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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K
Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended Commission File No. 0-11576
December 31, 1996
HARRIS & HARRIS GROUP, INC.
------------------------------------------------
(Exact name of registrant specified in its charter)
New York 13-3119827
- ------------------------- ----------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Rockefeller Plaza, Rockefeller Center, New York, New York 10020
- ------------------------------------------------------------- --------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 332-3600
---------------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $ .01 par value
--------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
The aggregate market value of the Common Stock held by non-affiliates of
Registrant as of March 14, 1997 was $37,414,515 based on the last sale price
as quoted by NASDAQ on such date (only officers and directors are considered
affiliates for this calculation).
As of March 14, 1997, the registrant has 10,442,682 shares of common stock,
par value $ .01 per share, outstanding.
TABLE OF CONTENTS
Page
PART I
Item 1. Business. . . . . . . . . . . . . . . . 1
Item 2. Properties. . . . . . . . . . . . . . . 6
Item 3. Legal Proceedings . . . . . . . . . . . 6
Item 4. Submission of Matters to a Vote of Security Holders 6
PART II
Item 5. Market for Company's Common Equity and Related
Stockholder Matters . . . . . . . . . 7
Item 6. Selected Financial Data . . . . . . . . 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . 9
Item 8. Financial Statements and Supplementary Data 13
Item 9. Disagreements on Accounting and
Financial Disclosure. . . . . . . . . 13
PART III
Item 10. Directors and Executive Officers of the Company 14
Item 11. Executive Compensation . . . . . . . . 18
Item 12. Security Ownership of Certain
Beneficial Owners and Management. . . 20
Item 13. Certain Relationships and Related Transactions 21
PART IV
Item 14. Exhibits, Financial Statements, Schedules and
Reports on Form 8-K . . . . . . . . . 21
Signatures. . . . . . . . . . . . . . . . . . . 22
Exhibit Index . . . . . . . . . . . . . . . . . 24
PART I
Item 1. Business
Harris & Harris Group, Inc. (the "Registrant" or "Company") is a venture
capital investment company, operating as a Business Development Company
("BDC") under the Investment Company Act of 1940 (the "1940 Act"). The
Company's objective is to achieve long-term capital appreciation, rather than
current income, from its investments. The Company has invested a substantial
portion of its assets in private development stage or start-up companies, and
in the development of new technologies in a broad range of industry segments.
These private businesses tend to be thinly capitalized, unproven, small
companies that lack management depth and have not attained profitability or
have no history of operations. The Company may also invest, to the extent
permitted under the 1940 Act, in publicly traded securities, including high
risk securities as well as investment grade securities. The Company may
participate in expansion financing and leveraged buy out financing of more
mature operating companies as well as other investments. As a venture
capital company, the Company invests in and provides managerial assistance to
its private investees which, in its opinion, have significant potential for
growth. There is no assurance that the Company's investment objective will
be achieved.
The Company was incorporated under the laws of the State of New York in
August 1981. Prior to September 30, 1992, the Company was registered and
filed under the reporting requirements of the Securities and Exchange Act of
1934 as an operating company. On that date the Company commenced operations
as a closed-end, non-diversified investment company under the 1940 Act. On
July 26, 1995, the Company elected to become a business development company
subject to the provision of Sections 55 through 65 of the 1940 Act, as
amended by the Small Business Incentive Act of 1980. As a BDC, the Company
operates as an internally managed investment company whereby its officers and
employees, under the general supervision of its Board of Directors, conduct
its operations.
Venture Capital Investments
The Company has invested a substantial portion of its assets in private
development stage or start-up companies. The Company may initially own 100
percent of the securities of a start-up investment for a period of time and
may control such company for a substantial period. In connection with its
venture capital investments, the Company may be involved in recruiting
management, formulating operating strategies, product development, marketing
and advertising, assisting in financial plans, as well as providing
management in the initial start-up stages and establishing corporate goals.
The Company may assist in raising additional capital for such companies from
other potential investors and may subordinate its own investment to that of
other investors. The Company may also find it necessary or appropriate to
provide additional capital of its own. The Company may introduce such
companies to potential joint venture partners, suppliers and customers. In
addition, the Company may assist in establishing relationships with
investment bankers and other professionals. The Company may also assist with
mergers and acquisitions. The Company may derive income from such companies
for the performance of any of the above services. Because of the speculative
nature of these investments and the lack of any market for such securities,
there is significantly greater risk of loss than is the case with traditional
investment securities. The Company expects that some of its venture capital
investments will be a complete loss or will be unprofitable and that some
will appear likely to become successful, but never realize their potential.
The Company has been and will continue to be risk seeking rather than risk
averse in its approach to its venture capital and other investments.
1
The Company may control a company for which it has provided venture
capital, or it may be represented on the company's board of directors by one
or more of its officers or directors, who may also serve as officers of such
a company. Particularly during the early stages of an investment, the
Company may in effect be conducting the operations of the company. As a
venture company emerges from the developmental stage with greater management
depth and experience, the Company expects that its role in the company's
operations will diminish. The Company seeks to assist each company in
establishing its own independent capitalization, management and board of
directors. The Company expects to be able to reduce its active involvement in
the management of its investment in those start-up companies that become
successful by a liquidity event, such as a public offering or sale of a
company.
The Company has invested a substantial portion of its assets in
securities that do not pay interest or dividends and that are subject to
legal or contractual restrictions on resale that may adversely affect the
liquidity and marketability of such securities.
Intellectual Property
The Company believes there is a role for organizations that can assist
in technology transfer. Scientists and institutions that develop and patent
intellectual property increasingly seek the rewards of entrepreneurial
commercialization of their inventions, particularly as governmental,
philanthropic and industrial funding for research has become harder to
obtain. The Company believes that several factors combine to give it a high
value-added role to play in the commercialization of technology: its
experience in organizing and developing successful new companies; its
willingness to invest its own capital at the highest risk, seed stage; its
access to high-grade institutional sources of intellectual property; its
experience in mergers, acquisitions and divestitures; its access to and
knowledge of the capital markets; and its willingness to do as much of the
early work as it is qualified to do.
The Company's form of investment may include: 1) funding of research
and development in the development of a technology; 2) obtaining licensing
rights to intellectual property or patents; 3) outright acquisition of
intellectual property or patents; and 4) formation and funding of companies or
joint ventures to commercialize intellectual property. Income from the
Company's investments in intellectual property or its development may take
the form of participation in licensing or royalty income, fee income, or some
other form of remuneration. At some point during the commercialization of a
technology, the Company's investment may be transformed into ownership of
securities of a development stage or start-up company as discussed above.
Investing in intellectual property is highly risky.
2
Illiquidity of Investments
Many of the Company's investments consist of securities acquired
directly from the issuer in private transactions. They may be subject to
restrictions on resale or otherwise be illiquid. The Company does not
anticipate that there will be any established trading market for such
securities. Additionally, many of the securities that the Company may invest
in will not be eligible for sale to the public without registration under the
Securities Act of 1933, as amended, which could prevent or delay any sale by
the Company of such investments or reduce the amount of proceeds that might
otherwise be realized therefrom. Restricted securities generally sell at a
price lower than similar securities not subject to restrictions on resale.
Further, even if a portfolio company or investee registers its securities and
becomes a reporting company under the Securities and Exchange Act of 1934,
the Company may be considered an insider by virtue of its board
representation and would be restricted in sales of such company's securities.
Managerial Assistance
The Company believes that providing managerial assistance to its
investees is critical to its business development activities. "Making
available significant managerial assistance" as defined in the 1940 Act with
respect to a business development company such as the Company means (a) any
arrangement whereby a business development company, through its directors,
officers, employees or general partners, offers to provide, and if accepted,
does so provide, significant guidance and counsel concerning the management,
operations, or business objectives and policies of a portfolio company; or
(b) the exercise by a business development company of a controlling influence
over the management or policies of a portfolio company by a business
development company acting individually or as a part of a group acting
together which controls such portfolio company. The Company is required by
the 1940 Act to make significant managerial assistance available at least
with respect to investee companies that the Company treats as qualifying
assets for purposes of the 70 percent test (see "Regulation"). The nature,
timing and amount of managerial assistance provided by the Company vary
depending upon the particular requirements of each investee company.
The Company may be involved with its investees in recruiting
management, product planning, marketing and advertising and the development
of financial plans, operating strategies and corporate goals. In this
connection, the Company may assist clients in developing and utilizing
accounting procedures to efficiently and accurately record transactions in
books of account, which will facilitate asset and cost control and the ready
determination of results of operations. The Company also seeks capital for
its investees from other potential investors and occasionally subordinates
its own investment to those of other investors. The Company introduces its
investees to potential suppliers, customers and joint venture partners and
assists its investees in establishing relationships with commercial and
investment bankers and other professionals, including management consultants,
recruiters, legal counsel and independent accountants. The Company also
assists with joint ventures, acquisitions and mergers.
