior securities
if covering assets are appropriately segregated;
or pledge our assets other than to secure the
issuances or in connection with hedging
transactions, short sales, when-issued and forward
commitment transactions and similar investment
strategies.
9
For purposes of clauses (a), (b) and (c) above, "total
assets" shall be calculated after giving effect to the
net proceeds of any issuance and net of any liabilities
and indebtedness that do not constitute senior
securities except for liabilities and indebtedness as
are excluded from treatment as senior securities by the
proviso to this item (2);
(3) make loans of money or property to any person, except
through loans and guaranties to entities, loans of
portfolio securities, the acquisition of fixed income
obligations consistent with our investment objective
and policies or the acquisition of securities subject
to repurchase agreements;
(4) underwrite the securities of other issuers, except to
the extent that in connection with the disposition of
portfolio securities or the sale of our own securities
we may be deemed to be an underwriter;
(5) purchase or sell real estate or interests therein in
excess of our total assets;
(6) purchase or sell commodities or purchase or sell
commodity contracts except for hedging purposes or in
connection with business operations and except for
precious metals and coins; or
(7) make any short sale of securities except in conformity
with applicable laws, rules and regulations and unless,
in giving effect to the sale, the market value of all
securities sold short does not exceed 25%, except short
sales "against the box" which are not subject to the
limitation, of the value of our total assets and our
aggregate short sales of a particular class of
securities does not exceed 25% of the then-outstanding
securities of that class.
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
us and are therefore in a better position than us to obtain
access to attractive venture capital investments. There can be
no assurance that we 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 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.
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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.
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).
We will be periodically examined by the SEC for compliance
with the 1940 Act.
As with other companies regulated by the 1940 Act, a BDC
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,
we are required to provide and maintain a bond issued by a
reputable fidelity insurance company to protect the BDC.
Furthermore, as a BDC, we are prohibited from protecting any
director or officer against any liability to us or our
shareholders arising from willful malfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the
conduct of 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 our assets consist of
qualifying assets. Qualifying assets include: (i) securities of
companies that were eligible portfolio companies at the time we
acquired their securities; (ii) securities of bankrupt or
insolvent companies that were eligible portfolio companies at the
time of our 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.
We are permitted by the 1940 Act, under specified
conditions, to issue multiple classes of senior debt and a single
class of preferred stock if our 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, we are
also permitted by the 1940 Act to issue warrants.
11
Except under certain conditions, we may sell our securities
at a price that is below the prevailing net asset value per share
only after a majority of our disinterested directors have
determined that such sale would be in the best interest of us and
our stockholders and upon the approval by the holders of a
majority of our outstanding voting securities, including a
majority of the voting securities held by non-affiliated persons.
If the offering of the securities is underwritten, a majority of
the disinterested directors must determine in good faith that the
price of the securities being sold is not less than a price which
closely approximates market value of the securities, less any
distribution discount or commission. As defined by the 1940 Act,
the term "majority of the Company's outstanding voting
securities" means the vote of (i) 67 percent or more of our
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 our
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 us
and our portfolio companies.
Subchapter M Status
We elected to be treated as a Regulated Investment Company
(a "RIC"), taxable under Subchapter 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, we must, in general, (1) annually derive at
least 90 percent of our 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 our 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 we must annually
distribute at least 90 percent of our investment company taxable
income, we may either distribute or retain our 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 our realized net
capital gains, we 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 our 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 we would pay tax, at the
corporate rate, on the distribution, and the shareholders would
receive a tax credit equal to their proportionate share of the
tax paid.
12
To the extent that we declare 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 us.
This tax credit, which is paid at the corporate rate, is often
credited at a higher rate than the actual tax due by a
shareholder on the deemed dividend income. The "residual" credit
can be used by the shareholder to offset other taxes due in that
year 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 - Subchapter M Status.")
The following simplified examples illustrate the tax
treatment under Subchapter M of the Code for us and our
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 15 percent* or $.15 per share,
retaining $.85 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 15 percent* federal capital
gains tax on 100 percent of the undistributed gain of $1.00 per
share or $.15 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 15
percent.
13
Although we may retain income and gains subject to the
limitations described above (including paying corporate level tax
on such amounts), we could be subject to an additional four
percent excise tax if we fail to distribute 98 percent of our
aggregate annual taxable income.
As noted above, in order to qualify as a RIC, we quarterly
must meet certain investment asset diversification requirements.
Because of the specialized nature of our investment portfolio,
we have been able to satisfy the diversification requirements
under Subchapter 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 we received SEC certifications for 1999-2002, there
can be no assurance that we will receive such certification for
2003 or subsequent years (to the extent we need additional
certifications as a result of changes in our portfolio). If we
require, but fail to obtain, the SEC certification for a taxable
year, we will fail to qualify as a RIC for such year. We will
also fail to qualify as a RIC for a taxable year if we do not
satisfy the Income Source Rule or Income Distribution Rule for
such year. In the event we do not qualify as a RIC for any
taxable year, we will be subject to federal tax with respect to
all of our taxable income, whether or not distributed. In
addition, all our distributions in that situation generally will
be taxable as ordinary dividends.
Although we generally intend to qualify as a RIC for each
taxable year, under certain circumstances we may choose to take
action with respect to one or more taxable years to ensure that
we would be taxed under Subchapter C of the Code (rather than
Subchapter M) for such year or years. We will take such action
only if we determine that the result of the action will benefit
us and our shareholders.
Prior to 1999, we were taxable under Subchapter 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"). We 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, we incurred ordinary and capital losses
from our operations. After our 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. We have previously used
loss carryforwards to offset Built-In Gains. As of January 1,
2004, the Company had $501,640 of pre-1999 loss carryforwards
remaining and $4,663,457 of unrealized Built-In Gains.
14
Subsidiaries
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100
percent wholly owned subsidiary of the Company and is
consolidated in our financial statements. Enterprises held the
lease for our office space until it expired on July 31, 2003,
which it sublet to us and an unaffiliated party; is a partner in
Harris Partners I, L.P. and is taxed as a C Corporation. Harris
Partners I, L.P. is a limited partnership and, until December 31,
2002, owned a 20 percent limited partnership interest in PHZ
Capital Partners L.P. Currently, Harris Partners I, L.P. owns
our interest in AlphaSimplex Group, LLC. The partners of Harris
Partners I, L.P. are Harris & Harris Enterprises, Inc. (sole
general partner) and Harris & Harris Group, Inc. (sole limited
partner).
Employees
We currently employ directly six full-time employees,
including Daniel V. Leff who joined us as of January 19, 2004.
Risk Factors
Investing in our common stock involves a number of
significant risks relating to our business and investment
objective. These risks and uncertainties are not the only ones
we face. Unknown additional risks and uncertainties, or ones
that we currently consider immaterial, may also impair our
business. If any of these risks or uncertainties materialize, our
business, financial condition or results of operations could be
materially adversely affected. In this event, the trading price
of our common stock could decline, and you could lose all or part
of your investment.
Risks related to the companies in our portfolio.
Investing in small, private companies involves a high degree
of risk and is highly speculative.
We have invested a substantial portion of our assets in
privately held development stage or start-up companies. These
businesses tend to lack management depth, to have limited or no
history of operations and to have not attained profitability.
Tiny technology companies are especially risky, involving
scientific, technological and commercialization risks. Because
of the speculative nature of these investments, these securities
have a significantly greater risk of loss than traditional
investment securities. Some of our venture capital investments
are likely to be complete losses or unprofitable and some will
never realize their potential. We have been and will continue to
be risk seeking rather than risk averse in our approach to
venture capital and other investments. Neither our investments
nor an investment in our common stock is intended to constitute a
balanced investment program.
15
We may invest in companies working with technologies or
intellectual property which currently has few or no proven
commercial applications.
Nanotechnology, in particular, is a developing area of
technology, of which much of the future commercial value is
unknown, difficult to estimate and subject to widely varying
interpretations. There are as of yet relatively few
nanotechnology products commercially available. The timing of
additional future commercially available nanotechnology products
is highly uncertain.
Our portfolio companies working with tiny technology may be
particularly susceptible to intellectual property litigation.
Research and commercialization efforts in tiny technology
are being undertaken by a wide variety of government, academic
and private corporate entities. As additional commercially
viable applications of tiny technology begin to emerge, ownership
of intellectual property on which these products are based may be
contested. Any litigation over the ownership of, or rights to,
any of our portfolio companies' technologies or products would
have a material adverse effect on that company's value and may
have a material adverse effect on the value of our common stock.
Our portfolio companies may not successfully market their
products.
Even if our portfolio companies are able to develop
commercially viable products, the market for new products and
services is highly competitive, rapidly changing and especially
sensitive to adverse general economic conditions. Commercial
success is difficult to predict, and the marketing efforts of our
portfolio companies may not be successful.
Unfavorable economic conditions could result in the
inability of our portfolio companies to access additional
capital, leading to financial losses in our portfolio.
Most of the companies in which we have made or will make
investments are susceptible to economic slowdowns or recessions.
An economic slowdown or adverse capital or credit market
conditions may affect the ability of a company in our portfolio
to raise additional capital from venture capital or other sources
or to engage in a liquidity event such as an initial public
offering or merger. These conditions may lead to financial
losses in our portfolio, which could have a material adverse
effect on the value of our common stock.
The value of our portfolio and the value of our common stock
could be adversely affected if the technologies utilized by our
portfolio companies are found to cause health or environmental
risks.
Our portfolio companies work with new technologies, which
could have potential environmental and health impacts. Tiny
technology in general and nanotechnology in particular are
currently the subject of health and environmental impact
research. If health or environmental concerns about tiny
technology or nanotechnology were to arise, our portfolio
16
companies may incur additional research, legal and regulatory
expenses, might have difficulty raising capital or could be
forced out of business. This would have an adverse effect on the
value of our portfolio and on the value of our common stock.
Risks related to the illiquidity of our investments.
We invest in illiquid securities and may not be able to
dispose of them when it is advantageous to do so, or ever.
Most of our investments are or will be equity or equity-
linked securities acquired directly from small companies. These
equity securities are generally subject to restrictions on resale
or otherwise have no established trading market. The illiquidity
of most of our portfolio of equity securities may adversely
affect our ability to dispose of these securities at times when
it may be advantageous for us to liquidate these investments. We
may never be able to dispose of these securities.
Unfavorable economic conditions could impair our ability to
engage in liquidity events.
Our business of making private equity investments and
positioning our portfolio companies for liquidity events may be
adversely affected by current and future capital markets and
economic conditions. The public equity markets currently provide
little opportunity for liquidity events, even for more mature
technology companies than those in which we typically invest.
The potential for public market liquidity could further decrease
and could lead to an inability to realize potential gains or
could lead to financial losses in our portfolio and a decrease in
our revenues, net income and assets. Recent government reforms
affecting stock markets, investment banks and securities research
practices may make it more difficult for privately held companies
to complete successful initial public offerings of their equity
securities. Slowdowns in initial public offerings also have an
adverse effect on the frequency and valuations of acquisitions of
privately held companies. The lack of opportunities to sell
investments in privately held companies also has an adverse
effect on the ability of these companies to raise capital.
Even if our portfolio companies complete initial public
offerings, the returns on our investments may be uncertain.
When companies in which we have invested as private entities
complete initial public offerings of their securities, these
newly issued securities are by definition unseasoned issues.
Unseasoned issues tend to be highly volatile and have uncertain
liquidity, which may negatively affect their price. In addition,
we are typically subject to lock-up provisions which prohibit us
from selling our investments into the public market for specified
periods of time after initial public offerings. The market price
of securities that we hold may decline substantially before we
are able to sell these securities. Most initial public offerings
of technology companies are listed on the Nasdaq National Market.
Recent government reforms of the Nasdaq National Market have
made market making by broker-dealers less profitable, which has
caused broker-dealers to reduce their market making activities,
thereby making the market for unseasoned stocks less liquid.
17
Risks related to our company.
Because there is generally no established market in which to
value our investments, our valuation committee's value
determinations may differ materially from the values that a ready
market or third party would attribute to these investments.
There is generally no public market for the equity
securities in which we invest. Pursuant to the requirements of
the Investment Company Act of 1940, which we refer to as the 1940
Act, we value substantially all of the equity securities in our
portfolio at fair value as determined in good faith by the
valuation committee of our board of directors within the
guidelines established by the board of directors. As a result,
determining fair value requires that judgment be applied to the
specific facts and circumstances of each portfolio investment
pursuant to specified valuation principles and processes. We are
required by the 1940 Act to value specifically each individual
investment on a quarterly basis and record unrealized
depreciation for an investment that we believe has become
impaired. Conversely, we must record unrealized appreciation if
we believe that the underlying portfolio company has appreciated
in value. Without a readily ascertainable market value and
because of the inherent uncertainty of valuation, the fair value
that we assign to our investments may differ from the values that
would have been used had a ready market existed for the
investments, and the difference could be material. Any changes
in fair value are recorded in our consolidated statements of
operations as a change in the "Net (decrease) increase in
unrealized appreciation on investments."
Because we are a non-diversified company with a relatively
concentrated portfolio, the value of our business is subject to
greater volatility than the value of companies with more broadly
diversified investments.
As a result of investing a greater portion of our assets in
the securities of a smaller number of issuers, we are classified
as a non-diversified company. We may be more vulnerable to
events affecting a single issuer or industry and therefore
subject to greater volatility than a company whose investments
are more broadly diversified. Accordingly, an investment in our
common stock may present greater risk to you than an investment
in a diversified company.
We may be obligated to pay substantial amounts under our
profit sharing plan.
Our employee profit-sharing plan requires us to distribute
to our officers and employees 20% of our net after-tax realized
income as reflected on our consolidated statements of operations
for that year, less the non-qualifying gain, if any. These
distributions may have a significant effect on the amount of
distributions made to our shareholders, if any.