3
In connection with its managerial assistance, the Company may be
represented by one or more of its officers or directors on the board of
directors of an investee. As an investment matures and the investee develops
management depth and experience, the Company's role will become progressively
less active. However, when the Company owns or on a pro forma basis could
acquire a substantial proportion of a more mature investee company's equity,
the Company remains active in and will frequently initiate planning of major
transactions by the investee. The Company's goal is to assist each investee
company in establishing its own independent and effective board of directors
and management.
Need for Follow-On Investments
Following its initial investment in investees, the Company has made and
anticipates that it will continue to make additional investments in such
investees as "follow-on" investments, in order to increase its investment in
an investee, and may exercise warrants, options or convertible securities
that were acquired in the original financing. Such follow-on investments may
be made for a variety of reasons including: 1) to increase the Company's
exposure to an investee, 2) to acquire securities issued as a result of
exercising convertible securities that were purchased in the original
financing, 3) to preserve the Company's proportionate ownership in a
subsequent financing, or 4) in an attempt to preserve or enhance the value of
the Company's investment. There can be no assurance that the Company will
make follow-on investments or have sufficient funds to make such investments;
the Company will have the discretion to make any follow-on investments as it
determines, subject to the availability of capital resources. The failure to
make such follow-on investments may, in certain circumstances, jeopardize the
continued viability of an investee and the Company's initial investment, or
may result in a missed opportunity for the Company to increase its
participation in a successful operation.
Competition
Numerous companies and individuals are engaged in the venture capital
business and such business is intensely competitive. Most of the competitors
have significantly greater experience, resources and managerial capabilities
than the Company and are therefore in a better position than the Company to
obtain access to attractive venture capital investments.
Regulation
The Small Business Investment Incentive Act of 1980 modified the
provisions of the 1940 Act that are applicable to a closed-end investment
BDC. 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, as modified by the Small Business Investment
Incentive Act of 1980, and is qualified in its entirety by the reference to
the full text of the 1940 Act and the rules thereunder by the Securities and
Exchange Commission (the "SEC").
Generally, to be eligible to elect BDC status, a company must primarily
engage in the business of furnishing capital and managerial expertise to
companies which do not have ready access to capital through conventional
financial channels. Such portfolio companies are termed "eligible portfolio
companies." More specifically, in order to qualify as a BDC, a company must
(i) be a domestic company; (ii) have registered a class of its securities or
have filed a registration statement with the SEC pursuant to Section 12 of
the Exchange Act of 1934; (iii) operate for the purpose of investing in the
securities of certain types of portfolio companies, namely, immature or
emerging companies and businesses suffering or just recovering from financial
distress (see following paragraph); (iv) extend significant managerial
assistance to such portfolio companies; (v) have a majority of "disinterested"
directors (as defined in the 1940 Act) and (vi) file (or, under certain
circumstances, intend to file) a proper notice of election with the SEC.
4
An eligible portfolio company generally is a domestic company that is
not an investment company and that (i) does not have a class of securities
registered on an exchange or included in the Federal Reserve Board's
over-the-counter margin list; (ii) is actively controlled by a BDC and has an
affiliate of a BDC on its board of directors or (iii) meets such other
criteria as may be established by the SEC. Control under the 1940 Act is
presumed to exist where a BDC owns 25 percent of the outstanding securities
of the investee.
The 1940 Act prohibits or restricts companies subject to the 1940 Act
from investing in certain types of companies, such as brokerage firms,
insurance companies, investment banking firms and investment companies.
Moreover, the 1940 Act limits the type of certain assets necessary for its
operations (such as office furniture, equipment and facilities) if, at the
time of acquisition, less than 70 percent of the value of the Company's
assets consist of qualifying assets. Qualifying assets include: (i)
securities of companies that were eligible portfolio companies at the time
such company acquired their securities; (ii) securities of bankrupt or
insolvent companies that were eligible at the time of such company's initial
investment in those companies; (iii) securities received in exchange for or
distributed in or with respect to any of the foregoing and (iv) cash items,
government securities and high quality short-term debt. The 1940 Act also
places restrictions on the nature of the transactions in which, and the
persons for whom, securities can be purchased in order for the securities to
be considered qualifying assets. Such restrictions include limiting
purchases to transactions not involving a public offering and acquiring
securities from either the portfolio company or their officers, directors or
affiliates.
The Company is permitted by the 1940 Act, under specified conditions,
to issue multiple classes of senior debt and a single class of preferred
stock if its asset coverage, as defined in the 1940 Act, is at least 200
percent after the issuance of the debt or the preferred stock (i.e., such
senior securities may not be in excess of 50 percent of its net assets). If
the value of the Company's assets, as defined, were to increase through the
issuance of additional capital stock or otherwise, the Company would be
permitted under the 1940 Act to issue senior securities.
The Company may sell its securities at a price that is below the
prevailing net asset value per share only after a majority of its
disinterested directors has determined that such sale would be in the best
interest of the Company and its stockholders and upon the approval by the
holders of a majority of its outstanding voting securities, including a
majority of the voting securities held by non-affiliated persons. If the
offering of the securities is underwritten, a majority of the disinterested
directors must determine in good faith that the price of the securities being
sold is not less than a price which closely approximates market value of the
securities, less any distribution discount or commission. As defined by the
1940 Act, the term "majority of the Company's outstanding voting securities"
means the vote of (i) 67 percent or more of the Company's Common Stock
present at the meeting, if the holders of more than 50 percent of the
outstanding Common Stock are present or represented by proxy or (ii) more
than 50 percent of the Company's outstanding Common Stock, whichever is less.
5
Most of the transactions involving the Company and its affiliates (as
well as affiliates of those affiliates) which were prohibited without the
prior approval of the Commission under the 1940 Act prior to its amendment by
the Small Business Investment Incentive Act are now permissible upon the
prior approval of a majority of the Company's independent directors and a
majority of the directors having no financial interest in the transactions.
However, certain transactions involving certain closely affiliated persons of
the Company, including its directors, officers, and employees, may still
require the prior approval of the Commission. In general, (i) any person who
owns, controls or holds power to vote, more than 5 percent of the Company's
outstanding Common Stock; (ii) any director, executive officer or general
partner of that person and (iii) any person who directly or indirectly
controls, is controlled by, or is under common control with, that person,
must obtain the prior approval of a majority of the Company's independent
directors and, in some situations, the prior approval of the Commission,
before engaging in certain transactions involving the Company or any company
controlled by the Company. The 1940 Act generally does not restrict
transactions between the Company and its portfolio companies. While a BDC
may change the nature of its business so as to cease being a BDC (and in
connection therewith withdraw its election to be treated as a BDC) only if
authorized to do so by a majority vote (as defined in the 1940 Act) of its
outstanding voting securities, stockholder approval of changes in other
fundamental investment policies of a BDC is not required (in contrast to the
general 1940 Act requirement, which requires stockholder approval for a
change in any fundamental investment policy). The Company is entitled to
change its diversification status without stockholder approval.
Item 2. Properties
The Company maintains its offices at One Rockefeller Plaza, Suite 1430,
New York, New York 10020, where it leases approximately 4,700 square feet of
office space pursuant to a lease agreement expiring in 2003.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of its shareholders
during the fourth quarter of the 1996 fiscal year.
6
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 22W, New York, New
York 10286 (Telephone (800) 524-4458, Attention: Ms. Diane Ajjan) serves as
transfer agent for the Company's common stock. Certificates to be
transferred should be mailed directly to the transfer agent, preferably by
registered mail.
Market Prices
The Company's common stock is traded on the NASDAQ National Market
System under the NASDAQ symbol "HHGP." The following table sets forth the
range of the high and low selling price of the Company's shares during
each quarter of the last two years, as reported by the National Association
of Securities Dealers, Inc.
1996 Quarter Ending Low High
March 31 $5.625 $7.875
June 30 $5.500 $7.375
September 30 $4.000 $5.875
December 31 $3.625 $4.875
1995 Quarter Ending Low High
March 31 $4.875 $6.375
June 30 $4.375 $5.125
September 30 $4.625 $5.875
December 31 $4.375 $8.125
On February 19, 1991, the Company's Board of Directors suspended
indefinitely the payment of dividends.
Shareholders
As of February 27, 1997, there were approximately 180 holders of
record of the Company's common stock which, the Company has been informed,
hold the Company's common stock for approximately 2,000 beneficial owners.
7
Item 6. Selected Financial Data
The following tables should be read in conjunction with the Financial
Statements included in Item 8 of this Form 10-K.
BALANCE SHEET DATA
Financial Position as of December 31:
1996 1995 1994 1993 1992
Total assets $ 38,555,290 $ 37,524,555 $ 32,044,073 $ 34,534,724 $ 29,377,482
Liabilities $ 2,622,687 $ 962,646 $ 733,271 $ 1,785,427 $ 6,724,139
Net asset
value $ 35,932,603 $ 36,561,909 $ 31,310,802 $ 32,749,297 $ 22,653,343
Net asset
value
per share $ 3.44 $ 3.54 $ 3.43 $ 3.66 $ 2.71
Shares
outstanding 10,442,682 10,333,902 9,136,747 8,944,828 8,350,999
Operating Data for year ended December 31 unless otherwise noted:
3 months ended
December 31,
1996 1995 1994 1993 1992
Investment
income $ 1,013,417 $ 1,109,517 $ 820,276 $ 453,950 $ 167,668
Net operating
loss (1,291,065) (1,099,409) (2,278,882) (1,614,625) (203,295)
Net realized
(loss) gain on
investments (2,465,175) 1,371,349 96,856 23,590,570 (128,332)
Net realized
(loss) income(3,756,240) 271,940 (2,182,026) 21,975,945 (331,627)
Net increase (decrease)
in unrealized
appreciation on
investments 2,967,248 158,219 (886,040) (13,083,344) (1,247,191)
Net (decrease) increase
in net assets
resulting from
operations (788,992) 430,159 (3,068,066) 8,892,601 (1,578,818)
(Decrease) increase
in net assets
resulting from
operations
per outstanding
share $ (0.08) $ 0.04 $ (0.34) $ 1.03 $ (0.19)
8
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Statement of Operations
The Company accounts for its operations under Generally Accepted
Accounting Principles for investment companies. On this basis, the principal
measure of its financial performance is captioned "Net increase (decrease) in
net assets from operations," which is the sum of three elements. The first
element is "Net operating loss," which is the difference between the Company's
income from interest, dividends, and fees and its operating expenses, net of
applicable income tax provisions (benefits). The second element is "Net
realized gain (loss) on investments," which is the difference between the
proceeds received from dispositions of portfolio securities and their stated
cost, net of applicable income tax provisions (benefits). These two elements
are combined in the Company's financial statements and reported as "Net
realized income (loss)." The third element, "Net increase (decrease) in
unrealized appreciation on investments," is the net change in the fair value
of the Company's investment portfolio, net of increase (decrease) in deferred
income taxes that would become payable if the unrealized appreciation were
realized through the sale or other disposition of the investment portfolio.
"Net realized gain (loss) on investments" and "Net increase (decrease)
in unrealized appreciation on investments" are directly related. When a
security is sold to realize a gain (loss), net unrealized appreciation
decreases (increases) and net realized gain increases (decreases).
Financial Condition
The Company's total assets and net assets were, respectively,
$38,555,290 and $35,932,603 at December 31, 1996, versus $37,524,555 and
$36,561,909 at December 31, 1995. Net asset value per share was $3.44 at
December 31, 1996, versus $3.54 at December 31, 1995.
The Company's financial condition is dependent on the success of its
investments. The Company has invested and expects to continue to invest a
substantial portion of its assets in private development stage or start-up
companies. These private businesses tend to be thinly capitalized, unproven,
small companies that lack management depth or have no history of operations.
At December 31, 1996, 49 percent of the Company's $39.0 million in total
assets consisted of investments at fair value in private businesses, of which
net unrealized appreciation was approximately $5.0 million before taxes. At
December 31, 1995, 35.5 percent of the Company's $37.5 million in total
assets consisted of investments at fair value in private businesses, of which
net unrealized appreciation was approximately $0.8 million.
9
A summary of the Company's investment portfolio is as follows:
December 31, 1996 December 31, 1995
Investments, at cost $ 28,981,093 $ 33,826,696
Unrealized appreciation 6,667,589 2,102,593
------------ ------------
Investments, at fair value $ 35,648,682 $ 35,929,289
============ ============
The accumulated unrealized appreciation on investments net of deferred taxes
is $4,371,591 at December 31, 1996, versus $1,404,343 at December 31, 1995.
Following an initial investment in a private company, the Company may
make additional investments in such investee in order to: (1) increase its
ownership percentage; (2) to exercise warrants or options that were acquired
in a prior financing; (3) to preserve the Company's proportionate ownership
in a subsequent financing or (4) attempt to preserve or enhance the value of
the Company's investment. Such additional investments are referred to as
"follow-on" investments. There can be no assurance that the Company will make
follow-on investments or have sufficient funds to make additional
investments. The failure to make such follow-on investments could jeopardize
the viability of the investee company and the Company's investment or could
result in a missed opportunity for the Company to participate to a greater
extent in an investee's successful operations. The Company attempts to
maintain adequate liquid capital to make follow-on investments in its private
investee portfolio companies. The Company may elect not to make a follow-on
investment either because it does not want to increase its concentration of
risk or because it prefers other opportunities, even though the follow-on
investment opportunity appears attractive.
The following table is a summary of the cash investments made by the
Company in its private placement portfolio during the year ended December 31,
1996:
New Investments: Amount
---------------- ------
BioSupplyNet, Inc. $ 575,000
Genomica Corporation 1,000,304
MultiTarget, Inc. 60,811
NeuroMetrix, Inc. 210,000
PowerVoice Technologies, Inc. 500,000
PureSpeech, Inc. 999,999
------------
Sub-total $ 3,346,114
Follow-on Investments:
----------------------
nFX Corporation $ 440,000
Micracor, Inc. 103,000
Gel Sciences, Inc. 545,000
------------
Sub-total $ 1,088,000
Exercise of Warrants Held:
--------------------------
Princeton Video Image, Inc. $ 547,500
------------
Total $ 4,981,614
============
Subsequent to December 31, 1996, the Company made follow-on investments
of $850,000 in PowerVoice Technologies, Inc. and $500,000 in Highline
Offshore Advisors, LLC. In addition, the Company signed loan agreements with
two of its investee companies for up to $750,000.
10
Results of Operations
Investment Income and Expenses:
The Company's principal objective is to achieve capital appreciation.
Therefore, a significant portion of the investment portfolio is structured to
maximize the potential for capital appreciation and provides little or no
current yield in the form of dividends or interest. The Company does earn
interest income from fixed-income securities, including U.S. Government
Obligations. The amount of interest income earned varies based upon the
average balance of the Company's fixed-income portfolio and the average yield
on this portfolio.
The Company had interest income of $803,819 in 1996, $999,869 in 1995
and $719,293 in 1994. The decrease is a result of a decline in the balance
of the Company's fixed-income portfolio to pay operating expenses and to
purchase non-income producing private portfolio investments. The Company
also received consulting and administrative fees from certain portfolio
companies which totaled $68,185 in 1996 and $88,209 in 1995.
Operating expenses were $2,985,316 in 1996, $2,806,141 in 1995 and
$4,364,806 in 1994. The increase from 1995 to 1996 is primarily owing to
additional consulting fees incurred in 1996 related to prospective private
portfolio investments. Operating expenses in 1994 included sign-up bonuses
totaling $1,000,000 to two executives hired by the Company. Most of the
Company's operating expenses are related to employee and director
compensation, office and rent expenses and consulting and professional fees
(primarily legal and accounting fees).
Net operating losses before taxes were $1,971,899 in 1996, $1,696,624
in 1995 and $3,544,530 in 1994.
The Company has in the past relied, and continues to rely to a large
extent, upon proceeds from sales of investments, rather than investment
income, to defray a significant portion of its operating expenses. Because
such sales cannot be predicted with certainty, the Company attempts to
maintain adequate working capital to provide for fiscal periods when there
are no such sales.
11
Realized Gains and Losses on Sales of Portfolio Securities:
During the three years ended December 31, 1996, 1995 and 1994, the
Company sold various investments, realizing a net loss of $3,792,576, a net
gain of $2,109,768 and a net loss of $71,396, respectively.
During 1996, the Company realized a loss on the sale of its equity
interest in Sonex International Corporation. However, because the investment
had been written off in 1994, the loss did not affect earnings in 1996.
Also during 1996, the Company sold and realized a loss on the sale of its
equity interest in Micracor Corporation.
During 1995, the Company sold various publicly traded securities,
realizing a net pre-tax capital gain of $2,109,768.
During 1994, the Company realized a net capital loss of $71,396 from
the disposition of various portfolio investments.
Unrealized Appreciation and Depreciation of Portfolio Securities:
Net unrealized appreciation on investments before taxes increased
$4,564,996 during the year ended December 31, 1996, from $2,102,593 to
$6,667,589, owing primarily to increased valuations for Gel Sciences, Inc.,
Nanophase Technologies Corporation, PHZ Capital Partners, Princeton Video
Image, Inc. and Biofield Corp; offset primarily by a decreased valuation of
nFX Corporation.
Net unrealized appreciation on investments before taxes increased
$243,414 during the year ended December 31, 1995, from $1,859,179 to
$2,102,593, owing primarily to increased valuations for CORDEX Petroleums,
Inc., Questech Corporation, Alliance Pharmaceutical Corporation and Magellan
Health Services, Inc.; offset primarily by a decreased valuation of Sonex
International Corporation.
Net unrealized appreciation on investments before taxes decreased
$1,142,734 during the year ended December 31, 1994, from $3,001,913 to
$1,859,179, owing primarily to unrealized losses in Sonex International
Corporation and Dynecology Incorporated; offset by an increase in unrealized
gain in Magellan Health Services, Inc.