18
Approximately 34% of the net asset value attributable to our
venture capital investment portfolio, or 12% of our net asset
value, as of December 31, 2003, is concentrated in one company,
NeuroMetrix, Inc., which is not a tiny technology company.
At December 31, 2003, we valued our investment in
NeuroMetrix, Inc., which is not a tiny technology company, at
$5,075,426, which represents 33.60% of the net asset value
attributable to our venture capital investment portfolio, or
12.48% of our net asset value. Any downturn in the business
outlook of NeuroMetrix, Inc., or any failure of the products of
NeuroMetrix, Inc. to receive widespread acceptance in the
marketplace, would have a significant effect on our specific
investment in NeuroMetrix, Inc. and the overall value of our
portfolio.
Approximately 39% of the net asset value attributable to our
venture capital investment portfolio, or 15% of our net asset
value, as of December 31, 2003, is not invested in tiny
technology.
Although all 12 of our investments added since August 2001
have been in tiny technology companies, and although we consider
13 of the companies in our venture capital investment portfolio
to be tiny technology companies, at December 31, 2003, only
60.74% of the net asset value attributable to our venture capital
investment portfolio, or 22.56% of our net asset value, was
invested in tiny technology companies, which may limit our
ability to achieve our investment objective.
We are dependent upon key management personnel for future
success.
We are dependent for the selection, structuring, closing and
monitoring of our investments on the diligence and skill of our
senior management and other key advisers. We utilize lawyers and
outside consultants, including two of our directors, Dr. Kelly S.
Kirkpatrick and Lori D. Pressman, to assist us in conducting due
diligence when evaluating potential investments. There is
generally no publicly available information about the companies
in which we invest, and we rely significantly on the diligence of
our employees and advisers to obtain information in connection
with our investment decisions. Our future success to a
significant extent depends on the continued service and
coordination of our senior management team, and particularly
depends on our Chairman and Chief Executive Officer, Charles E.
Harris. The departure of any of our executive officers, key
employees or advisers could materially adversely affect our
ability to implement our business strategy. We do not maintain
for our benefit any key man life insurance on any of our officers
or employees. Our President, Chief Operating Officer and Chief
Financial Officer, Mel P. Melsheimer, is scheduled to retire on
December 31, 2004, pursuant to the Mandatory Retirement Plan. We
could be adversely affected by his retirement.
19
We will need to hire additional employees as the size of our
portfolio increases.
We anticipate that it will be necessary for us to add
investment professionals with expertise in tiny technology to
accommodate the increasing size of our portfolio. We may need to
provide additional scientific, business or investment training
for our hires. There is competition for highly qualified
personnel, and we may not be successful in our efforts to recruit
and retain highly qualified personnel.
The market for venture capital investments, including tiny
technology investments, is highly competitive.
We face substantial competition in our investing activities
from many competitors, including but not limited to, private
venture capital funds; investment affiliates of large industrial,
technology, service and financial companies; small business
investment companies; wealthy individuals; and foreign investors.
Our most significant competitors typically have significantly
greater financial resources than we do. Many sources of funding
compete for a small number of attractive investment
opportunities. Hence, we face substantial competition in
sourcing good investment opportunities on terms of investment
that are commercially attractive.
In addition to the difficulty of finding attractive
investment opportunities, our status as a regulated business
development company may hinder our ability to participate in
investment opportunities or to protect the value of existing
investments.
We are required to disclose on a quarterly basis the names
and business descriptions of our portfolio companies and the
value of any portfolio securities. Most of our competitors are
not subject to these disclosure requirements. Our obligation to
disclose this information could hinder our ability to invest in
some portfolio companies. Additionally, other current and future
regulations may make us less attractive as a potential investor
than a competitor not subject to the same regulations.
Our failure to make follow-on investments in our portfolio
companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we
may make additional investments in that portfolio company as
"follow-on" investments, in order to: (1) increase or maintain
in whole or in part our ownership percentage; (2) exercise
warrants, options or convertible securities that were acquired in
the original or subsequent financing; or (3) attempt to preserve
or enhance the value of our investment. Recently, "pay to play"
provisions have become common in venture capital transactions.
These provisions require proportionate investment in subsequent
rounds of financing in order to preserve preferred rights such as
anti-dilution protection or even to prevent preferred shares from
being converted to common shares.
20
We may elect not to make follow-on investments or otherwise
lack sufficient funds to make those investments. We have the
discretion to make any follow-on investments, subject to the
availability of capital resources. The failure to make follow-on
investments may, in some circumstances, jeopardize the continued
viability of a portfolio company and our initial investment, or
may result in a missed opportunity for us to increase our
participation in a successful operation, or may cause us to lose
some or all preferred rights pursuant to "pay to play"
provisions. Even if we have sufficient capital to make a desired
follow-on investment, we may elect not to make a follow-on
investment because we may not want to increase our concentration
of risk, because we prefer other opportunities or because we are
inhibited by compliance with business development company
requirements or the desire to maintain our tax status.
Bank borrowing or the issuance of debt securities or
preferred stock by us to fund investments in portfolio companies
or to fund our operating expenses would make our total return to
common shareholders more volatile.
Use of debt or preferred stock as a source of capital
entails two primary risks. The first risk is that the use of
debt leverages our available common equity capital, magnifying
the impact on net asset value of changes in the value of our
investment portfolio. For example, a business development
company that uses 33% leverage (that is, $50 of leverage per $100
of common equity) will show a 1.5% increase or decline in net
asset value for each 1% increase or decline in the value of its
total assets. The second risk is that the cost of debt or
preferred stock financing may exceed the return on the assets the
proceeds are used to acquire, thereby diminishing rather than
enhancing the return to common shareholders. To the extent that
we utilize debt or preferred stock financing for any purpose,
these two risks would likely make our total return to common
shareholders more volatile. In addition, we might be required to
sell investments, in order to meet dividend, interest or
principal payments, when it may be disadvantageous for us to do
so.
As provided in the 1940 Act and subject to some exceptions,
we can issue debt or preferred stock so long as our total assets
immediately after the issuance, less some ordinary course
liabilities, exceed 200% of the sum of the debt and any preferred
stock outstanding. The debt or preferred stock may be
convertible in accordance with SEC guidelines, which may permit
us to obtain leverage at more attractive rates. The requirement
under the 1940 Act to pay, in full, dividends on preferred shares
or interest on debt before any dividends may be paid on our
common stock means that dividends on our common stock from
earnings may be reduced or eliminated. An inability to pay
dividends on our common stock could conceivably result in our
ceasing to qualify as a regulated investment company, or RIC,
under the tax Code, which would be materially adverse to the
holders of our common stock.
We are authorized to issue preferred stock, which would
convey special rights and privileges to its owners.
We are currently authorized to issue up to 2,000,000 shares
of preferred stock, under terms and conditions determined by our
board of directors. These shares would have a preference over
our common stock with respect to dividends and liquidation. The
21
statutory class voting rights of any preferred shares we would
issue could make it more difficult for us to take some actions
that may, in the future, be proposed by the board and/or holders
of common stock, such as a merger, exchange of securities,
liquidation or alteration of the rights of a class of our
securities if these actions were perceived by the holders of the
preferred shares as not in their best interests. The issuance of
preferred shares convertible into shares of common stock might
also reduce the net income and net asset value per share of our
common stock upon conversion. These effects, among others, could
have an adverse effect on your investment in our common stock.
Loss of status as a RIC would reduce our net asset value and
distributable income.
We currently qualify as a RIC under the tax Code. As a RIC,
we do not have to pay federal income taxes on our income
(including realized gains) that is distributed to our
shareholders. Accordingly, we are not permitted under accounting
rules to establish reserves for taxes on our unrealized capital
gains. If we failed to qualify for RIC status, to the extent
that we had unrealized gains, we would have to establish reserves
for taxes, which would reduce our net asset value, net of a
reduction in the reserve for employee profit sharing,
accordingly. To the extent that we, as a RIC, were to decide to
make a deemed distribution of net realized capital gains and
retain the net realized capital gains, we would have to establish
appropriate reserves for taxes upon making that decision.
We operate in a regulated environment.
We are subject to substantive SEC regulations as a business
development company. Securities and tax laws and regulations
governing our activities may change in ways adverse to our and
our shareholders' interests, and interpretations of these laws
and regulations may change with unpredictable consequences. Any
change in the laws or regulations that govern our business could
have an adverse impact on us or on our operations. Also, as
business and financial practices continue to evolve, they may
render the regulations under which we operate less appropriate
and more burdensome than they were when originally imposed.
Quarterly results fluctuate and are not indicative of future
quarterly performance.
Our quarterly operating results fluctuate as a result of a
number of factors. These factors include, among others,
variations in and the timing of the recognition of realized and
unrealized gains or losses, the degree to which we and our
portfolio companies encounter competition in our markets and
general economic and capital markets conditions. As a result of
these factors, results for any one quarter should not be relied
upon as being indicative of performance in future quarters.
22
To the extent that we do not realize income or retain after-
tax realized capital gains, we may have a greater need for
additional capital to fund our investments and operating
expenses.
As a RIC, we must annually distribute at least 90% of our
investment company taxable income as a dividend and may either
distribute or retain our realized net capital gains from
investments. As a result, these earnings may not be available to
fund investments. If we fail to generate net realized capital
gains or to obtain funds from outside sources, it would have a
material adverse effect on our financial condition and results of
operations as well as our ability to make follow-on and new
investments. Because of the structure and objectives of our
business, we generally expect to experience net operating losses
and rely on proceeds from sales of investments, rather than on
investment income, to defray a significant portion of our
operating expenses. These sales are unpredictable and may not
occur. In addition, as a business development company, we are
generally required to maintain a ratio of at least 200% of total
assets to total borrowings, which may restrict our ability to
borrow to fund these requirements.
Investment in foreign securities could result in additional
risks.
The Company may invest in foreign securities, although we
currently have no investments in foreign securities. If we
invest in securities of foreign issuers, we may be subject to
risks not usually associated with owning securities of U.S.
issuers. These risks can include fluctuations in foreign
currencies, foreign currency exchange controls, social, political
and economic instability, differences in securities regulation
and trading, expropriation or nationalization of assets, and
foreign taxation issues. In addition, changes in government
administrations or economic or monetary policies in the United
States or abroad could result in appreciation or depreciation of
our securities and could favorably or unfavorably affect our
operations. It may also be more difficult to obtain and enforce
a judgment against a foreign issuer. Any foreign investments
made by us must be made in compliance with U.S. and foreign
currency restrictions and tax laws restricting the amounts and
types of foreign investments.
Item 2. Properties
The Company maintains its offices at 111 West 57th Street,
New York, New York 10019, where it leases approximately 2,600
square feet of office space pursuant to a lease agreement
expiring in 2010. (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
None
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 our common stock.
Certificates to be transferred should be mailed directly to the
transfer agent, preferably by registered mail.
Market Prices
Our 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.
2003 Quarter Ending Low High
March 31 $2.36 $3.99
June 30 $2.71 $7.95
September 30 $4.47 $9.49
December 31 $6.18 $12.29
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
Dividends
On January 22, 2002, we announced a deemed dividend of
$0.0875 per share for 2001 for a total of $775,620, and in 2002
we paid federal income taxes on behalf of shareholders of
$0.030625 per share for a total of $271,467. We 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.
We did not pay a cash dividend or declare a deemed dividend
for 2002 and 2003.
Recent Sales of Unregistered Securities
The Company did not sell any equity securities during 2003
that were not registered under the Securities Act of 1933.
24
Shareholders
As of February 17, 2004, there were approximately 140
holders of record of the Company's common stock which, the
Company has been informed, hold the Company's common stock for
approximately 12,450 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.
Financial Position as of December 31:
2003 2002 2001 2000 1999(1)
Total assets $44,115,128 $35,951,969 $39,682,367 $43,343,423 $65,320,768
Total liabilities $ 3,432,390 $ 8,695,923 $15,347,597 $11,509,948 $11,685,963
Net assets $40,682,738 $27,256,046 $24,334,770 $31,833,475 $53,634,805
Net asset value per
outstanding share $ 2.95 $ 2.37 $ 2.75 $ 3.51 $ 5.80
Cash dividends paid $ 0.00 $ 0.00 $ 0.00 $ 184,817 $ 3,647,017
Cash dividends paid
per outstanding share $ 0.00 $ 0.00 $ 0.00 $ 0.02 $ 0.35
Shares outstanding 13,798,845 11,498,845 8,864,231 9,064,231 9,240,831
Operating Data for year ended December 31:
2003 2002 2001 2000 1999(1)
Total investment income $ 167,785 $ 253,461 $ 510,661 $ 687,050 $ 287,684
Total expenses(2) $ 2,731,527 $ 2,124,549 $ 1,035,221 $(2,623,200) $ 9,924,020
Net operating (loss)
income $(2,563,742) $(1,871,088) $ (524,560) $ 3,310,250 $(9,636,336)
Total tax expense
(benefit) $ 13,761 $ 199,309 $ 27,951 $ (51,869) $ (733,970)
Net realized (loss)
gain on investments $ (984,925) $ 2,390,302 $ 1,276,366 $ 18,963,832 $ 8,615,670
Net realized (loss)
income $(3,548,667) $ 519,214 $ 751,806 $ 22,274,082 $(1,020,666)
Net increase (decrease)
in unrealized
appreciation on
investments $ 343,397 $(3,241,408) $(7,641,044) $(37,781,289) $38,102,047
Net (decrease) increase
in net assets resulting
from operations $(3,205,270) $(2,722,194) $(6,889,238) $(15,507,207) $37,081,381
(Decrease) increase
in net assets resulting
from operations per
outstanding share $ (0.28) $ (0.24) $ (0.78) $ (1.71) $ 4.01
(1) Certain reclassifications have been made to the 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)/
expenses: ($163,049) in 2002; ($984,021) in 2001; ($4,812,675) in 2000;
$8,110,908 in 1999.
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 2003 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 our control. Although
we believe 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 us or any other person that our
objectives and plans will be achieved.
Background and Overview
We incorporated under the laws of the state of New York in
August 1981. In 1983, we completed an initial public offering
and invested $406,936 in Otisville BioTech, Inc., which also
completed an initial public offering later that year. In 1984,
Charles E. Harris purchased a controlling interest in us, thereby
also becoming the control person in Otisville. We then divested
our other assets and became a financial services company, with
the investment in Otisville as the initial focus of our business
activity. We hired new management for Otisville, and Otisville
acquired new technology targeting the development of a human
blood substitute.
By 1988, we operated two insurance brokerages and a trust
company as wholly-owned subsidiaries. In 1989, Otisville changed
its name to Alliance Pharmaceutical Corporation, and by 1990, we
had completed selling our $406,936 investment in Alliance for
total proceeds of $3,923,559.
In 1992, we sold our insurance brokerage and trust company
subsidiaries to their respective managements and registered as an
investment company under the 1940 Act, commencing operations as a
closed-end, non-diversified investment company. In 1995, we
elected to become a business development company subject to the
provisions of Sections 55 through 65 of the 1940 Act. Throughout
our corporate history, we have made early stage venture capital
investments in a variety of industries. In 1994, we made our
first tiny technology investment. Since August 2001, we have
made initial investments exclusively in tiny technology,
including our last 12 initial investments.
27
Since our investment in Otisville in 1983, we have made a
total of 54 venture capital investments, including four
investments, via private placements, in securities of publicly
traded companies. We have sold 36 of these 54 investments,
realizing total proceeds of $105,659,158 on our invested capital
of $38,366,523. Sixteen of these 36 investments were profitable.
The average and median holding periods for these 36 investments
were 3.6 years and 3.3 years, respectively. At December 31,
2003, we valued the 18 venture capital investments remaining in
our portfolio at $15,106,576, or 37.13%, of our net assets, net
of unrealized depreciation of $2,375,303. At December 31, 2003,
the average and median holding periods for our 18 current venture
capital investments were 2.9 years and 1.8 years, respectively.
We have invested a substantial portion of our assets in
private, development stage or start-up companies. These private
businesses tend to be thinly capitalized, unproven, small
companies that lack management depth, have little or no history
of operations and are developing unproven technologies. At
December 31, 2003, $15,106,576, or 37.13%, of our net assets
consisted of venture capital investments at fair value, net of
unrealized depreciation of $2,375,303. At December 31, 2002,
$12,036,077, or 44.2%, of our net assets consisted of venture
capital investments at fair value, of which net unrealized
depreciation was $2,718,389. At December 31, 2001, $13,120,978,
or 53.9%, of our net assets consisted of venture capital
investments at fair value, of which net unrealized appreciation
was $1,215,444.
Because none of our current venture capital investments have
readily available market values, we value our venture capital
investments each quarter at fair value as determined in good
faith by our valuation committee within guidelines established by
our board of directors in accordance with the 1940 Act. (See
"Footnote to Consolidated Schedule of Investments" contained in
Item 8. Consolidated Financial Statements and Supplementary
Data.")
We have broad discretion in the investment of our capital.
However, we invest primarily in illiquid equity securities of
private companies. Generally, these investments take the form of
preferred stock, are subject to restrictions on resale and have
no established trading market. Our principal objective is to
achieve long-term capital appreciation. Therefore, a significant
portion of our investment portfolio provides little or no income
in the form of dividends or interest. We do earn interest income
from fixed-income securities, including U.S. government and
government agency securities. The amount of interest income we
earn varies with the average balance of our fixed-income
portfolio and the average yield on this portfolio and is not
expected to be material to our results of operations.
General business and capital markets conditions in 2002 and
2003 were adverse for the venture capital industry. There were
few opportunities to take venture capital-backed companies public
or sell them to established companies. During this period, it
was also difficult to finance venture capital-backed companies
privately and, in general, for venture capital funds themselves
to raise capital.
28
We present the financial results of our operations utilizing
accounting principles generally accepted in the United States for
investment companies. On this basis, the principal measure of
our financial performance during any period is the net
increase/(decrease) in our net assets resulting from our
operating activities, which is the sum of the following three
elements:
Net Operating Income / (Loss) - the difference between our
income from interest, dividends, and fees and our operating
expenses.
Net Realized Gain / (Loss) on Investments - the difference
between the net proceeds of sales of portfolio securities and
their stated cost.
Net Increase / (Decrease) in Unrealized Appreciation on
Investments - the net change in the fair value of our investment
portfolio.
Because of the structure and objectives of our business, we
generally expect to experience net operating losses and seek to
generate increases in our net assets from operations through the
long term appreciation of our venture capital investments. We
have in the past relied, and continue to rely, on proceeds from
sales of investments, rather than on investment income, to defray
a significant portion of our operating expenses. Because sales
of our investments are unpredictable, we attempt to maintain
adequate working capital to provide for fiscal periods when we
have no sales of investments.
Results of Operations
Years Ended December 31, 2003, 2002, and 2001
During the three years ended December 31, 2003, 2002, and
2001, we had net decreases in net assets resulting from
operations of $3,205,270, $2,722,194 and $6,889,238,
respectively.
Investment Income and Expenses:
- -------------------------------
During the three years ended December 31, 2003, 2002, and
2001, we had net operating losses of $2,563,742, $1,871,088 and
$524,560, respectively. The variation in these results is
primarily owing to the changes in operating expenses. During
the three years ended December 31, 2003, 2002, and 2001,
operating expenses were $2,731,527, $2,124,549 and $1,035,221,
respectively. The increase during 2003 was primarily owing to
increases in salary and benefits. During 2003, the full year
effect of a new employee who started in September 2002 was
realized. In addition, we recorded expense of $225,000 owing to
the establishment of a Mandatory Retirement Plan in 2003. The
increase in expenses in 2002 was primarily owing to the $163,049
reversal of the profit sharing accrual in 2002 versus the
$984,021 reversal of the profit sharing accrual in 2001, as well
as an increase in salaries and benefits, primarily owing to an
increase in the retirement medical benefit expense and the
expense of a new employee who started in September 2002, and an
increase in professional fees, primarily as a result of expenses
associated with new investments and preparation of our proxy
statement.
29
Realized Gains and Losses on Sales of Portfolio Securities:
- -----------------------------------------------------------
During the three years ended December 31, 2003, 2002, and
2001, we realized net (losses) gains on sales of portfolio
securities of ($971,164), $3,284,737 and $1,394,781,
respectively.
During 2003, we realized a loss of $1,000,001 on the tax
write-off of our investment in Kriton, Inc., which had been
previously written-off for book purposes. As a result of the
loss realized in 2003 on the tax write-off of Kriton Medical,
Inc., unrealized appreciation increased by $1,000,001.
During 2002, we realized a gain of $4,776,360 from the
liquidation of our partnership interest in PHZ Capital Partners
L.P., and losses of $350,583 and $1,248,825 from the liquidation
of Informio, Inc. and the sale of our previously written-off
investment in Schwoo, Inc., respectively.
During 2001, we realized gains on the sales of our
investments in Nanophase Technologies Corporation of $2,762,696
and Genomica Corporation of $1,022,905. We realized losses on
the sales of our investments in: Essential.com, Inc., $1,349,512;
shares of SciQuest.com, Inc. purchased in the open market,
$1,258,679; and MedLogic Global Corporation, $1,033,765. We also
realized a gain of $1,266,729 from our partnership interest in
PHZ Capital Partners L.P. As a result of the gains and losses
realized during 2001, unrealized appreciation decreased by
$3,948,271.
Unrealized Appreciation and Depreciation of Portfolio Securities:
- -----------------------------------------------------------------
During the year ended December 31, 2003, net unrealized
depreciation on investments decreased by $343,397. During the
years ended December 31, 2002, and 2001, net unrealized
appreciation decreased by $3,936,534 and $7,731,508,
respectively. The decrease in net unrealized depreciation during
2003 was primarily owing to decreases in the valuations of our
venture capital investments of $1,421,220, including an increase
in unrealized depreciation of Agile Material and Technologies,
Inc. of $750,000, Experion Systems, Inc. of $325,662 and
NeoPhotonics Corporation of $345,558, offset by a decrease in
unrealized depreciation of Continuum Photonics, Inc. of $226,046
and an increase in unrealized appreciation in Nanotechnologies,
Inc. of $357,963. In addition, unrealized appreciation increased
by $1,000,001 as a result of the loss realized in 2003 on the tax
write-off of Kriton Medical, Inc., which had previously been
written off for book purposes.
The decrease during 2002 was primarily owing to decreases in
the valuations of our venture capital investments of $3,933,834,
including a decrease in unrealized appreciation of NeuroMetrix,
Inc. of $1,986,081. Unrealized appreciation (depreciation) on
investments was ($2,720,113) and $1,216,420 at December 31, 2002,
and 2001, respectively.
The decrease in net unrealized appreciation during 2001 was
primarily owing to decreases in the valuations of our venture
capital investments, including decreases in the valuations of our
holdings of Nanophase Technologies Corporation, Genomica Corporation
30
and Schwoo, Inc. of $5,499,664, $1,540,375 and $1,248,827, respectively,
offset by increases in unrealized appreciation of $1,528,082 and
$1,033,775 as a result of the realization of the losses on the sales
of our investments in SciQuest.com, Inc. and MedLogic Global Corporation.
Financial Condition
Year ended December 31, 2003
At December 31, 2003, our total assets and net assets were
$44,115,128 and $40,682,738, respectively. Our NAV at that date
was $2.95, and our shares outstanding increased to 13,798,845
versus 11,498,845 at December 31, 2002.
During the 12 months ended December 31, 2003, significant
financial developments included the receipt of net proceeds of
$16,631,962 pursuant to the issuance of 2,300,000 new shares of
our common stock and a decrease in payable to broker for
unsettled trade of $5,696,725. In addition, the value of our
venture capital investments increased by $3,070,499, to
$15,106,576 at December 31, 2003, primarily owing to three new
venture capital investments and five follow-on investments
totaling $3,727,718 and increases in the valuations of our
venture capital investments of $848,883, offset by write-downs in
the valuations of our venture capital investments of $1,506,102.
The following table is a summary of additions to our
portfolio of venture capital investments during the year ended
December 31, 2003:
New Investment Amount
Chlorogen, Inc. $ 525,900
NanoGram Devices Corporation $ 750,000
Nanosys, Inc. $1,500,000
Follow-on Investment
Chlorogen, Inc. $ 259,100
NanoOpto Corporation $ 125,000
Nanotechnologies, Inc. $ 169,718
Nantero, Inc. $ 323,000
NeoPhotonics, Inc. $ 75,000
----------
Total $3,727,718
==========
Year Ended December 31, 2002
At December 31, 2002, our total assets and net assets were
$35,951,969 and $27,256,046, respectively. Our NAV at that date
was $2.37, and our shares outstanding increased to 11,498,845
versus 8,864,231 at December 31, 2001.
During the 12 months ended December 31, 2002, significant
financial developments included: (1) the payment of $271,467 in
federal income taxes as a result of our deemed dividend
distribution to shareholders; (2) a net decrease in the
31
unrealized appreciation of our venture capital investments of
$3,933,834, including a decrease in the unrealized appreciation
of NeuroMetrix, Inc. of $1,986,081; (3) a decrease in bank loan
payable of $12,495,777; (4) the receipt of net proceeds of
$5,643,470 pursuant to the issuance and exercise of transferable
rights for 2,634,614 new shares of our common stock; and (5) the
receipt of $5,700,000 in cash and a recorded receivable in the
amount of $786,492 related to the liquidation of our partnership
interest in PHZ Capital Partners L.P.
In addition, the value of our venture capital investments
decreased by $1,084,901, to $12,036,077 at December 31, 2002,
primarily owing to seven new venture capital investments and two
follow-on investments totaling $7,195,988, partially offset by
write-downs in the valuations of our venture capital investments
of $5,213,959 and the liquidations of Informio, Inc. and our
partnership interest in PHZ Capital Partners L.P., which
decreased the value of our venture capital investments by a total
of $3,072,382 from the value at December 31, 2001.
The following table is a summary of additions to our
portfolio of venture capital investments for the year ended
December 31, 2002:
New Investment Amount
Agile Materials & Technologies, Inc. $1,000,000
Continuum Photonics, Inc. $1,000,000
Nanopharma Corp. $ 700,000
NanoOpto Corporation $ 625,000
Nanotechnologies, Inc. $ 750,000
Neo Photonics Corporation $1,000,000
Optiva, Inc. $1,250,000
Follow-on Investment
Experion Systems, Inc. $ 517,706
NeuroMetrix, Inc. $ 353,282
----------
Total $7,195,988
==========
The following tables summarize the fair value of our
portfolios of venture capital investments and U.S. Government and
Agency Obligations, as compared with their cost, at December 31,
2003, and December 31, 2002:
December 31,
2003 2002
--------------------------
Venture capital investments,
at cost $17,481,879 $14,754,466
Unrealized depreciation (1) 2,375,303 2,718,389
Venture capital investments, ----------- -----------
at fair value $15,106,576 $12,036,077
=========== ===========
32
December 31,
2003 2002
-------------------------
U.S. Government and Agency
Obligations, at cost $27,121,899 $15,452,469
Unrealized depreciation (1) 1,413 1,724
U.S. Government and Agency ----------- -----------
Obligations, at fair value $27,120,486 $15,450,745
=========== ===========
(1) At December 31, 2003, and December 31, 2002, the accumulated
unrealized depreciation on investments, including deferred taxes,
was $3,221,635 and $3,565,032, respectively.