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable securities
(the primary measure of liquidity) at December 31, 1996 of $19,296,591,
versus $23,833,891 at December 31, 1995 and $20,465,118 at December 31, 1994.
Management believes that its cash, receivables and marketable securities
provide the Company with sufficient liquidity for its operations.
12
Risks
Pursuant to Section 64(b)(1) of the Investment Company Act of 1940, a
Business Development Company is required to describe the risk factors
involved in an investment in the securities of such company inherent in the
nature of the company's investment portfolio. There are significant risks
inherent in the Company's venture capital business. The Company has invested
a substantial portion of its assets in private development stage or start-up
companies. These private businesses tend to be thinly capitalized, unproven,
small companies that lack management depth and have not attained
profitability or have no history of operations. Because of the speculative
nature and the lack of a public market for these investments, there is
significantly greater risk of loss than is the case with traditional
investment securities. The Company expects that some of its venture capital
investments will be a complete loss or will be unprofitable and that some
will appear to be likely to become successful but never realize their
potential. The Company has been risk seeking rather than risk averse in its
approach to venture capital and other investments. Neither the Company's
investments nor an investment in the Company is intended to constitute a
balanced investment program. The Company does not currently pay or intend to
pay cash dividends. The Company has in the past relied and continues to rely
to a large extent upon proceeds from sales of investments rather than
investment income to defray a significant portion of its operating expenses.
Item 8. Financial Statements and Supplementary Data
See Index to Financial Statements for a list of the Financial
Statements and Supplementary Data included in this Form 10-K.
Item 9. Disagreements on Accounting and Financial Disclosure
None.
13
PART III
Item 10. Directors and Executive Officers of the Company
OFFICERS
- --------
* Charles E. Harris, Chairman and Chief Executive Officer. For additional
information about Mr. Harris, please see the Directors' biographical
information section below.
Mel P. Melsheimer, age 57, has served as President, Chief Operating
Officer and Chief Financial Officer since February 1997. Harris & Harris
Group has employed Mel P. Melsheimer as a nearly full-time consultant since
1994. Mr. Melsheimer has had extensive entrepreneurial experience as well as
senior operational and financial management responsibilities with public and
privately owned companies. Mr. Melsheimer has served as a consultant to the
Company or as an officer of an investee company since March 1994. From
November 1992 to February 1994, he served as Executive Vice President, Chief
Operating Officer and Secretary of Dairy Holdings, Inc. From June 1991 to
August 1992, he served as President and Chief Executive Officer of Land-O-Sun
Dairies as well as Executive Vice President of Finevest Foods, Inc. From
March 1989 to May 1991, he served as Vice President, Chief Financial Officer
and Treasurer of Finevest Foods, Inc. From January 1984 to February 1989, he
served as Chairman, Chief Executive Officer and Founder of PHX Pacific, Inc.
and President and Chief Executive Officer of MPM Capital Corp. From January
1981 to December 1983, he served as Executive Vice President and Chief
Operating Officer of AZL Resources. From November 1975 to December 1980, he
served as Executive Vice President and Chief Financial Officer of AZL
Resources. From January 1968 to November 1975, he served in a financial
capacity before becoming Vice President and Chief Financial Officer of
Pepsi-Cola Company, PepsiCo, Inc. in 1972. He was graduated from the
University of Southern California (MBA) and Occidental College
(B.A., Economics).
David C. Johnson, Jr., age 40, joined the Company in February 1994, as
a Senior Vice President and has served as Executive Vice President since
January 1995. From 1984, until joining the Company, Mr. Johnson served as a
Vice President of Salomon Brothers Inc. He was graduated from The Darden
School at the University of Virginia (MBA, 1984) and the University of North
Carolina at Chapel Hill (B.A., 1978).
Rachel M. Pernia, age 37, has served since January 1992 as a Vice
President and Controller of the Company and as Treasurer since November 1994.
From 1988 until Ms. Pernia joined the Company, she was employed as Assistant
Controller for Cellcom Corp. From 1985 through 1988, she was employed as a
senior corporate accountant by Bristol-Myers Squibb Company. She was
graduated from Rutgers University (B.A., 1981) and is a certified public
accountant.
14
DIRECTORS
- ---------
Dr. C. Wayne Bardin, age 61, was elected to the Company's Board of
Directors in December 1994. Dr. Bardin's professional appointments have
included: Vice President, The Population Council; Professor of Medicine,
Chief of the Division of Endocrinology, The Milton S. Hershey Medical Center
of Pennsylvania State University; and Senior Investigator, Endocrinology
Branch, National Cancer Institute. Dr. Bardin also serves as a consultant to
several pharmaceutical companies. He has directed basic and clinical
research leading to over 500 publications and patents. He has negotiated 15
licensing and manufacturing agreements. He has directed clinical R&D under
18 INDs filed with the U.S. FDA. Dr. Bardin has been appointed to the
editorial boards of 15 journals. He has also served on national and
international committees and boards for NIH, WHO, The Ford Foundation, and
numerous scientific societies. Dr. Bardin received a B.A. from Rice
University; a M.S. and M.D. from Baylor University and a Doctor Honoris Causa
from the University of Caen, and the University of Paris.
G. Morgan Browne, age 62, was elected to the Company's Board of
Directors in June 1992. Since 1985, Mr. Browne has been Administrative
Director of the Cold Spring Harbor Laboratory, a private not-for-profit
institution that conducts research and education programs in the fields of
molecular biology and genetics. In prior years, he was active in the
management of numerous scientifically based companies as an individual
consultant or as an associate of Laurent Oppenheim Associates, Industrial
Management Consultants. He is a director of Oncogene Science, Inc.
(principally engaged in drug discovery based on gene transcription), a
founding director of the New York Biotechnology Association, and a founding
director and Treasurer of the Long Island Research Institute. He is a
graduate of Yale University and attended New York University Graduate School
of Business.
Harry E. Ekblom, age 68, has been a director of the Company since 1984.
Mr. Ekblom currently serves as Vice Chairman of A.T. Hudson & Co., Inc. and
President of Harry E. Ekblom & Co., Inc., each of which is engaged in the
business of management consulting. He became President of Harry E. Ekblom &
Co., Inc. in 1984 and joined A.T. Hudson in March 1985. Before 1984, he was
employed by European American Bank as the Chairman of its Board of Directors
and Chief Executive Officer. Mr. Ekblom is a director of Pan Energy Corp.
(principally engaged in interstate transmission of natural gas) and The
Commercial Bank of New York. He is a graduate of Columbia College and the
New York University School of Law, a member of the New York Bar, and holds
honorary degrees from Hofstra University and Pace University.
Dugald A. Fletcher, age 67, was elected to the Company's Board of
Directors in June 1996. Mr. Fletcher has been President of Fletcher & Company,
Inc., a management consulting firm, for the past five years. He is also
Chairman of Binnings Building Products Company, Inc. and an Advisor to the
Gabelli Growth Fund and a Director of Gabelli Convertible Securities Fund.
Previously, he was an advisor to the Gabelli/Rosenthal LP, a leveraged buyout
fund; Chairman of Keller Industries (building and consumer products);
Director and investor in Mid-Atlantic Coca-Cola Bottling Company; Senior Vice
President of Booz-Allen & Hamilton and President of Booz-Allen Acquisition
Services; Executive Vice President and a Director of Paine Webber, Inc.; and
President of Baker, Weeks and Co.,Inc. He is a graduate of Harvard College
and of Harvard Business School.
15
* Charles E. Harris, age 54, has been a director of the Company and
Chairman of its Board of Directors since April 1984. He has served as Chief
Executive Officer of the Company since July 1984. From April 1990 to August
1991, he served as Chairman of publicly owned Ag Services of America, Inc.,
in which the Company then held an equity interest. From its formation in
November 1989 until June 1990, he served as Chairman and Chief Executive
Officer of publicly owned Molten Metal Technology, Inc., which the Company
cofounded and in which the Company then held an equity interest. From July
1986 to January 1989, he served as Chairman of publicly owned Re Capital
Corporation, which the Company founded and in which the Company then held an
equity interest. From July 1984 to July 1985, he served as a director and
was the control person of publicly owned Alliance Pharmaceutical, which the
Company founded and in which the Company then held an equity interest. Prior
to 1984, he was Chairman of Wood, Struthers and Winthrop Management Corp.,
the investment advisory subsidiary of Donaldson, Lufkin & Jenrette. He was a
member of the Advisory Panel for the Congressional Office of Technology
Assessment. He is a Trustee of The Institute for Genomic Research, and a
director of the insurance company Dearborn Risk Management, Inc. He is a
member of the New York Society of Security Analysts. Among his eleemosynary
activities, he is a life-sustaining fellow at the Massachusetts Institute of
Technology and a member of the President's Council at Cold Spring Harbor
Laboratory. He was graduated from Princeton University (A.B., 1964) and the
Columbia University Graduate School of Business (MBA, 1967).