The following table summarizes the fair value composition of
our venture capital investment portfolio at December 31, 2003,
and December 31, 2002:
December 31,
Category 2003 2002
-------------------------
Tiny Technology 60.7% 49.0%
Other Venture Capital Investments 39.3% 51.0%
----- -----
Total Venture Capital Investments 100.0% 100.0%
===== =====
Cash Flow
Year Ended December 31, 2003
Cash flow used in operating activities for the year ended
December 31, 2003, was $6,592,321, reflecting the following
changes from December 31, 2002, to December 31, 2003: an increase
to restricted funds of $455,134; a payment of a payable to a
broker for an unsettled trade of $5,696,725; and a decrease to
current income tax liability of $857,656. In addition, net
realized and unrealized loss on investments was $1,047,140, and
the net decrease in net assets resulting from operations was
$3,624,643.
Cash used in investing activities for the year ended
December 31, 2003, was $15,582,923, primarily reflecting an
increase in our investment in U.S. Treasury Bills of $11,669,430
and investments in private placements of $3,727,718.
Cash provided by financing activities for the year ended
December 31, 2003, was $16,633,462, primarily reflecting net
proceeds of $16,631,962 from the issuance of 2,300,000 new shares
of our common stock. We expect to invest or earmark for
investment the net proceeds within approximately one year,
depending on the available investment opportunities for the types
of investments that we make. Although we intend to make our
initial investments exclusively in companies that we believe are
involved significantly in tiny technology, we may also make
follow-on investments in existing portfolio companies involved in
other technologies. Pending investment in portfolio companies,
we intend to invest the net proceeds of any offering of shares of
our common stock in time deposits and/or income-producing
securities that are issued or guaranteed by the federal
government or an agency of the federal government of a government
33
owned corporation, which are likely to yield less than our
operating expense ratio. We may also pay operating expenses,
including due diligence expenses on potential investments, from
the proceeds, which will reduce the net proceeds of any offering
of shares of our common stock that we will have available for
investment.
Year Ended December 31, 2002
Cash flow provided by operating activities for the year
ended December 31, 2002, was $1,923,048, reflecting the following
changes from December 31, 2001, to December 31, 2002: a payable
to a broker for an unsettled trade of $5,969,725; an increase in
funds held in escrow of $750,000; and an increase in a receivable
from a partnership liquidation of $786,492. In addition, net
realized and unrealized loss on investments was $651,797, and the
net decrease in net assets resulting from operations was
$2,722,194.
Cash provided by investing activities for the year ended
December 31, 2002, was $10,751,980, reflecting a decrease in our
investment in U.S. Treasury Bills of $10,358,006 and the proceeds
from the liquidation of investments of $7,631,100, offset by
investments in private placements of $7,195,988.
Cash used in financing activities for the year ended
December 31, 2002, was $6,842,807, reflecting the payment of the
outstanding balance on the asset line of credit of $12,495,777,
offset by the net proceeds from a rights offering of $5,643,470.
We intended to invest in tiny technology, under normal
circumstances, directly or indirectly, the net proceeds of the
rights offering in accordance with our investment objectives and
policies, within the 12 months following the receipt of the net
proceeds of the rights offering, depending on the available
investment opportunities.
Liquidity and Capital Resources
Our primary sources of liquidity are cash, receivables and
freely marketable securities, net of short-term indebtedness.
Our secondary sources of liquidity are restricted securities of
companies that are publicly traded. We currently have no
restricted securities of companies that are publicly traded.
Year Ended December 31, 2003
At December 31, 2003, 2002, and 2001, our net primary
liquidity was $27,563,886, $16,508,057 and $13,459,654,
respectively. On each of those corresponding dates, our
secondary liquidity was $0, as we had no restricted securities of
companies that are publicly traded.
Our net primary sources of liquidity are more than adequate
to cover our gross cash operating expenses over the next 12
months. Our gross cash operating expenses totaled $2,455,454,
$2,256,991 and $1,992,341 in 2003, 2002 and 2001, respectively.
During the year ended December 31, 2003, the increase in our
net primary liquidity was primarily owing to: (1) our payment of
federal, state and local taxes; (2) our investments in Chlorogen,
Inc., NanoGram Devices Corporation, NanoOpto Corporation,
Nanosys, Inc., Nanotechnologies, Inc., Nantero, Inc. and
NeoPhotonics, Inc.; and (3) our use of funds for operating
34
expenses; offset by our receipt of $16,631,962 of net proceeds
from an offering of our common stock that closed on December 30,
2003.
On November 19, 2001, we established an asset account line
of credit of up to $12,700,000. The asset account line of credit
is secured by our U.S. government and government agency
securities. Under the asset account line of credit, we may
borrow up to 95% of the current value of our U.S. government and
government agency securities. Our outstanding balance under the
asset line of credit at both December 31, 2003, and December 31,
2002, was $0. The asset line of credit bears interest at a rate
of the Broker Call Rate plus 50 basis points.
Year Ended December 31, 2002
At December 31, 2002, and 2001, our net primary liquidity
was $16,508,057 and $13,459,654, respectively. On each of the
corresponding dates, our secondary liquidity was $0. Our
tertiary source of liquidity was our partnership interest in PHZ
Capital Partners L.P., from which we received cash distributions
in 2002 and 2001 of $6,588,661 and $172,068, respectively. We
liquidated our 20% partnership interest in PHZ for $5,700,000
effective December 31, 2002, and we received a final distribution
of $786,492 on January 16, 2003. At December 31, 2002, this
final distribution of $786,492 was included in net primary
liquidity as a receivable.
During the year ended December 31, 2002, the increase in our
net primary liquidity was primarily owing to: (1) our payment of
federal income taxes; (2) our investments in Nanopharma Corp.,
NanoOpto Corporation, NeoPhotonics Corporation, Experion Systems,
Inc., Continuum Photonics, Inc., Nanotechnologies, Inc., Optiva,
Inc., Agile Materials & Technologies, Inc. and NeuroMetrix, Inc.;
(3) our funds held in escrow for a pending venture capital
investment; and (4) our use of funds for operating expenses;
offset by our receipt of $5,643,470 of net proceeds from a rights
offering of our common stock that closed July 31, 2002.
Critical Accounting Policies
Critical accounting policies are those that are both
important to the presentation of our financial condition and
results of operations and those that require management's most
difficult, complex or subjective judgments. Our critical
accounting policies are those applicable to the valuation of
investments.
Valuation of Portfolio Investments
As a business development company, we invest primarily in
illiquid securities including debt and equity securities of
private companies. The investments are generally subject to
restrictions on resale and generally have no established trading
market. We value substantially all of our equity investments at
fair value as determined in good faith by our valuation committee
on a quarterly basis. The valuation committee, comprised of at
least three or more non-interested board members, reviews and
approves the valuation of our investments within the guidelines
established by the board of directors. Fair value is generally
36
defined as the amount that an investment could be sold for in an
orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing our assets, external measures of
value, such as public markets or third party transactions, are
utilized whenever possible. Valuation is not based on long term
work-out value, nor immediate liquidation value, nor incremental
value for potential changes that may take place in the future.
Recent Developments -- Portfolio Companies
During 2004 to the date of this filing, we have made three
follow-on investments totaling $688,401 and one new investment of
$150,000 in privately held tiny-technology companies.
In January 2004, we sold our investment in the preferred
stock of NeoPhotonics, Inc., which had been valued at $0, for
$10. We will realize a tax loss of $915,108 on the transaction,
which had previously been written off for book purposes.
Other Developments
On July 22, 2003, the board of directors approved a
resolution stating that we are committed to maintaining the
privacy of our shareholders and to safeguarding their non-public
personal information. Generally, we do not receive any non-
public personal information relating to our shareholders,
although some non-public personal information of our shareholders
may become available to us. We do not disclose any non-public
personal information about our shareholders or former
shareholders to anyone, except as permitted by law or as is
necessary in order to service shareholder accounts (for example,
to a transfer agent or third party administrator). We restrict
access to non-public personal information about our shareholders
to our employees and to employees of our service providers and
their affiliates with a legitimate business need for the
information. We maintain physical, electronic and procedural
safeguards designed to protect the non-public personal
information of our shareholders.
As of January 19, 2004, Daniel V. Leff, Ph.D,. joined the
Company as Executive Vice President and Managing Director. Mr.
Leff was most recently a Senior Associate with Sevin Rosen Funds
in the firm's Dallas, Texas office. He will relocate to Los
Angeles, California, where he will establish and head a West
Coast office for Harris & Harris Group. As of March 15, 2004, we
entered into a 12 month agreement for office space in Los Angeles
at an annual expense of $26,100. This agreement is renewable
upon mutual consent of the parties. In addition, as a Managing
Director, Mr. Leff will be one of our four decision makers with
respect to all of our venture capital investments. He will also
be involved in the Company's strategic direction, along with our
other senior officers.
On February 17, 2004, we filed a registration statement with
the Securities and Exchange Commission on Form N-2 with respect
to 3,000,000 shares of our Common Stock. After the effective
date, the Common Stock may be sold at prices and on terms to be
set forth in one or more supplements to the prospectus from time
to time.
36
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk
Our business activities are highly risky. We consider 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 our investments nor an investment in us is intended
to constitute a balanced investment program. We have exposure
to public-market price fluctuations to the extent of our
publicly traded portfolio.
We have invested a substantial portion of our assets in
private development stage or start-up companies. These private
businesses tend to be thinly capitalized, unproven, small
companies 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. We expect that some of our 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 our
private equity investments complete initial public offerings
(IPOs), we are 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 we invest, the
valuation of the equity interests in our portfolio is subject to
the estimate of our Board of Directors in accordance with our
Asset Valuation Policy Guidelines. In the absence of a readily
ascertainable market value, the estimated value of our 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 our 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 Auditors......................... 39
Consolidated Financial Statements
- ---------------------------------
Consolidated Statements of Assets and Liabilities
as of December 31, 2003 and 2002.................. 40
Consolidated Statements of Operations for the
years ended December 31, 2003, 2002, 2001......... 41
Consolidated Statements of Cash Flows for the
years ended December 31, 2003, 2002 and 2001....... 42
Consolidated Statements of Changes in Net Assets for
the years ended December 31, 2003, 2002 and 2001... 43
Consolidated Schedule of Investments as of
December 31, 2003.................................. 44-47
Footnote to Consolidated Schedule of Investments....... 48-50
Notes to Consolidated Financial Statements............. 51-60
Financial Highlights for the years ended
December 31, 2003, 2002, 2001, 2000 and 1999....... 61
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 AUDITORS
Report of Independent Auditors
To the Board of Directors and Shareholders of
Harris & Harris Group, Inc.
In our opinion, the accompanying consolidated statements of
assets and liabilities, including the consolidated schedule of
investments, and the related consolidated statements of
operations, of cash flows and of changes in net assets present
fairly, in all material respects, the financial position of
Harris & Harris Group, Inc. (the "Company") at December 31, 2003
and December 31, 2002, and the results of its operations, its
cash flows and the changes in its net assets for each of the two
years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
These financial statements are the responsibility of the
Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance
with auditing standards generally accepted in the United States
of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits, which included
confirmation of securities at December 31, 2003 by
correspondence with the custodian, provide a reasonable basis
for our opinion. The financial statements of the Company as of
December 31, 2001 and for the year then ended were audited by
other auditors who have ceased operations. Those auditors
expressed an unqualified opinion on those financial statements
in their report dated March 21, 2002.
As more fully disclosed in Note 2, the financial statements
include investments valued at $15,106,576 (37.13% of net assets)
at December 31, 2003, the fair values of which have been
estimated by the Board of Directors in the absence of readily
ascertainable market values. Those estimated values may differ
significantly from the values that would have been used had a
ready market for the investments existed, and the differences
could be material.
/s/ PricewaterhouseCoopers, LLP
- -------------------------------
March 10, 2004
New York, N.Y.
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
December 31, 2003 December 31, 2002
Investments, at value
(Cost: $44,603,778 at 12/31/03,
$30,206,935 at 12/31/02)..........$ 42,227,062 $ 27,486,822
Cash and cash equivalents........... 425,574 5,967,356
Restricted funds (Note 5)........... 1,212,078 756,944
Funds in escrow..................... 0 750,000
Receivable from portfolio company... 0 786,492
Interest receivable................. 450 189
Income tax receivable............... 17,375 0
Prepaid expenses.................... 6,841 96,631
Other assets........................ 225,748 107,535
----------------- -----------------
Total assets........................$ 44,115,128 35,951,969
================= =================
LIABILITIES & NET ASSETS
Accounts payable and accrued
liabilities.......................$ 2,723,398 $ 1,451,568
Payable to broker for unsettled
trade............................. 0 5,696,725
Accrued profit sharing (Note 3)..... 0 15,233
Deferred rent....................... 39,648 5,397
Current income tax liability........ 0 857,656
Deferred income tax liability
(Note 6).......................... 669,344 669,344
----------------- -----------------
Total liabilities................... 3,432,390 8,695,923
Commitments and contingencies ----------------- -----------------
(Note 7)
Net assets..........................$ 40,682,738 $ 27,256,046
================= =================
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized;
none issued.......................$ 0 $ 0
Common stock, $0.01 par value,
25,000,000 shares authorized;
15,627,585 issued at 12/31/03
and 13,327,585 issued at 12/31/02. 156,276 133,276
Additional paid in capital (Note 4). 49,564,475 32,845,872
Additional paid in capital -
common stock warrants (Note 4).... 0 109,641
Accumulated net realized gain
(loss)............................ (2,410,847) 1,137,820
Accumulated unrealized depreciation
of investments, including
deferred tax liability of
$844,918 at 12/31/03 and 12/31/02. (3,221,635) (3,565,032)
Treasury stock, at cost (1,828,740
shares at 12/31/03 and 12/31/02).. (3,405,531) (3,405,531)
----------------- -----------------
Net assets..........................$ 40,682,738 $ 27,256,046
================= =================
Shares outstanding.................. 13,798,845 11,498,845
================= =================
Net asset value per outstanding
share.............................$ 2.95 $ 2.37
================= =================
The accompanying notes are an integral part of these consolidated
financial statements.
40
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
Investment income:
Interest from:
Fixed-income securities........................ $ 125,173 $ 184,050 $ 422,196
Portfolio companies............................ 450 0 9,616
Dividend income.................................. 0 0 1,000
Other income..................................... 42,162 69,411 77,849
------------- ------------- -------------
Total investment income........................ 167,785 253,461 510,661
Expenses:
Profit-sharing reversal (Note 3)................. 0 (163,049) (984,021)
Salaries and benefits............................ 1,540,692 1,130,352 1,045,063
Professional fees................................ 303,795 344,717 261,582
Administration and operations.................... 446,185 433,569 406,488
Rent............................................. 200,711 173,291 166,312
Directors' fees and expenses..................... 162,014 154,682 90,047
Depreciation..................................... 51,073 30,607 26,901
Custodian fees................................... 10,178 9,604 14,518
Interest expense (Note 4)........................ 16,879 10,776 8,331
------------- ------------- -------------
Total expenses................................. 2,731,527 2,124,549 1,035,221
------------- ------------- -------------
Operating loss before income taxes............... (2,563,742) (1,871,088) (524,560)
Income tax benefit (Note 6)...................... 0 0 0
------------- ------------- -------------
Net operating loss................................. (2,563,742) (1,871,088) (524,560)
Net realized (loss) income from investments:
Realized (loss) income from investments.......... (971,164) 3,284,737 1,394,781
------------- ------------- -------------
Total realized (loss) income................... (971,164) 3,284,737 1,394,781
Income tax expense (Note 6)...................... (13,761) (894,435) (118,415)
------------- ------------- -------------
Net realized (loss) income from investments...... (984,925) 2,390,302 1,276,366
------------- ------------- -------------
Net realized (loss) income......................... (3,548,667) 519,214 751,806
Net decrease (increase) in unrealized
depreciation on investments:
Increase as a result of investment sales......... 1,000,001 1,602,048 4,802,738
Decrease as a result of investment sales......... 0 (322,208) (854,467)
Increase on investments held..................... 764,616 285 3,232,919
Decrease on investments held..................... (1,421,220) (5,216,659) (14,912,698)
------------- ------------- -------------
Change in unrealized depreciation
on investments............................... 343,397 (3,936,534) (7,731,508)
Income tax benefit (Note 6)...................... 0 695,126 90,464
------------- ------------- -------------
Net decrease (increase) in unrealized
depreciation on investments.................... 343,397 (3,241,408) (7,641,044)
------------- ------------- -------------
Net decrease in net assets resulting from operations:
Total............................................ $ (3,205,270) $ (2,722,194) $ (6,889,238)
============= ============= =============
Per outstanding share............................ $ (0.28) $ (0.24) $ (0.78)
============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
41
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
Cash flows used in operating activities:
Net decrease in net assets
resulting from operations........................ $ (3,205,270) $ (2,722,194) $ (6,889,238)
Adjustments to reconcile net decrease in net
assets resulting from operations to net cash
used in operating activities:
Net realized and unrealized loss on investments.. 627,767 651,797 5,950,398
Deferred income taxes............................ 0 (695,126) 90,464
Depreciation..................................... 51,073 30,607 26,901
Other............................................ 0 0 2,010
Changes in assets and liabilities:
Restricted funds................................. (455,134) (274,924) (216,837)
Receivable from portfolio company................ 786,492 (786,492) 0
Funds in escrow.................................. 750,000 (750,000) 0
Interest receivable.............................. (261) (107) 30,000
Income tax receivable............................ (17,375) 0 0
Prepaid expenses................................. 89,790 (81,798) 67,782
Notes receivable................................. 0 10,487 401
Other assets..................................... 44,130 1,570 23,667
Accounts payable and accrued liabilities......... 1,271,830 412,217 267,587
Payable to broker for unsettled trade............ (5,696,725) 5,696,725 (115,005)
Accrued profit sharing........................... (15,233) (163,049) (3,304,959)
Deferred rent.................................... 34,251 (9,253) (9,253)
Current income tax liability..................... (857,656) 602,588 (5,496,498)
------------- ------------- -------------
Net cash (used in) provided by operating
activities..................................... (6,592,321) 1,923,048 (9,572,580)
Cash provided by investing activities:
Net (purchase) sale of short-term investments
and marketable securities...................... (11,669,430) 10,358,006 (10,263,667)
Investment in private placements and loans....... (3,727,718) (7,195,988) (1,818,826)
Proceeds from sale of investments................ 27,641 7,631,100 9,385,615
Purchase of fixed assets......................... (213,416) (41,138) (6,508)
------------- ------------- -------------
Net cash (used in) provided by investing
activities...................................... (15,582,923) 10,751,980 (2,703,386)
Cash flows used in financing activities:
Purchase of treasury stock (Note 4).............. 0 0 (338,000)
Proceeds from note payable....................... 0 0 12,495,777
Payment of note payable (Note 4)................. 0 (12,495,777) 0
Proceeds from public offering, net (Note 4)...... 16,631,962 5,643,470 0
Collection on notes receivable................... 1,500 9,500 0
------------- ------------- -------------
Net cash provided by (used in) financing
activities..................................... 16,633,462 (6,842,807) 12,157,777
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents:
Cash and cash equivalents at beginning of
the year....................................... 5,967,356 135,135 253,324
Cash and cash equivalents at end of the year..... 425,574 5,967,356 135,135
------------- ------------- -------------
Net (decrease) increase in cash and cash
equivalents.................................... $ (5,541,782) $ 5,832,221 $ (118,189)
============= ============= =============
Supplemental disclosures of cash flow information:
Income taxes paid................................ $ 575,100 $ 307,585 $ 5,795,916
Interest paid.................................... $ 16,879 $ 19,106 $ 0
The accompanying notes are an integral part of these
consolidated financial statements.
42
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
Changes in net assets from operations:
Net operating loss............................... $ (2,563,742) $ (1,871,088) $ (524,560)
Net realized (loss) income on investments........ (984,925) 2,390,302 1,276,366
Net increase in unrealized appreciation
on investments as a result of sales............ 1,000,001 1,279,840 4,038,735
Net decrease in unrealized
appreciation on investments held............... (656,604) (4,521,248) (11,679,779)
------------- -------------- -------------
Net decrease in net assets resulting
from operations.................................... (3,205,270) (2,722,194) (6,889,238)
Changes in net assets from
capital stock transactions:
Purchase of treasury stock....................... 0 0 (338,000)
Proceeds from sale of stock...................... 23,000 26,346 0
Additional paid in capital on common
stock issued................................... 16,608,962 5,617,124 0
Deemed dividend shareholder tax credit........... 0 0 (271,467)
------------- -------------- -------------
Net increase (decrease) in net assets resulting
from capital stock transactions.................... 16,631,962 5,643,470 (609,467)
------------- -------------- -------------
Net increase (decrease) in net assets.............. 13,426,692 2,921,276 (7,498,705)
------------- -------------- -------------
Net Assets:
Beginning of the year............................ 27,256,046 24,334,770 31,833,475
------------- -------------- -------------
End of the year.................................. $ 40,682,738 $ 27,256,046 $ 24,334,770
============= ============== =============
The accompanying notes are an integral part of these
consolidated financial statements.
43
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated Companies (8)(9)(10) -- 11.3% of total investments
Private Placement Portfolio (Illiquid) -- 11.3% of total investments
AlphaSimplex Group, LLC (2)(12) -- Investment advisory firm headed
by Dr. Andrew W. Lo, holder of the Harris & Harris Group Chair
at MIT
Limited Liability Company interest.......................................(B) -- $ 118,750
Continuum Photonics, Inc. (1)(2)(6) -- Develops optical networking
components by merging cutting-edge materials, MEMS and
electronics technologies -- 3.70% of fully diluted equity
Series B Convertible Preferred Stock.....................................(D) 2,000,000 745,035
Exponential Business Development Company (1)(2)(5)(12) --
Venture capital partnership focused on early stage companies
Limited Partnership interest.............................................(A) -- 25,000
Heartware, Inc. (1)(2)(6)(15) -- Develops ventricular assist devices --
0% percent of fully diluted equity
Series A-2 Non-Voting Preferred Stock....................................(D) 47,620 0
NanoGram Corporation (1)(2)(4)(6)(13) -- Develops a broad suite of
intellectual property utilizing nanotechnology -- 1.81% of fully
diluted equity
Series 1 Convertible Preferred Stock.....................................(A) 63,210 21,672
NanoOpto Corporation (1)(2)(6) -- Develops high performance, integrated
optical communications sub-components on a chip by utilizing
patented nano-manufacturing technology -- 2.60% of fully diluted equity
Series A-1 Convertible Preferred Stock...................................(B) 267,857
Series B Convertible Preferred Stock.....................................(B) 293,842 172,567
Nanosys, Inc. (1)(2)(4)(6) -- Develops nanotechnology-enabled systems
incorporating novel and patent-protected zero and one-dimensional
nanometer-scale materials -- 1.65% of fully diluted equity
Series C Convertible Preferred Stock.....................................(A) 803,428 1,500,000
Nantero, Inc. (1)(2)(6) -- Develops a high density nonvolatile random
access memory chip using nanotechnology -- 3.35% of fully diluted equity
Series A Convertible Preferred Stock.....................................(B) 345,070
Series B Convertible Preferred Stock.....................................(B) 207,051 861,309
NeoPhotonics Corporation (1)(2)(6)(13)(14) -- Develops and manufactures
planar optical devices and components using nanomaterials
deposition technology -- 1.53% of fully diluted equity
Series D Convertible Preferred Stock.....................................(D) 1,498,802
Secured Convertible Note.................................................(D) $75,000 75,000
Optiva, Inc. (1)(2)(5)(6) -- Develops and commercializes nanomaterials
for advanced applications -- 1.96% of fully diluted equity
Series C Convertible Preferred Stock.....................................(B) 1,249,999 1,250,000
----------
Total Private Placement Portfolio (cost: $6,354,651).................................................$ 4,769,333
-----------
Total Investments in Unaffiliated Companies (cost: $6,354,651).......................................$ 4,769,333
-----------
The accompanying notes are an integral part of this
consolidated schedule.
44
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled Affiliated Companies (8)(9)(11) --
24.5% of total investments
Private Placement Portfolio (Illiquid) -- 24.5% of total investments
Agile Materials & Technologies, Inc. (1)(2)(6) -- Develops and sells
variable integrated passive RF electronic equipment components --
8.15% of fully diluted equity
Series A Convertible Preferred Stock.....................................(D) 3,732,736 $ 250,000
Chlorogen, Inc. (1)(2)(4)(6) -- Develops patented chloroplast technology
to produce plant-made proteins -- 9.76% of fully diluted equity
Series A Convertible Preferred Stock.....................................(A) 4,478,038 785,000
Experion Systems, Inc. (1)(2)(5)(7) -- Develops and sells
software to credit unions -- 12.44% of fully diluted equity
Series A Convertible Preferred Stock.....................................(B) 294,118
Series B Convertible Preferred Stock.....................................(B) 35,294
Series C Convertible Preferred Stock.....................................(B) 222,184 711,338
NanoGram Devices Corporation (1)(2)(4)(6)(14) -- Develops power
components for biomedical applications by utilizing a patented
nanomaterial synthesis process -- 5.00% of fully diluted equity
Series A-1 Convertible Preferred Stock...................................(A) 63,210
Series A-2 Convertible Preferred Stock...................................(A) 750,000 813,210
Nanopharma Corp. (1)(2)(5)(6) -- Develops advanced nanoscopic drug
delivery vehicles and systems -- 14.39% of fully diluted equity
Series A Convertible Preferred Stock.....................................(A) 684,516 700,000
Nanotechnologies, Inc. (1)(2)(6) -- Develops high-performance
nanoscale materials for industry -- 6.48% of fully diluted equity
Series B Convertible Preferred Stock.....................................(B) 1,538,837
Series C Convertible Preferred Stock.....................................(B) 235,720 1,277,681
NeuroMetrix, Inc. (1)(2)(5) -- Develops and sells medical devices for
monitoring neuromuscular disorders -- 12.08% of fully diluted equity
Series A Convertible Preferred Stock.....................................(B) 875,000
Series B Convertible Preferred Stock.....................................(B) 625,000
Series C-2 Convertible Preferred Stock...................................(B) 1,148,100
Series E Convertible Preferred Stock.....................................(B) 499,996
Series E-1 Convertible Preferred Stock...................................(B) 235,521 5,075,426
Questech Corporation (1)(2)(5) -- Manufactures and markets proprietary
metal decorative tiles -- 6.73% of fully diluted equity
Common Stock.............................................................(B) 646,954
Warrants at $5.00 expiring 10/25/04......................................(B) 1,966
Warrants at $1.50 expiring 11/16/05......................................(B) 1,250
Warrants at $1.50 expiring 08/03/06......................................(B) 8,500
Warrants at $1.50 expiring 11/21/07......................................(B) 3,750
Warrants at $1.50 expiring 11/19/08......................................(B) 5,000 724,588
-----------
Total Private Placement Portfolio (cost: $11,127,228)................................................$10,337,243
-----------
Total Investments in Non-Controlled Affiliated Companies (cost: $11,127,228).........................$10,337,243
-----------
The accompanying notes are an integral part of this
consolidated schedule.
45
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
Method of Shares/
Valuation (3) Principal Value
U.S. Government and Agency Obligations -- 64.2% of total investments
U.S. Treasury Bills -- due date 01/08/04.................................(J) $ 4,264,000 $ 4,263,275
U.S. Treasury Bills -- due date 01/15/04.................................(J) 900,000 899,658
U.S. Treasury Bills -- due date 02/05/04.................................(J) 17,308,000 17,293,634
U.S. Treasury Bills -- due date 02/12/04.................................(J) 1,670,000 1,668,347
U.S. Treasury Bills -- due date 02/19/04.................................(J) 1,600,000 1,598,176
U.S. Treasury Bills -- due date 03/18/04.................................(J) 1,400,000 1,397,396
-----------
Total Investments in U.S. Government (cost: $27,121,899).............................................$27,120,486
-----------
Total Investments -- 100% (cost: $44,603,778)........................................................$42,227,062
===========
The accompanying notes are an integral part of this
consolidated schedule.