Charles F. Hays, age 51, joined the Board as a director in March 1995.
Since 1993, Mr. Hays has been Senior Vice President, Chief Financial and
Administrative Officer of Mid Ocean Ltd. His positions have included:
Managing Director & Chief Financial and Administrative Officer of Marsh &
McLennan, Incorporated, from 1984 to 1993; Vice President and Treasurer of
the Guy Carpenter & Company subsidiary of Marsh & McLennan Companies, from
1979 to 1984; Assistant Vice President of Corporate Development of Marsh &
McLennan Companies, from 1977 to 1979; Assistant Treasurer of Morgan Guaranty
Trust Company, from 1975 to 1977; and Deputy Director of AmerAsian Group of
Companies, from 1971 to 1972. He is a graduate of the University of Kansas
and Stanford University Graduate School of Business.
Jon J. Masters, age 59, was elected to the Company's Board of Directors
in February 1992. Since July 1996, Mr. Masters has been Vice Chairman of
Robb Peck McCooey Specialist Corporation. Prior to that, since 1976, he was
a member of the law firm of Christy & Viener, which he cofounded. Mr.
Masters is a graduate of Princeton University and Harvard Law School.
Glenn E. Mayer, age 71, has been a director of the Company since 1981.
In December 1991, Mr. Mayer joined, as a Senior Vice President, the
Investment Banking division of Reich & Company. Reich & Co. is now a
division of Fahnestock & Company, Inc., a member firm of the New York Stock
Exchange. For fifteen years prior to that, he was employed by Jesup & Lamont
Securities Co. and its successor firms, in the Corporate Finance department.
Mr. Mayer is a graduate of Indiana University.
William R. Polk, age 68, has been a director of the Company since
August 1988. For the last seven years, Mr. Polk has been an author and
self-employed consultant. He is the former President of the Adlai Stevenson
Institute of International Affairs, a former member of the Policy Planning
Council of the United States Department of State, and a former Professor of
the University of Chicago and Harvard University. Mr. Polk is a graduate of
Harvard University and Oxford University.
16
James E. Roberts, age 51, was elected to the Company's Board of
Directors in June 1995. Since May 1995, Mr. Roberts has been Vice Chairman
of Trenwick America Reinsurance Corporation. During the nine years prior to
that, Mr. Roberts held the following positions at Re Capital Corporation:
President and Chief Executive Officer, from 1992 to 1995; President and Chief
Operating Officer, 1991 to 1992; Director since 1989 and Senior Vice
President, 1986 to 1991; President and Chief Executive Officer of the
Company's principal operating subsidiary, Re Capital Reinsurance Corporation
from 1991 to 1995. Mr. Roberts has also served as Senior Vice President and
Chief Underwriting Officer of North Star Reinsurance Corporation, from 1979
to 1986; Vice President of Rollins Burdick Hunter of New York, Inc., 1977 to
1979; Secretary of American Home Assurance/National Union Insurance Group of
American International Group, Inc., 1973 to 1977; and commercial casualty
underwriter at Continental Insurance Company, 1972 to 1973. Mr. Roberts is a
graduate of Cornell University.
Robert B. Schulz, age 39, was elected to the Company's Board of
Directors in February 1997. In February 1997, Mr. Schulz joined C B Health
Ventures, L.P. as a Venture Partner. Prior to that, he served as the
Company's President and Chief Operating Officer from March 1994 to his
resignation in February 1997. From 1984, until joining the Company, he was
employed by CS First Boston Corporation, most recently as a Director in the
Insurance Group. Mr. Schulz received his MBA degree from Columbia University
Graduate School of Business in 1983. Prior to attending Columbia University,
he was employed as a research engineer in the Alternate Energy Group of
Chevron Research Company and as a project manager of Dynecology,
Incorporated, a high technology, family owned engineering research firm. He
graduated from the Massachusetts Institute of Technology in 1979 with his
B.S. and M.S. degrees in chemical engineering.
* Charles E. Harris is an "interested person" of the Company, as defined in
the Investment Company Act of 1940, as an owner of more than five percent of
the Company's stock, as a control person and as an officer of the Company.
17
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth a summary for each of the last three years of
the cash and non-cash compensation awarded to, earned by, or paid to the
Chief Executive Officer of the Company and the other executive officers of
the Company, whose individual remuneration exceeded $100,000 for the year
ended December 31, 1996.
Annual Compensation Long Term
Compensation
Awards
Name and Principal Other Annual Stock All Other
Position Year Salary Bonus Compensation Options Compensation
- ------------------ ---- ------ ----- ------------ ------- ------------
($) ($) ($)(1) (#) ($)(2)
Charles E. Harris 1996 595,246 -- -- -- 9,500
Chairman & CEO 1995 592,400 -- -- 160,000 9,240
(3) 1994 605,739 -- -- -- 9,240
Robert B. Schulz 1996 207,194 -- -- -- 9,500
President & COO 1995 201,014 -- -- 250,000 9,240
(5) 1994 146,908 500,000 -- -- --
C. Richard Childress 1996 262,200 -- -- -- --
CFO & EVP 1995 254,953 -- -- 75,000 9,240
(4) 1994 264,458 -- -- -- 9,240
David C. Johnson,Jr. 1996 197,763 -- -- -- 9,500
EVP (5) 1995 192,500 -- -- 200,000 9,240
1994 158,246 500,000 -- -- 9,240
(1) Amounts of "Other Annual Compensation" earned by the named executive
officers for the periods presented did not meet the threshold reporting
requirements.
(2) Amounts reported represent the Company's contributions on behalf of
the named executive to the Harris & Harris Group, Inc. 401(k) Plan
described below.
(3) As of August 15, 1990, Mr. Harris entered into a non-competition and
employment contract with the Company that was amended on June 30,
1992, January 3, 1993, and June 30, 1994 (the "Employment Contract").
The term of the Employment Contract expires on December 31, 1999.
Mr. Harris is to receive compensation under his Employment Contract in
the form of salary and other benefits. Annual base salary are to be
increased annually as of January 1 of each year to reflect inflation
and in addition may be increased by such amounts as the Board deems
appropriate.
The Employment Contract provides Mr. Harris with life insurance for
the benefit of his designated beneficiaries in the amount of
$2,000,000. The Employment Contract also provides reimbursement for
uninsured medical expenses, not to exceed $5,000 per annum, adjusted
for inflation, over the period of the contract, and disability insurance
in the amount of 100 percent of his base salary.
The Employment Contract 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, for a period
of two years, equal to the executive's base salary.
18
In addition, Mr. Harris is entitled to receive severance pay pursuant
to the severance compensation agreement that he entered into with the
Company, effective August 15, 1990. The severance compensation agreement
provides that if, following a change in control of the Company, as
defined in the agreement, such individual's employment is terminated by
the Company without cause or by the executive within one year of such
change in control, the individual shall be entitled to receive
compensation in a lump sum payment equal to 2.99 times the individual's
average annualized compensation and payment of other welfare benefits.
If the executive's termination is without cause or is a constructive
discharge, the amount payable under the Employment Contract will be
reduced by the amounts paid pursuant to the severance compensation
agreement.
(4) On October 1, 1996, Mr. Childress resigned as Executive Vice President
and Chief Financial Officer of the Company. He currently is a
consultant to the Company. The numbers exclude $30,450, $28,960 and
$28,260 for 1996, 1995 and 1994, respectively, of non-accountable office
expense allowance received by Mr. Childress.
(5) Bonus amounts represent sign-up remuneration received upon beginning
employment with the Company during 1994.
There were no stock options granted to the executive officers included
in the above table during the year ended December 31, 1996.
19
Item 12. Security Ownership of Certain Beneficial Owners and Management
Security ownership of Directors, Nominees and Officers and other
principal holders of the Company's voting securities
The following table sets forth certain information with respect to
beneficial ownership (as that term is defined in the rules and regulations of
the Securities and Exchange Commission) of the Company's common stock as of
March 14, 1997 by (1) each person who is known by the Company to be the
beneficial owner of more than five percent of the outstanding common stock,
(2) each director of the Company, (3) each current executive officer listed in
the Summary Compensation Table and (4) all directors and executive officers
of the Company as a group. Except as otherwise indicated, to the Company's
knowledge, all shares are beneficially owned and investment and voting power
is held as stated by the persons named as owners.