46
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2003
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last 12 months are considered to
be non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the
Asset Valuation Policy Guidelines.
(4) Initial investment was made during 2003.
(5) No changes in valuation occurred in these investments during the 12
months ended December 31, 2003.
(6) These investments are development stage companies. A development
stage company is defined as a company that is devoting substantially
all of its efforts to establishing a new business, and either it has
not yet commenced its planned principal operations or it has
commenced such operations but has not realized significant revenue
from them.
(7) Previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in which
we own less than five percent of the portfolio company. Investments
in non-controlled affiliated companies consist of investments in
which we own more than five percent but less than 25 percent of the
portfolio company. Investments in controlled affiliated companies
consist of investments in which we own more than 25 percent of the
portfolio company.
(9) The percentage ownership of each portfolio company disclosed in the
Consolidated Schedule of Investments expresses the potential equity
interest in each such portfolio company. The calculated percentage
represents the amount of the issuer's equity securities we own or can
acquire as a percentage of the issuer's total outstanding equity
securities plus equity securities reserved for issued and outstanding
warrants, convertible securities and all authorized stock options,
both granted and ungranted.
(10) The aggregate cost for federal income tax purposes of investments
in unaffiliated companies is $6,354,651. The gross unrealized
appreciation based on the tax cost for these securities is $162,198.
The gross unrealized depreciation based on the tax cost for these
securities is $1,747,516.
(11) The aggregate cost for federal income tax purposes of investments
in non-controlled affiliated companies is $11,127,228. The gross
unrealized appreciation based on the tax cost for these securities is
$2,772,007. The gross unrealized depreciation based on the tax cost
for these securities is $3,561,992.
(12) Non-registered investment company.
(13) On April 30, 2003, NeoPhotonics Corporation distributed its shares
in NanoGram Corporation to shareholders of record on November 14,
2002. We received 63,210 shares of Series 1 Preferred Stock.
(14) On April 30, 2003, NeoPhotonics Corporation distributed its shares
in NanoGram Devices Corporation to shareholders of record on November
14, 2002. We received 63,210 shares of Series A-1 Convertible
Preferred Stock.
(15) On July 10, 2003, we received 47,620 shares of Series A-2 Non-
Voting Preferred stock of Heartware, Inc., a new company formed to
acquire the assets and assume certain liabilities of Kriton Medical,
Inc. as part of Kriton's bankruptcy.
The accompanying notes are an integral part of this
consolidated schedule.
47
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
ASSET VALUATION POLICY GUIDELINES
Our investments can be classified into five broad categories for
valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR
RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT
DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires
periodic valuation of each investment in our portfolio to determine
net asset value. Under the 1940 Act, unrestricted securities with
readily available market quotations are to be valued at the current
market value; all other assets must be valued at "fair value" as
determined in good faith by or under the direction of the Board of
Directors.
Our Board of Directors is responsible for (1) determining
overall valuation guidelines and (2) ensuring the valuation of
investments within the prescribed guidelines.
Our Valuation Committee, comprised of at least three or more
independent Board members, is responsible for reviewing and approving
the valuation of our assets within the guidelines established by the
Board of Directors.
Fair value is generally defined as the amount that an investment
could be sold for in an orderly disposition over a reasonable time.
Generally, to increase objectivity in valuing our assets, external
measures of value, such as public markets or third-party
transactions, are utilized whenever possible. Valuation is not based
on long-term work-out value, nor immediate liquidation value, nor
incremental value for potential changes that may take place in the
future.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might
ultimately be realized, as such amounts depend on future
circumstances and cannot reasonably be determined until the
individual investments are actually liquidated.
Our valuation policy with respect to the five broad investment
categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or
more of the following basic methods of valuation:
A. Cost: The cost method is based on our original cost. This
method is generally used in the early stages of a company's
development until significant positive or negative events occur
subsequent to the date of the original investment that dictate a
48
change to another valuation method. Some examples of these events are:
(1) a major recapitalization; (2) a major refinancing; (3) a significant
third-party transaction; (4) the development of a meaningful public
market for the company's common stock; and (5) significant positive or
negative changes in a company's business.
B. Private Market: The private market method uses actual,
executed, historical transactions in a company's securities by
responsible third parties as a basis for valuation. The private
market method may also use, where applicable, unconditional firm
offers by responsible third parties as a basis for valuation.
C. Public Market: The public market method is used when there
is an established public market for the class of the company's
securities held by us. We discount market value for securities that
are subject to significant legal and contractual restrictions. Other
securities, for which market quotations are readily available, are
carried at market value as of the time of valuation. Market value
for securities traded on securities exchanges or on the Nasdaq
National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter
market and listed securities for which no sale was reported on that
day, market value is the mean of the closing bid price and asked
price on that day. This method is the preferred method of valuation
when there is an established public market for a company's
securities, as that market provides the most objective basis for
valuation.
D. Analytical Method: The analytical method is generally used
to value an investment position when there is no established public
or private market in the company's securities or when the factual
information available to us dictates that an investment should no
longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of our Valuation Committee members, based
on the data available to them. The resulting valuation, although
stated as a precise number, is necessarily within a range of values
that vary depending upon the significance attributed to the various
factors being considered. Some of the factors considered may include
the financial condition and operating results of the company, the
long-term potential of the business of the company, the values of
similar securities issued by companies in similar businesses, the
proportion of the company's securities we owned and the nature of any
rights to require the company to register restricted securities under
applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following
basic methods of valuation:
E. Cost: The cost method is based on our original cost. This
method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and
development in technology or product development until significant
positive or adverse events occur subsequent to the date of the
original investment that dictate a change to another valuation
method.
F. Private Market: The private market method uses actual
third-party investments in intellectual property or patents or
research and development in technology or product development as a
basis for valuation, using actual executed historical transactions by
responsible third parties. The private market method may also use,
where applicable, unconditional firm offers by responsible third
parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value
an investment after analysis of the best available outside
information where the factual information available to us dictates
that an investment should no longer be valued under either the cost
or private market method. This valuation method is inherently
imprecise and ultimately the result of reconciling the judgments of
our Valuation Committee members. The resulting valuation, although
stated as a precise number, is necessarily within a range of values
that vary depending upon the significance attributed to the various
49
factors being considered. Some of the factors considered may include
the results of research and development, product development
progress, commercial prospects, term of patent, projected markets,
and other subjective factors.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are
readily available are carried at market value as of the time of
valuation using the most recent bid quotations when available.
I. Fixed-Income Securities for which market quotations are not
readily available are carried at fair value using one or more of the
following basic methods of valuation:
Independent pricing services that provide quotations based
primarily on quotations from dealers and brokers, market
transactions, and other sources.
Fair value as determined in good faith by the Valuation
Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
J. Short-Term Fixed-Income Investments are valued at market
value at the time of valuation. Short-term debt with remaining
maturity of 60 days or less is valued at amortized cost.
ALL OTHER INVESTMENTS
K. All Other Investments are reported at fair value as
determined in good faith by the Valuation Committee.
The reported values of securities for which market quotations
are not readily available and for other assets reflect the Valuation
Committee's judgment of fair values as of the valuation date using
the outlined basic methods of valuation. They do not necessarily
represent an amount of money that would be realized if we had to
sell the securities in an immediate liquidation. Thus, valuations
as of any particular date are not necessarily indicative of amounts
that we may ultimately realize as a result of future sales or other
dispositions of investments we hold.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE COMPANY
- --------------------
Harris & Harris Group, Inc. (the "Company," "us," "our" and
"we") is a venture capital company operating as a business
development company ("BDC") under the Investment Company Act of 1940,
which we refer to as the 1940 Act. A BDC is a specialized type of
company under the 1940 Act. We operate as an internally managed
investment company whereby our officers and employees, under the
general supervision of our Board of Directors, conduct our
operations.
We elected to become a BDC on July 26, 1995, after receiving the
necessary approvals. From September 30, 1992, until the election of
BDC status, we operated as a closed-end, non-diversified investment
company under the 1940 Act. Upon commencement of operations as an
investment company, we revalued all of our assets and liabilities at
fair value as defined in the 1940 Act. Prior to such time, we were
registered and filed under the reporting requirements of the
Securities and Exchange Act of 1934 as an operating company and,
while an operating company, operated directly and through
subsidiaries.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100
percent wholly owned subsidiary of the Company. Enterprises held the
lease for the office space until it expired on July 31, 2003, which
it sublet to the Company and an unaffiliated party; is a partner in
Harris Partners I, L.P. and is taxed as a C corporation. Harris
Partners I, L.P. is a limited partnership and owned, until December
31, 2002, a 20 percent limited partnership interest in PHZ Capital
Partners L.P. Currently, Harris Partners I, L.P. owns our interest
in AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P.
are Enterprises (sole general partner) and Harris & Harris Group,
Inc. (sole limited partner).
We filed for the 1999 tax year to elect treatment as a
Regulated Investment Company ("RIC") under Sub-Chapter M of the Internal
Revenue Code of 1986 (the "Code") and qualified for the same
treatment for 2000-2002. There can be no assurance that we will
qualify as a RIC for 2003 and subsequent years or that if we do
qualify, we will continue to qualify for subsequent years. In
addition, even if we were to qualify as a RIC for a given year, we
might take action in a subsequent year to ensure that we would be
taxed in that subsequent year as a C Corporation, rather than as a
RIC. As a RIC, we must, among other factors, distribute at least 90
percent of our investment company taxable income and may either
distribute or retain our realized net capital gains on investments.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
The following is a summary of significant accounting policies
followed in the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States for investment
companies and include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include
money market instruments with maturities of less than three months.
51
Portfolio Investment Valuations. Investments are stated at
"value" as defined in the 1940 Act and in the applicable regulations
of the Securities and Exchange Commission. Value, as defined in
Section 2(a)(41) of the 1940 Act, is (i) the market price for those
securities for which a market quotation is readily available and (ii)
for all other assets is as determined in good faith by, or under the
direction of, the Board of Directors. (See "Asset Valuation Policy
Guidelines" in the "Footnote to Consolidated Schedule of
Investments.")
Securities Transactions. Securities transactions are accounted
for on the date the securities are purchased or sold (trade date);
dividend income is recorded on the ex-dividend date; and interest
income is accrued as earned. Realized gains and losses on investment
transactions are determined on specific identification for financial
reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, we recorded income
taxes using the liability method in accordance with the provision of
Statement of Financial Accounting Standards No. 109. Accordingly,
deferred tax liabilities had been established to reflect temporary
differences between the recognition of income and expenses for
financial reporting and tax purposes, the most significant difference
of which relates to our unrealized appreciation on investments.
The December 31, 2003 consolidated financial statements include
a provision for deferred taxes on the remaining net built-in gains as
of December 31, 1998, net of the unutilized operating and capital
loss carryforwards incurred by us through December 31, 1998.
We pay federal, state and local income taxes on behalf of our
wholly owned subsidiary, Harris & Harris Enterprises, which is a C
corporation. (See "Note 6. Income Taxes.")
Estimates by Management. The preparation of the consolidated
financial statements in conformity with accounting principles
generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities as of December 31, 2003, and December 31, 2002, and
the reported amounts of revenues and expenses for the three years
ended December 31, 2003. The most significant estimates relate to
the fair valuations of investments for the years ended December 31,
2003, and 2002. Actual results could differ from these estimates.
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
- ------------------------------------
As of January 1, 2003, we implemented the Amended and Restated
Harris & Harris Group, Inc. Employee Profit-Sharing Plan, which we
refer to as the 2002 Plan.
The Plan (and its predecessor) provides for profiting sharing by
our officers and employees equal to 20% of our "qualifying income"
for that plan year. For the purposes of the Plan, qualifying income
is defined as net realized income as reflected on our consolidated
statements of operations for that year, less nonqualifying gains, if
any.
For purposes of the Plan, our net realized income includes
investment income, realized gains and losses, and operating expenses
(including taxes paid or payable by us), but is calculated without
including dividends paid or distributions made to shareholders,
payments under the Plan, unrealized gains and losses, and loss carry-
overs from other years. The proportion of net after-tax realized
gains attributable to asset values as of September 30, 1997 is
considered nonqualifying gain, which reduces qualifying income.
On October 15, 2002, our shareholders approved the performance
goals under the 2002 Plan in accordance with Section 162(m) of the
Code, effective as of January 1, 2003. The Code generally provides
that a public company such as we are may not deduct compensation paid
to its chief executive officer or to any of its four most highly
compensated officers to the extent that the compensation paid to the
officer/employee exceeds $1,000,000 in any tax year, unless payment
is made upon the attainment of objective performance goals that are
approved by our shareholders.
52
Under the 2002 Plan, our net realized income includes investment
income, realized qualifying gains and losses, and operating expenses
(including taxes paid or payable by us), but is calculated without
including dividends paid or loss carry-overs from other years, which
we refer to as qualifying income. As soon as practicable following
the year-end audit, the Audit Committee will determine whether, and
if so how much, qualifying income exists for a plan year. Once
determined, 90% of the qualifying income will be paid out to Plan
participants pursuant to the distribution percentages set forth in
the Plan. The remaining 10% will be paid out after we have filed our
federal tax return for that plan year.