Name and Address of Number of Shares of
Beneficial Owner Common Stock Owned Percent of Class (1)
- ------------------- ------------------- --------------------
Charles E. and Susan T. Harris
One Rockefeller Plaza,
Suite 1430
New York, NY 10020 1,690,988 (2) 15.60%
American Bankers Insurance Group
11222 Quail Roost Drive
Miami, FL 33157 1,075,269 (3) 10.30%
Jordan Financial Services Group
1751 Mound Street, Suite 1A
Sarasota, FL 34236 1,404,011 (4) 13.44%
C. Wayne Bardin 20,000 (6) *
G. Morgan Browne 50,000 (5) *
Harry E. Ekblom 55,000 (5) *
Dugald A. Fletcher 20,000 (6) *
Charles F. Hays 26,300 (6) *
David C. Johnson, Jr. 337,574 (7) 3.18%
Jon J. Masters 50,000 (5) *
Glenn E. Mayer 72,000 (5)(8) *
Mel P. Melsheimer 305,072 (10) 2.84%
William R. Polk 71,000 (5) *
James E. Roberts 22,000 (6) *
Robert B. Schulz 131,845 (9) 1.25%
All Directors and Officers
as a group (15 persons) 2,959,779 24.87%
* Less than one percent of issued and outstanding stock.
20
(1) Shares of common stock subject to options and warrants are deemed
outstanding for computing the percentage of class of the person or
group holding such options or warrants, but are not deemed outstanding
for computing the percentage of class of any other person.
(2) Includes 504,732 shares for which Mrs. Harris has sole investment power;
766,655 shares for which Mr. Harris has sole investment power; 21,996
shares owned by a child for which Mrs. Harris has sole voting and
dispositive power; 1,271,387 shares for which Mr. Harris has sole voting
power, and 237,605 shares subject to currently exercisable warrants for
which Mr. Harris has sole investment power. Excludes 130,000 shares
owned by the Susan T. and Charles E. Harris Foundation in which Charles
E. Harris and Susan T. Harris are designated trustees; voting and
dispositive power are vested with the trustees. On August 17, 1995, the
Company granted Mr. Harris stock options to purchase 160,000 shares of
common stock that vest over a five-year period, of which 32,000 have
vested. The total shares have been included in the table.
(3) Represents shares owned by subsidiaries of American Bankers Insurance
Group, Inc.
(4) Represents shares owned by Jordan Financial Services Group as of March
12, 1997. Jordan Financial Services Group is a registered investment
advisor that holds these shares for investment purposes only on behalf of
various clients.
(5) Includes option to purchase 50,000 shares.
(6) Includes option to purchase 20,000 shares, which vest over a five-year
period. The total shares have been included in the table.
(7) On August 17, 1995, the Company granted Mr. Johnson stock options to
purchase 200,000 shares of common stock that vest over a five-year
period, of which 40,000 have vested. The total shares have been included
in the table.
(8) Includes 2,000 shares owned by Mrs. Mayer.
(9) On August 17, 1995, the Company granted Mr. Schulz stock options to
purchase 250,000 shares of common stock that vest over a five-year
period, of which 50,000 have vested. The vested shares have been
included in the table. On February 14, 1997, Mr. Schulz resigned as
President, COO & CCO from Harris & Harris Group, Inc. and was voted a
Director and granted an option to purchase 20,000 shares of common stock
that vest over a five-year period. Unless Mr. Schulz exercises the
50,000 stock options by May 14, 1997, the vested options will expire.
(10) On February 10, 1997, the Company granted Mr. Mel P. Melsheimer stock
options to purchase 300,000 shares of common stock that vest over a
five-year period. The total shares have been included in this table.
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, 1996.
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a) Exhibits. The exhibits which are filed with this Form 10-K or
incorporated herein by reference are set forth in the Exhibit Index on page
24.
(b) Reports on Form 8-K. The Company did not file any reports on Form
8-K during the last quarter of 1996.
21
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 31, 1997 By:/s/
-------------------------
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/
- -------------------- Chairman of the Board, March 31, 1997
Charles E. Harris Chief Compliance Officer and
Chief Executive Officer
/s/
- -------------------- President, Chief Operating March 31, 1997
Mel P. Melsheimer Officer and Chief Financial Officer
/s/
- -------------------- Executive Vice President March 31,1997
David C. Johnson, Jr.
/s/
- -------------------- Vice President, Controller, March 31,1997
Rachel M. Pernia Treasurer and Principal
Accounting Officer
22
/s/
- -------------------- Director March 21, 1997
C. Wayne Bardin
/s/
- -------------------- Director March 21, 1997
G. Morgan Browne
/s/
- -------------------- Director March 21, 1997
Harry E. Ekblom
/s/
- -------------------- Director March 21, 1997
Dugald A. Fletcher
/s/
- -------------------- Director March 21, 1997
Charles F. Hays
/s/
- -------------------- Director March 31, 1997
Jon J. Masters
/s/
- -------------------- Director March 21, 1997
Glenn E. Mayer
/s/
- -------------------- Director March 21, 1997
William R. Polk
/s/
- -------------------- Director March 21, 1997
James E. Roberts
/s/
- -------------------- Director March 21, 1997
Robert B. Schulz
23
EXHIBIT INDEX
The following exhibits are filed with this report or are incorporated
herein by reference to a prior filing, in accordance with Rule 12b-32 under
the Securities Exchange Act of 1934. (Asterisk denotes exhibits filed with
this report.)
Exhibit No. Description
- ----------- -----------
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.
4.1 Specimen certificate of common stock certificate, incorporated by
reference to Exhibit 4 to Company's Registration Statement on Form
N-2 filed October 29, 1992.
8.1 Harris & Harris Group, Inc. 1988 Stock Option Plan, as amended and
restated, incorporated by reference to Exhibit 8.1 to the
Company's Form 10-K for the year ended December 31, 1995.
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 Employment Agreement by and between the Company and Charles E.
Harris dated August 15, 1990, incorporated by reference to Exhibit
10 (r) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1990.
10.2 Amendment No.1 to the Employment Agreement dated as of August 15,
1990 between the Company and Charles E. Harris dated as of June
30, 1992, incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement in Form N-2 filed on October 29,
1992.
10.3 Amendment No.2 to the Employment Agreement dated as of August 15,
1990 between the Company and Charles E. Harris dated as of January
6, 1993, incorporated by reference to Exhibit 10.22 to the
Company's Registration Statement in Form N-2 filed on December 3,
1993.
10.4 Amendment No.3 to the Employment Agreement dated as of August 15,
1990 between the Company and Charles E. Harris dated as of June 30,
1994.
24
10.5 Severance Compensation Agreement by and between the Company and
Charles E. Harris dated August 15, 1990, incorporated by reference
to exhibit 10 (s) to the Company's Annual Report on Form 10-K for
the year ended December 31, 1990.
10.11 Warrant issued by the Company to Charles E. Harris dated September
23, 1985 as clarified and restated on May 1, 1989, incorporated by
reference to Exhibit 10 (n) to the Company's Annual Report on Form
10-K for the year ended December 31, 1989.
10.13 Stock Purchase Agreement, Standstill Agreement and Termination
and Release by and among Harris & Harris Group, Inc. and American
Bankers Life Assurance Company of Florida dated May 18, 1995,
incorporated by reference to Exhibit 10.13 to the Company's Form
10-K for the year ended December 31, 1995.
10.14 Form of Indemnification Agreement which has been established with
all directors and executive officers of the Company, incorporated
by reference to Exhibit 10.14 to the Company's Form 10-K for the
year ended December 31, 1995.
24* Consent of Arthur Andersen LLP
25
HARRIS & HARRIS GROUP, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
The following reports and financial schedules of Harris & Harris Group,
Inc. are filed herewith and included in response to Item 14(a).
Documents Page
- --------- ----
Report of Independent Public Accountant . . . . . 27
Financial Statements
- --------------------
Statements of Assets and Liabilities
as of December 31, 1996 and 1995 . . . . . . 28
Statements of Operations for the
years ended December 31, 1996, 1995 and 1994 29
Statements of Cash Flows for the
years ended December 31, 1996, 1995 and 1994. 30
Statements of Changes in Net Assets for the
years ended December 31, 1996, 1995 and 1994. 31
Schedule of Investments as of December 31, 1996 . 32-35
Footnote to Schedule of Investments . . . . . . . 36-39
Notes to Financial Statements . . . . . . . . . . 40-46
Selected Per Share Data and Ratios for the
years ended December 31, 1996, 1995, 1994 and 1993
and the three month period ended December 31, 1992 47
Schedules other than those listed above have been omitted because they
are not applicable or the required information is presented in the financial
statements and/or related notes.
26
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Harris & Harris Group, Inc.:
We have audited the accompanying statements of assets and liabilities
of Harris & Harris Group, Inc. (a New York corporation) as of December 31,
1996 and 1995, including the schedule of investments, as of December 31,
1996, and the related statements of operations, cash flows and changes in
net assets for the three years ended December 31, 1996, and the selected
per share data and ratios for each of the four years ended December 31,
1996 and the period from commencement of investment company operations
(October 1, 1992) to December 31, 1992. These financial statements and
selected per share data and ratios are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and selected per share data and ratios based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
and selected per share data and ratios are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. Our procedures
included confirmation of securities owned as of December 31, 1996 and 1995,
by correspondence with the custodian and brokers. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
As explained in Note 2, the financial statements include securities
valued at $18,825,365 (52.4 percent of net assets), whose values have been
estimated by the Board of Directors in the absence of readily ascertainable
market values. However, because of the inherent uncertainty of valuation,
those estimated values may differ significantly from the values that would
have been used had a ready market for the securities existed, and the
differences could be material.