Under the 2002 Plan, awards previously granted to the four
current Participants (Messrs. Harris and Melsheimer and Ms. Shavin
and Matthews, herein referred to as the "grandfathered participants")
will be reduced by 10% with respect to "Non-Tiny Technology
Investments" (as defined in the 2002 Plan) and by 25% with respect to
"Tiny Technology Investments" (as defined in the 2002 Plan) and will
become permanent. These reduced awards are herein referred to as
"grandfathered participations." The amount by which the awards are
reduced will be allocable and reallocable each year by the
Compensation Committee among current and new participants as awards
under the 2002 Plan. The grandfathered participations will be
honored by us whether or not the grandfathered participant is still
employed by us or is still alive (in the event of death, the
grandfathered participations will be paid to the grandfathered
participant's estate), unless the grandfathered participant is
dismissed for cause, in which case all awards, including the
grandfathered participations, will be immediately cancelled and
forfeited. With regard to new investments and follow-on investments
made after the date on which the first new employee begins
participating in the 2002 Plan, both current and new participants
will be required to be employed by us at the end of a plan year in
order to participate in profit-sharing on our investments with
respect to that year.
Notwithstanding any provisions of the 2002 Plan, in no event may
the aggregate amount of all awards payable for any Plan Year during
which we remain a "business development company" within the meaning
of the 1940 Act be greater than 20% of our "net income after taxes"
within the meaning of Section 57(n)(1)(B) of the 1940 Act. In the
event the awards as calculated exceed that amount, the awards will be
reduced pro rata.
The 2002 Plan may be modified, amended or terminated by the
Compensation Committee at any time. Notwithstanding the foregoing,
the grandfathered participations may not be further modified.
Nothing in the 2002 Plan will preclude the Compensation Committee
from naming additional participants in the 2002 Plan or, except for
grandfathered participations, changing the Award Percentage of any
Participant (subject to the overall percentage limitations contained
in the 2002 Plan). Currently, under the 2002 Plan, the distribution
amounts for non-grandfathered investments for each officer and
employee are: Charles E. Harris, 7.790%; Mel P. Melsheimer, 3.733%;
Douglas W. Jamison, 3.5%; Daniel V. Leff, 3.0%; Helene B. Shavin,
1.524%; and Jacqueline M. Matthews, 0.453%, which together equal 20%.
In one case, for a former employee who left other than due to
termination for cause, any amount earned will be accrued and may
subsequently be paid to the participant.
The grandfathered participations are set forth below:
Grandfathered Participations
---------------------------------------------
Name of Officer/Employee Non-Tiny Technology (%) Tiny Technology (%)
- ------------------------ ----------------------- -------------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews 0.40770 0.33975
TOTAL 18.00000 15.00000
53
Accordingly, an additional 2% of Qualifying Income with respect
to grandfathered Non-Tiny Technology Investments, 5% of Qualifying
Income with respect to grandfathered Tiny Technology Investments and
the full 20% of Qualifying Income with respect to new investments are
available for allocation and reallocation from year to year.
Currently, Douglas W. Jamison and Daniel V. Leff are each allocated
0.80% of the Non-Tiny Technology Grandfathered Participations and 2%
of the Tiny Technology Grandfathered Participations.
We calculate the profit-sharing accrual based on the terms of
the plan in effect. During the first quarter of 2003, we paid out 90
percent of the 2002 profit sharing in the amount of $13,710. The
remaining 10 percent of the 2002 profit sharing, $1,523, was paid out
upon the completion and filing of our 2002 federal tax return.
During 2003, we made no accrual for profit sharing.
NOTE 4. CAPITAL TRANSACTIONS
- -----------------------------
In 1998, the Board of Directors approved that effective January
1, 1998, 50 percent of all Directors' fees be used to purchase our
common stock from us. However, effective March 1, 1999, the Board of
Directors approved that Directors may purchase our common stock in
the open market, rather than from us.
Since 1998, we have repurchased a total of 1,859,047 of our
shares for a total of $3,496,388, including commissions and expenses,
at an average price of $1.88 per share. These treasury shares were
reduced by the purchases made by the Directors. On July 23, 2002,
because of our strategic decision to invest in tiny technology, the
Board of Directors reaffirmed its commitment not to authorize the
purchase of additional shares of stock in the foreseeable future.
On July 8, 2002, we filed a final prospectus under Rule 497 of
the Securities Act of 1933 with the SEC for the issuance of
transferable rights to our shareholders. The rights allowed the
shareholders to subscribe for a maximum of 2,954,743 new shares of
our common stock, of which 2,634,614 new shares were subscribed for
pursuant to the rights offering. The actual amount of gross proceeds
raised upon completion of the offer was $5,927,882; net proceeds were
$5,643,470, after expenses of $284,412. From the completion of the
offering through December 31, 2003, we have invested $5,477,718 in
accordance with our investment objectives and policies.
On December 24, 2003, we filed a final prospectus under Rule 497
of the Securities Act of 1933 with the SEC for issuance of 2,000,000
shares of our common stock plus 300,000 additional shares if the
underwriter exercised its over-allotment option. All of the
2,300,000 shares were sold. The actual amount of net proceeds
raised upon completion of the offering was $17,296,000; net proceeds
of the offering, less offering costs of $664,038, were $16,631,962.
We intend to use the net proceeds of the offering, less offering
costs, to make new investments in tiny technology as well as follow-
on investments in our existing venture capital investments, and for
working capital.
As of December 31, 2003, there are no distributable earnings.
The difference between the book basis and tax basis components of
distributable earnings is primarily attributed to Built-In Gains
generated at the time of our qualification as a RIC (see Note 6.
"Income Taxes"), nondeductible deferred compensation and net
operating losses.
Beginning with the Consolidated Statements of Assets and
Liabilities at December 31, 2003, additional paid in capital common
stock warrants and additional paid in capital have been combined and
are reported as additional paid in capital.
54
NOTE 5. EMPLOYEE BENEFITS
- --------------------------
On October 19, 1999, Charles E. Harris signed an Employment
Agreement with us (disclosed in a Form 8-K filed on October 27, 1999)
(the "Employment Agreement"), which superseded an employment
agreement that was about to expire on December 31, 1999. The
Employment Agreement shall terminate on December 31, 2004 ("Term")
subject to either an earlier termination or an extension in
accordance with the terms; on January 1, 2000 and on each day
thereafter, the Term extends automatically by one day unless at any
time we or Mr. Harris, by written notice, decides not to extend the
Term, in which case the Term will expire five years from the date of
the written notice.
During the period of employment, Mr. Harris shall serve as our
Chairman and Chief Executive Officer; be responsible for the general
management of our affairs and all our subsidiaries, reporting
directly to our Board of Directors; serve as a member of the Board
for the period of which he is and shall from time to time be elected
or reelected; and serve, if elected, as our President and as an
officer and director of any subsidiary or affiliate of us.
Mr. Harris is to receive compensation under his Employment
Agreement in the form of base salary of $208,315 for 2000, with
automatic yearly adjustments to reflect inflation. In addition, the
Board may increase such salary, and consequently decrease it, but not
below the level provided for by the automatic adjustments described
above. Mr. Harris is also entitled to participate in our Profit-
Sharing Plan as well as in all compensation or employee benefit plans
or programs, and to receive all benefits, perquisites, and emoluments
for which salaried employees are eligible. Under the Employment
Agreement, we will furnish Mr. Harris with certain perquisites which
include a company car, membership in certain clubs and up to a $5,000
annual reimbursement for personal, financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance
for the benefit of his designated beneficiaries in the amount of
$2,000,000; provides reimbursement for uninsured medical expenses,
not to exceed $10,000 per annum, adjusted for inflation, over the
period of the contract; provides Mr. Harris and his spouse with long-
term care insurance; and disability insurance in the amount of 100
percent of his base salary. These benefits are for the term of the
Employment Agreement.
The Employment Agreement provides for us to adopt a supplemental
executive retirement plan (the "SERP") for the benefit of Mr. Harris.
Under the SERP, we will cause an amount equal to one-twelfth of Mr.
Harris's current annual salary to be credited each month (a "Monthly
Credit") to a special account maintained for this purpose on our
books for the benefit of Mr. Harris (the "SERP Account"). The
amounts credited to the SERP Account will be deemed invested or
reinvested in such mutual funds or U.S. Government securities as
determined by Mr. Harris. The SERP Account will be credited and
debited to reflect the deemed investment returns, losses and expenses
attributed to such deemed investments and reinvestments. Mr.
Harris's benefit under the SERP will equal the balance in the SERP
Account and such benefit will always be 100 percent vested (i.e., not
forfeitable). Mr. Harris will determine the form and timing of the
distribution of the balance in the SERP Account; provided, however,
in the event of the termination of his employment, the balance in the
SERP Account will be distributed to Mr. Harris or his beneficiary, as
the case may be, in a lump-sum payment within 30 days of such
termination. We will establish a rabbi trust for the purpose of
accumulating funds to satisfy the obligations incurred by us under
the SERP. The restricted funds for the SERP Plan total $1,212,078 as
December 31, 2003. Mr. Harris' rights to benefits pursuant to this
SERP will be no greater than those of a general creditor of us.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also
provides for certain death benefits payable to the surviving spouse
equal to the executive's base salary for a period of two years.
55
In addition, Mr. Harris is entitled to receive severance pay
pursuant to the severance compensation agreement that he entered into
with us, effective August 15, 1990. The severance compensation
agreement provides that if, following a change in our control, as
defined in the agreement, such individual's employment is terminated
by us without cause or by the executive within one year of such
change in control, the individual shall be entitled to receive
compensation in a lump sum payment equal to 2.99 times the
individual's average annualized compensation and payment of other
welfare benefits. If Mr. Harris's termination is without cause or is
a constructive discharge, the amount payable under the Employment
Agreement will be reduced by the amounts paid pursuant to the
severance compensation agreement.
As of January 1, 1989, we adopted an employee benefits program
covering substantially all of our employees under a 401(k) Plan and
Trust Agreement. As of January 1, 1999, we adopted the Harris &
Harris Pension Plan and Trust, a money purchase plan which would
allow us to stay compliant with the 401(k) top-heavy regulations and
deduction limitation regulations. In 2001, Congress enacted the
Economic Growth and Tax Relief Reconciliation Act of 2001 which has
increased the deduction limits for plans such as the 401(k) Plan.
This Act eliminates the need for us to maintain two separate plans.
Effective December 31, 2001, the Pension Plan merged into the 401(k)
Plan, with the 401(k) Plan being the surviving plan. Contributions
to the plan are at our discretion.
On June 30, 1994, we adopted a plan to provide medical and
dental insurance for retirees, their spouses and dependents who, at
the time of their retirement, have ten years of service with us and
have attained 50 years of age or have attained 45 years of age and
have 15 years of service with us. On February 10, 1997, we amended
this plan to include employees who "have seven full years of service
and have attained 58 years of age." The coverage is secondary to any
government provided or subsequent employer provided health insurance
plans. The annual premium cost to us with respect to the entitled
retiree shall not exceed $12,000, subject to an index for inflation.
Based upon actuarial estimates, we provided an original reserve of
$176,520 that was charged to operations for the period ending June
30, 1994. As of December 31, 2003, we had a reserve of $531,293 for
the plan. Recent changes to the Medicare program may affect our
costs under this plan. In accordance with FASB Staff Position 106-1,
our estimates of the obligation under this standard do not reflect
these changes. Specific authoritative guidance regarding these
changes is pending and when issued, could require us to change
previously reported information.
We are making the following disclosures about our plan to
provide medical and dental insurance for retirees.
Reconciliation of Accumulated
Postretirement Benefit Obligations 2003 2002
- ---------------------------------- ---- ----
Projected accumulated postretirement
benefit obligation at beginning of year $404,912 $324,100
Service cost 58,710 38,772
Interest cost 26,281 22,347
Actual (gain)/loss 35,385 19,693
-------- --------
Projected accumulated postretirement
benefit obligation at end of year $525,288 $404,912
======== ========
56
In accounting for the plan, the assumption made in 2003 for the
discount rate was 6%. The assumed health care cost trend rates in
2003 were 12% grading to 6% over six years for medical and 3% per
year for dental. The effect on disclosure information of a one
percentage point change in the assumed health care cost trend rate
for each future year is shown below.
1% Decrease Assumed 1% Increase
in Rates Rates in Rates
----------- ---------- -------------
Aggregated service and
interest cost $ 76,271 $ 84,991 $ 93,241
Accumulated postretirement
benefit obligation $477,410 $525,288 $578,459
On March 20, 2003, in order to begin planning for eventual
management succession, the Board of Directors voted to establish a
mandatory retirement plan for individuals who are employed by us in a
bona fide executive or high policy making position. There are
currently two such individuals, the Chairman and CEO, and the
President and COO. Under this plan, mandatory retirement will take
place effective December 31 of the year in which the eligible
individuals attain the age of 65. On an annual basis beginning in
the year in which the designated individual attains the age of 65, a
committee of the Board consisting of non-interested directors may
determine to postpone the mandatory retirement date for that
individual for one additional year for our benefit.
Under applicable law prohibiting discrimination in employment on
the basis of age, we can impose a mandatory retirement age of 65 for
our executives or employees in high policy-making positions only if
each employee subject to the mandatory retirement age is entitled to
an immediate retirement benefit at retirement age of at least $44,000
per year. The benefits payable at retirement to Charles E. Harris,
our Chairman and Chief Executive Officer, and Mel P. Melsheimer, our
President, Chief Operating Officer and Chief Financial Officer, under
our existing retirement plans do not equal this threshold. Mr.
Harris has offered, for our benefit, to waive his right to exclude
certain other benefits from this calculation, which makes it unlikely
that any provision will have to be made for him in order for us to
comply with this threshold requirement. For Mr. Melsheimer, however,
a new plan must be established to provide him with the difference
between the benefit required under the age discrimination laws and
that provided under our existing plans. The expense to us of
providing the benefit under this new plan is currently estimated to
be $450,000. This benefit will be unfunded, and the expense is being
amortized over the fiscal periods through the year ended December 31,
2004.
NOTE 6. INCOME TAXES
- ---------------------
Provided that a proper election is made, a corporation taxable
under Subchapter C of the Internal Revenue Code (a "C Corporation")
that elects to qualify as a RIC continues to be taxable as a C
Corporation on any gains realized within 10 years of its
qualification as a RIC (the "Inclusion Period") from sales of assets
that were held by the corporation on the effective date of the RIC
election ("C Corporation Assets") to the extent of any gain built
into the assets on such date ("Built-In Gain"). (If the corporation
fails to make a proper election, it is taxable on its Built-In Gain
as of the effective date of its RIC election.) We had Built-In Gains
at the time of our qualification as a RIC and made the election to be
taxed on any Built-In Gain realized during the Inclusion Period.
Prior to 1999, we incurred ordinary and capital losses from
operations. After our election of RIC status, those losses remained
available to be carried forward to subsequent taxable years. We have
previously used loss carryforwards to offset Built-In Gains. As of
January 1, 2004, we had $501,640 of pre-1999 loss carryforwards
remaining and $4,663,457 of unrealized Built-In Gains remaining.
57
Continued qualification as a RIC requires us to satisfy certain
investment asset diversification requirements in future years. Our
ability to satisfy those requirements may not be controllable by us.
There can be no assurance that we will qualify as a RIC in
subsequent years.
To the extent that we retain capital gains and declare a deemed
dividend to shareholders, the dividend is taxable to the
shareholders. We would pay tax, at the corporate rate, on the
distribution, and the shareholders would receive a tax credit equal
to their proportionate share of the tax paid. We took advantage of
this rule for 2001. Our financial statements for 2001 include a tax
liability of $290,748. The taxes paid by our shareholders as a
result of our deemed dividend declaration 2001 ($271,467) are
reflected as a deduction to the additional paid-in capital in our
Consolidated Statement of Assets and Liabilities rather than an
expense in the Consolidated Statement of Operations.
We pay federal, state and local taxes on behalf of our wholly
owned subsidiary, Harris & Harris Enterprises, Inc., which is taxed
as a C Corporation.
In 2003, we realized long-term capital losses of $1,000,001 from
the tax write-off of Kriton Medical, Inc. We also had net realized
short-term gains of $17,590 from the sale of U.S. Government and
Agency obligations. We offset our net realized short-term capital
gains with our long-term capital losses and neither owed federal
income on the gain nor were required to distribute any portion of this
gain to shareholders. As of December 31, 2003, we have a capital loss
carryforward of $914,225 which will expire in 2011. To the extent
that these carryover losses are used to offset future capital gains,
it is probable that the gains so offset will not be distributed to
shareholders.
In 2002, we realized long-term capital losses of $470,622
primarily from long-term capital gains of $1,008,653 from the
liquidation of our partnership interest in PHZ Capital Partners L.P.
offset by losses on the sale of Schwoo, Inc. of $1,248,825 and on the
liquidation of Informio, Inc. of $350,583. We also realized short-
term capital gains of $732,936 primarily from the liquidation of our
partnership interest in PHZ Capital Partners L.P. Realized short-
term capital gains were reduced by realized long-term capital losses
resulting in net realized short-term capital gains. We offset the
net realized short-term gains with 2002 expenses and neither owed
federal income taxes on the gain nor were required to distribute any
portion of this gain to shareholders.
For the years ended December 31, 2003, 2002 and 2001, the
Company's income tax (benefit) expense was allocated as follows:
2003 2002 2001
Investment operations $ 0 $ 0 $ 0
Realized income on investments 13,761 894,435 118,415
Decrease in unrealized
appreciation on investments 0 (695,126) (90,464)
--------- ---------- ---------
Total income tax expense $ 13,761 $ 199,309 $ 27,951
========= ========== =========
The above tax expense consists of the following:
2003 2002 2001
Current $ 13,761 $ 894,435 $118,415
Deferred -- Federal 0 (695,126) (90,464)
--------- ---------- ---------
Total income tax expense $ 13,761 $ 199,309 $ 27,951
========= ========= ========
58
The Company's net deferred tax liability at December 31, 2003
and 2002 consists of the following:
2003 2002
Unrealized appreciation on investments $ 844,918 $ 844,918
Net operating and capital loss carryforward (175,574) (175,574)
---------- ----------
Net deferred income tax liability $ 669,344 $ 669,344
========== ==========
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
During 1993, we signed a 10-year lease for office space which
expired on July 31, 2003. On April 17, 2003, we signed a seven-year
sublease for office space at 111 West 57th Street in New York City to
replace the expired lease. Total rent expense was $200,711 for 2003.
Future minimum sublease payments in each of the following years are:
2004 -- $134,816; 2005 -- $138,187; 2006 -- $141,641; 2007 --
$145,182; 2008 -- $148,811; and thereafter for the remaining term --
$203,571.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
- -------------------------------------
On November 19, 2001, we established an asset account line of
credit. The asset account line of credit is secured by government and
government agency securities. Under the asset account line of credit,
we may borrow up to 95 percent of the current value of the government
and government agency securities with which we secure the line.
Our available line of credit at December 31, 2003, was $23,572,275.
Our outstanding balance under the asset account line of credit at both
December 31, 2002, and December 31, 2003, was $0. The asset account
line of credit bears interest at a rate of the Broker Call Rate plus
50 basis points.
NOTE 9. SUBSEQUENT EVENTS
- --------------------------
During 2004, we have made three follow-on investments totaling
$688,401 and one new investment of $150,000 in privately held tiny
technology companies.
In January 2004, we sold our investment in the preferred stock
of NeoPhotonics, Inc., which had been valued at $0, for $10. We
realized a loss of $915,108 on the transaction.
On February 17, 2004, we filed a registration statement with the
Securities and Exchange Commission on Form N-2 with respect to
3,000,000 shares of our Common Stock. After the effective date, the
Common Stock may be sold at prices and on terms to be set forth in
one or more supplements to the prospectus from time to time.
59
NOTE 10. SELECTED QUARTERLY DATA (UNAUDITED)
2003
--------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 64,676 $ 50,564 $ 30,612 $ 21,933
Net operating loss $ 584,460 $ 726,989 $ 572,346 $ 679,947
Net (decrease) in net
assets resulting from
operations $(1,215,127) $ (544,709) $(1,270,298) $ (175,136)
Net (decrease) in net
assets resulting from
operations per
outstanding share $ (0.11) $ (0.05) $ (0.11) $ (0.01)
2002
--------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 59,462 $ 60,368 $ 77,413 $ 56,218
Net operating loss $ 556,233 $ 654,718 $ 479,433 $ 180,704
Net (decrease) increase
in net assets resulting
from operations $(1,036,934) $ 434,289 $ 660,988 $(2,780,537)
Net (decrease) increase
in net assets resulting
from operations per
outstanding share $ (0.12) $ 0.05 $ 0.06 $ (0.24)
60
FINANCIAL HIGHLIGHTS
Per share operating performance
for a share outstanding throughout the year:*
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- ----------------- ----------------- -----------------
Net asset value,
beginning of year $ 2.37 $ 2.75 $ 3.51 $ 5.80 $ 2.13
Net operating
(loss) income (0.22) (0.19) (0.06) 0.37 (1.04)
Net realized
(loss) gain on
investments (0.09) 0.24 0.14 2.09 0.93
Net increase
(decrease) in
unrealized
appreciation
(depreciation) as
a result of sales 0.09 0.13 0.45 (2.35) (0.46)
Net (decrease)
increase in
unrealized
appreciation
(depreciation) on
investments held (0.06) (0.46) (1.30) (1.82) 4.58
-------------- ------------- -------------- -------------- -------------
Total from
investment
operations (0.28) (0.28) (0.77) (1.71) 4.01
Net decrease as a
result of cash
dividend 0.00 0.00 0.00 (0.02) (0.35)
Net decrease as a
result of deemed
dividend 0.00 0.00 (0.03) (0.62) 0.00
-------------- -------------- --------------- -------------- --------------
Total distributions 0.00 0.00 (0.03) (0.64) (0.35)
Net increase
(decrease) from
capital stock
transactions 0.86 (0.10) 0.04 0.06 0.01
-------------- -------------- --------------- -------------- --------------
Net asset value,
end of year** $ 2.95 $ 2.37 $ 2.75 $ 3.51 $ 5.80
============== ============== =============== ============== ==============
Cash dividends paid
per share $ 0.00 $ 0.00 $ 0.00 $ 0.02 $ 0.35
Deemed dividend
per share $ 0.00 $ 0.00 $ 0.0875 $ 1.78 $ 0.00
Market value per
share, end of year $ 11.53 $ 2.46 $ 1.90 $ 2.4375 $ 11.50
Total income tax
liability per share $ 0.06 $ 0.15 $ 0.18 $ 0.78 $ 0.16
Ratio of expenses
to average net
assets 9.5% 8.3% 3.45% (6.21)% 34.08%
Ratio of net operating
(loss) gain to
average net assets (8.9)% (7.3)% (1.75)% 52.7% (3.50)%
Investment return based on:
Stock price 368.7% 40.5% (22.1)% (78.8)% 666.7%
Net asset value 24.5% (13.8)% (21.7)% (39.5)% 188.7%
Portfolio turnover 0% 46.00% 9.00% 20.56% 53.54%
Net assets, end
of year $ 40,682,738 $ 27,256,046 $ 24,334,770 $ 31,833,475 $ 53,634,805
Number of shares
outstanding 13,798,845 11,498,845 8,864,231 9,064,231 9,240,831
*Based on average shares outstanding.
**Reflects the decline in net asset value as a result of the $0.02 dividend
paid in 2000.
The accompanying notes are an integral part of this schedule.
61
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
On February 26, 2002, we appointed the accounting firm of
PricewaterhouseCoopers LLP as our independent accountants 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 our
Audit Committee and was subject to ratification by our
stockholders.
In connection with our 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 our financial statements
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.
We 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 our
financial statements.
We 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.
Item 9a. Controls and Procedures
As of the end of the period covered by this report, our
chief executive officer and chief financial officer conducted an
evaluation of our disclosure controls and procedures (as defined
in Rules 13a-14 and 15d-14 of the Securities Exchange Act of
1934). Based upon this evaluation, our chief executive officer
and chief financial officer concluded that our disclosure
controls and procedures are effective in timely alerting them of
any material information relating to us that is required to be
disclosed by us in the reports it files or submits under the
Securities Exchange Act of 1934.
There have not been any significant changes in our 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 III
Item 10. Directors and Executive Officers of the Company
The information set forth under the captions "Election of
Directors," "Executive Officers" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in our Proxy Statement for Annual
Meeting of Shareholders to be held May 12, 2004, filed pursuant
to Regulation 14A under the Securities Exchange Act of 1934 on or
about March 15, 2004 (the "2004 Proxy Statement") is herein
incorporated by reference.
The Board of Directors has determined that Dugald A. Fletcher
is the "Audit Committee Financial Expert" serving on our Audit
Committee. Mr. Fletcher is independent as defined under Section
2(a)19 of the Investment Company Act of 1940.
Item 11. Executive Compensation
The information set forth under the captions "Summary
Compensation Table" and "Compensation of Directors" in the 2004
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" in the 2004 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, 2003.
Item 14. Principal Accountant Fees and Services
The information set forth under the captions "Audit Committee
Report," "Audit Committee Pre-Approval Policy," "Audit Fees" and "Tax
Fees" in the 2004 Proxy Statement is herein incorporated by reference.
63
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, 2003 and 2002;
o Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001;
o Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001;
o Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2003, 2002 and 2001;
o Consolidated Schedule of Investments as of December 31, 2003;
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, 2003, 2002, 2001, 2000 and 1999.
(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 December 24,
2003.
9.1 Harris & Harris Group, Inc. Custodian Agreement with JP
Morgan, incorporated by reference to Exhibit 9.1 to the
Company's Form 10-K for the year ended December 31,
1995.
10.1 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.
64
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.
31.01* Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.02* Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.01* Certification of CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.02* Certification of 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 filed during the quarter ended December 31, 2003
--------------------------------------------------------------------
We filed a report on Form 8-K on October 16, 2003, concerning
NAV at September 30, 2003.
We filed a report on Form 8-K on December 24, 2003, concerning
our follow-on public offering of 2,000,000 shares of common stock
at $8.00 per share.
We filed a report on Form 8-K on December 30, 2003, concerning
our follow-on public offering of 2,300,000 shares of common stock
at $8.00 per share, which includes the underwriter's exercise, in
full, of the overallotment option.
_____________
*filed herewith
65
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 10, 2004 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 10, 2004
- --------------------- and Chief Executive Officer
Charles E. Harris
/s/ Mel P. Melsheimer President, Chief Operating March 10, 2004
- --------------------- Officer, Chief Financial Officer,
Mel P. Melsheimer Treasurer and Chief Compliance Officer
/s/ Helene B. Shavin Vice President and Controller March 10, 2004
- ---------------------
Helene B. Shavin
/s/ C. Wayne Bardin Director March 10, 2004
- ---------------------
C. Wayne Bardin
/s/ Phillip A. Bauman Director March 10, 2004
- ---------------------
Phillip A. Bauman
66
/s/ G. Morgan Browne Director March 10, 2004
- ---------------------
G. Morgan Browne
/s/ Dugald A. Fletcher Director March 10, 2004
- ---------------------
Dugald A. Fletcher
/s/ Dr. Kelly S. Kirkpatrick Director March 10, 2004
- -----------------------------
Dr. Kelly S. Kirkpatrick
/s/ Glenn E. Mayer Director March 10, 2004
- ---------------------
Glenn E. Mayer
/s/ Mark A. Parsells Director March 10, 2004
- ---------------------
Mark A. Parsells
/s/ Lori D. Pressman Director March 10, 2004
- ---------------------
Lori D. Pressman
/s/ Charles E. Ramsey Director March 10, 2004
- ---------------------
Charles E. Ramsey
67
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
11.0 Computation of Per Share Earnings is set forth under Item 8.
31.01 Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.02 Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.01 Certification of CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.02 Certification of CFO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
68