In our opinion, the financial statements and selected per share data and
ratios referred to above present fairly, in all material respects, the
financial position of Harris & Harris Group, Inc. as of December 31, 1996 and
1995, the results of its operations, its cash flows and the changes in its net
assets for the three years ended December 31, 1996, and the selected per share
data and ratios for each of the four years ended December 31, 1996 and the
three month period ended December 31, 1992, in conformity with generally
accepted accounting principles.
Arthur Andersen LLP
New York, New York
February 10, 1997
27
STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
December 31, 1996 December 31, 1995
Investments, at value (See accompanying
schedule of investments and notes) . . $ 35,648,682 $ 35,929,289
Cash and cash equivalents. . . . . . . . 155,440 364,354
Receivable from brokers. . . . . . . . . 0 205,789
Interest receivable. . . . . . . . . . . 198,342 300,718
Taxes receivable (Note 6). . . . . . . . 2,119,492 367,929
Prepaid expenses . . . . . . . . . . . . 81,501 86,976
Other assets . . . . . . . . . . . . . . 351,833 269,500
------------ ------------
Total assets . . . . . . . . . . . . . . $ 38,555,290 $ 37,524,555
============ ============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities $ 374,326 $ 352,129
Deferred rent. . . . . . . . . . . . . . 60,914 59,887
Deferred income tax liability (Note 6) 2,187,447 550,630
------------ ------------
Total liabilities. . . . . . . . . . . . 2,622,687 962,646
Commitments and contingencies (Note 7)
------------ ------------
Net assets . . . . . . . . . . . . . . . $ 35,932,603 $ 36,561,909
============ ============
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized; none issued $ 0 $ 0
Common stock, $0.01 par value, 25,000,000
shares authorized; 10,442,682 issued and
outstanding at 12/31/96 and 10,333,902
issued and outstanding at 12/31/95. . . 104,427 103,339
Additional paid in capital . . . . . . . 15,850,576 15,691,978
Accumulated net realized income. . . . . 15,606,009 19,362,249
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $2,295,998 at 12/31/96
and $698,250 at 12/31/95. . . . . . . . 4,371,591 1,404,343
------------ ------------
Net assets . . . . . . . . . . . . . . . $ 35,932,603 $ 36,561,909
============ ============
Shares outstanding . . . . . . . . . . . 10,442,682 10,333,902
------------ ------------
Net asset value per outstanding share. . $ 3.44 $ 3.54
============ ============
The accompanying notes are an integral part of these financial statements.
28
STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
Investment income:
Interest from:
Fixed-income securities $ 803,819 $ 999,869 $ 719,293
Affiliated companies. . 40,779 11,222 11,913
Dividend income--unaffiliated
companies . . . . . . . . 8,024 8,436 88,067
Consulting and
administrative fees . . . 68,185 88,209 0
Other income . . . . . . . 92,610 1,781 1,003
------------ ------------ ------------
Total investment income 1,013,417 1,109,517 820,276
Expenses:
Salaries and benefits. . . 1,524,826 1,560,132 2,061,981
Sign-up bonuses. . . . . . 0 0 1,000,000
------------ ------------ ------------
Total salaries and benefits 1,524,826 1,560,132 3,061,981
Administration and operations 474,537 440,605 424,714
Professional fees. . . . . 675,241 461,526 421,865
Depreciation and amortization 57,426 161,876 271,430
Rent . . . . . . . . . . . 160,601 124,713 114,667
Directors' fees and expenses 80,702 40,836 52,816
Custodian fees . . . . . . 11,983 16,453 17,333
------------ ------------ ------------
Total expenses. . . . . 2,985,316 2,806,141 4,364,806
------------ ------------ ------------
Operating loss before
income taxes. . . . . . (1,971,899) (1,696,624) (3,544,530)
Income tax benefit (Note 6) 680,834 597,215 1,265,648
------------ ------------ ------------
Net operating loss. . . . . (1,291,065) (1,099,409) (2,278,882)
Net realized (loss) gain on investments:
Realized (loss) gain on
sale of investments . . (3,792,576) 2,109,768 (71,396)
------------ ------------ ------------
Total realized (loss) gain (3,792,576) 2,109,768 (71,396)
Income tax benefit
(provision) (Note 6). . 1,327,401 (738,419) 168,252
------------ ------------ ------------
Net realized (loss) gain
on investments. . . . . (2,465,175) 1,371,349 96,856
------------ ------------ ------------
Net realized (loss) income (3,756,240) 271,940 (2,182,026)
Net increase (decrease) in unrealized appreciation on investments:
Increase as a result of
investment sales. . . . 2,525,548 337,577 7,955
Decrease as a result of
investment sales. . . . 0 (562,765) (1,223,026)
Increase on investments held 4,112,413 1,002,347 1,028,961
Decrease on investments held (2,072,965) (533,745) (956,624)
------------ ------------ ------------
Change in unrealized
appreciation (depreciation)
on investments. . . . 4,564,996 243,414 (1,142,734)
Income tax (provision)
benefit (Note 6). . . . (1,597,748) (85,195) 256,694
------------ ------------ ------------
Net increase (decrease) in
unrealized appreciation
on investments. . . . . 2,967,248 158,219 (886,040)
------------ ------------ ------------
Net (decrease) increase in net assets from operations:
Total. . . . . . . . . . . $ (788,992) $ 430,159 $(3,068,066)
============ ============ ============
Per outstanding share. . . $ (0.08) $ 0.04 $ (0.34)
============ ============ ============
The accompanying notes are an integral part of these financial statements.
29
STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
Cash flows (used in) provided by operating activities:
Net (decrease) increase in
net assets resulting from
operations . . . . . . . . $ (788,992) $ 430,159 $(3,068,066)
Adjustments to reconcile
(decrease) increase in
net assets from operations
to net cash (used in) provided
by operating activities:
Net realized and unrealized
(gain) loss on investments (772,420) (2,353,182) 1,214,130
Deferred income taxes. . . 1,636,817 241,479 (408,655)
Depreciation and amortization 57,426 161,876 271,430
Other. . . . . . . . . . . (10,144) 40,859 2,451
Changes in assets and liabilities:
Receivable from brokers. . 205,789 3,835,602 (4,041,391)
Prepaid expenses . . . . . 5,475 (21,756) 183,643
Interest receivable. . . . 102,376 (227,392) (64,949)
Taxes receivable . . . . . (1,679,377) 1,184,567 (1,190,637)
Other assets . . . . . . . (103,981) (9,372) 153,071
Accounts payable and
accrued liabilities . . 22,197 (43,241) 142,570
Payable for securities purchased 0 0 (797,380)
Deferred rent. . . . . . . 10,279 10,281 20,560
Collection on note receivable 0 54,664 17,105
Purchase of fixed assets (35,777) (16,409) (30,188)
------------ ------------- -----------
Net cash (used in) provided
by operating activities (1,350,332) 3,288,135 (7,596,306)
Cash provided by (used in) investing activities:
Net (purchase) sale of
short-term investments
and marketable securities 6,035,532 (3,324,957) 9,953,393
Investment in private
placements . . . . . . (4,981,614) (4,236,352) (3,671,851)
------------ ------------- -----------
Net cash provided by (used in)
investing activities 1,053,918 (7,561,309) 6,281,542
Cash flows provided by financing activities:
Purchase of treasury stock 0 (646,430) 0
Proceeds from exercise
of stock options . . 87,500 62,500 0
Proceeds from private
placement of stock (Note 4) 0 5,000,001 0
Proceeds from sale of stock 0 0 1,409,007
------------ ------------- -----------
Net cash provided by
financing activities 87,500 4,416,071 1,409,007
------------ ------------- -----------
Net (decrease) increase in cash
and cash equivalents:
Cash and cash equivalents
at beginning of the year 364,354 221,457 127,214
Cash and cash equivalents
at end of the year 155,440 364,354 221,457
------------ ------------- -----------
Net (decrease) increase
in cash. . . . . . . . $ (208,914) $ 142,897 $ 94,243
============ ============= ===========
Supplemental disclosures of cash flow information:
Income taxes paid . . . . $ 57,234 $ 8,323 $ 26,820
The accompanying notes are an integral part of these financial statements.
30
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
Changes in net assets from operations:
Net operating loss . . $(1,291,065) $(1,099,409) $(2,278,882)
Net realized (loss) gain
on investments . . (2,465,175) 1,371,349 96,856
Net increase (decrease)
in unrealized appreciation
on investments as a
result of sales. . 1,641,606 (146,372) (933,059)
Net increase in unrealized
appreciation on
investments held 1,325,642 304,591 47,019
------------ ------------ ------------
Net (decrease) increase in net assets
resulting from operations (788,992) 430,159 (3,068,066)
Changes in net assets from
capital stock transactions:
Purchase of stock. . . 0 (646,430) 0
Restricted stock award (Note 3) 0 110,283 220,564
Sales of stock to employees 0 0 1,409,007
Proceeds from exercise of
stock options and warrants 87,500 62,500 0
Proceeds from private placement
of common stock (Note 4) 0 5,000,001 0
Tax benefit of restricted
stock award and common
stock transactions 72,186 294,594 0
---------- ---------- ---------
Net increase in net assets
resulting from capital
stock transactions . . 159,686 4,820,948 1,629,571
---------- ---------- -----------
Net (decrease) increase
in net assets. . . . . . (629,306) 5,251,107 (1,438,495)
Net assets:
Beginning of the year. . 36,561,909 31,310,802 32,749,297
------------ ------------ ------------
End of the year. . . . . $ 35,932,603 $ 36,561,909 $ 31,310,802
============ ============ ============
The accompanying footnotes are an integral part of these financial statements.
31
SCHEDULE OF INVESTMENTS DECEMBER 31, 1996
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Investments in Unaffiliated Companies
(9)(12)(13) -- 17.3% of total investments
Publicly Traded Portfolio -- 9.7% of total investments
(Common Stock unless noted otherwise)
Oil and Gas Related
CORDEX Petroleums Inc. (1)
Argentine oil and gas exploration
Class A Common Stock . . . .. . . . . (C) 4,052,080 $ 263,786
Biotechnology and Healthcare Related
Alliance Pharmaceutical Corporation (1). . (C) 70,000 945,000
Biofield Corp.(1)(4) . . . . . . . . . . . (C) 75,000 1,050,938
Magellan Health Services, Inc. (1)(2)(6) . (C) 54,368 1,206,347
------------
Total Publicly Traded Portfolio (cost: $1,827,774) . . . . . $ 3,466,071
Private Placement Portfolio (Illiquid) -- 7.6% of total investments
Exponential Business Development Company (1)(2)(5)
Venture capital partnership focused
on early stage companies
Limited partnership interest. . . . . . (A) - - $ 25,000
Micracor, Inc. (1)(2) -- Designs and manufactures
advanced solid state photonic systems
Convertible Note. . . . . . . . . . . . (D) $ 103,000 69,000
Princeton Video Image, Inc. (1)(2)(7)(8) --
Real time sports and entertainment advertising
3.5% of fully diluted equity
Common Stock. . . . . . . . . . . . . . (B) 68,400
Warrants at $2.25 expiring 8/25/97. . . (D) 6,700 2,613,425
------------
Total Private Placement Portfolio (cost: $771,000). . . . . . $ 2,707,425
------------
Total Investments in
Unaffiliated Companies (cost: $2,598,774) . . . . . . . . . $ 6,173,496
------------
The accompanying notes are an integral part of this schedule.
32
SCHEDULE OF INVESTMENTS DECEMBER 31, 1996
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Private Placement Portfolio in Non-Controlled Affiliates
(9)(13) (Illiquid) -- 32.1% of total investments
Dynecology Incorporated (1)(2)(5)(7)
Develops various environmental
intellectual properties -- Option expiring
12/13/98 to purchase at $15 per share
135,000 shares of Common Stock equaling
18.1% of fully diluted equity. . . . . . .(D) - - $ 40,000
Gel Sciences, Inc. (1)(2)(7) -- Develops
engineered response gels for controlled
release systems -- 10.3% of fully diluted equity
Warrants at $1.65 expiring 02/01/00. . . .(D) 27,766
Common Stock . . . . . . . . . . . . . . .(B) 171,172
Series A Preferred Stock . . . . . . . . .(D) 135,178
Series A-1 Preferred Stock . . . . . . . .(D) 57,607
Series B Convertible Preferred Stock . . .(B) 397,409
Series C Convertible Preferred Stock . . .(B) 101,515 2,349,312
Harber Brothers Productions, Inc. (1)(2)(5)(7)
Finances, produces and markets media
products that combine entertainment, music,
learning and interactivity --
21.5% of fully diluted equity
Series A Voting Convertible
Preferred Stock. . . . . . . . . . . . . .(A) 967,500 967,500
Highline Capital Management, LLC. (2)(7)
Organizes and manages investment partnerships
24.9% of fully diluted equity. . . . . . .(A) - - 500,000
Nanophase Technologies Corporation (1)(2)(7)
Manufactures and markets inorganic
crystals of nanometric dimensions
7.6% of fully diluted equity
Series D Convertible Preferred Stock . . .(B) 1,162,204 2,614,959
NeuroMetrix, Inc. (1)(2)(4)(7) -- Developing a
device for diabetics to monitor their
blood glucose -- 30% of fully diluted equity
Warrants at $1.60 expiring 6/2/97. . . . .(A) 125,000
Series A Convertible Preferred Stock . . .(A) 175,000 210,000
PHZ Capital Partners Limited Partnership (1)(2)(5)
Organizes and manages investment partnerships
20.0% of fully diluted equity
Limited partnership interest . . . . . . .(B) 1,000,000
One year 8% note due 9/22/97 . . . . . . .(A) $ 500,000 500,000
PureSpeech, Inc. (1)(2)(4)(7) -- Develops and markets
innovative speech recognition technology
7.3% of fully diluted equity
Series A Convertible Preferred Stock . . .(A) 190,476 999,999
Questech Corporation (1)(2)(5)(11)
Manufactures and markets proprietary
decorative tiles and signs -- 18.9% of
fully diluted equity
Common Stock . . . . . . . . . . . . . . .(B) 565,792 2,263,168
Warrants at $4.00 expiring 11/28/01 . . .(A) 166,667 167
-----------
Total Private Placement Portfolio
in Non-Controlled Affiliates (cost: $8,381,515) . . . . . . $11,445,105
-----------
The accompanying notes are an integral part of this schedule.
33
SCHEDULE OF INVESTMENTS DECEMBER 31, 1996
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----
Private Placement Portfolio in Controlled Affiliates
(9)(13) (Illiquid) -- 13.1% of total investments
BioSupplyNet, Inc. (1)(2)(4)(7) -- Expands
commercially the print and World Wide Web
product directories developed by
Cold Spring Harbor Laboratory Press --
34.5% fully diluted equity
Series A Voting Convertible
Preferred Stock. . . . . . . . . . . . (A) 575,000 $ 575,000
Genomica Corporation (1)(2)(4)(7)(10)
Develops software that enables the
study of complex genetic diseases
23.9% of fully diluted equity
Common Stock . . . . . . . . . . . . . (A) 199,800
Series A Voting Convertible
Preferred Stock. . . . . . . . . . . . (A) 1,660,200 1,000,304
MultiTarget, Inc. (1)(2)(4)(7) -- Developing
intellectual property related to
localized treatment of cancer
37.5% of fully diluted equity
Series A Convertible Preferred Stock (A) 375,000 60,811
nFX Corporation (1)(2) -- Develops neural-network
software -- 37.4% of fully diluted equity
Series A Voting Convertible
Preferred Stock. . . . . . . . . . (D) 1,294,288 996,740
Series B Non-Voting Convertible
Preferred Stock . . . . . . . . . . . (D) 689,920 1,539,980
PowerVoice Technologies, Inc. (1)(2)(4)(7)
Exploits innovative distributed computing
technology for use in small business
telephone systems -- 29.2% of fully diluted equity
Series A Convertible Preferred Stock (A) 500,000 500,000
------------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $4,672,835) . . . . . . . . 4,672,835
U.S. Government Obligations -- 37.5% of total investments
U.S. Treasury Note dated 3/01/93 due date
02/28/98 -- 5.125% rate. . . . . . . . (K) $ 5,000,000 $ 4,967,950
U.S. Treasury Bill dated 07/18/96 due date
01/16/97 -- 5.1% yield . . . . . . . . (H) 1,513,000 1,499,894
U.S. Treasury Bill dated 08/15/96 due date
02/13/97 -- 5.3% yield . . . . . . . . (H) 3,935,000 3,833,742
U.S. Treasury Bill dated 08/22/96 due date
02/20/97 -- 5.0% yield . . . . . . . . (H) 1,100,000 1,082,193
U.S. Treasury Bill dated 10/24/96 due date
04/24/97 -- 5.2% yield . . . . . . . . (H) 1,015,000 998,493
U.S. Treasury Bill dated 12/12/96 due date
06/12/97 -- 5.1% yield . . . . . . . . (H) 1,000,000 974,974
------------
Total Investments in U.S. Government Obligations
(cost: $13,327,969) . . . . . . . . . . . . . . . . . . . . $ 13,357,246
------------
Total Investments -- 100% (cost: $28,981,093) . . . . . . . . $ 35,648,682
============
The accompanying notes are an integral part of this schedule.
34
SCHEDULE OF INVESTMENTS DECEMBER 31, 1996
Notes to Schedule of Investments
(1) Represents a non-income producing security. Equity investments
that have not paid dividends within the last twelve months are considered
to be non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the
Method of Valuation A to L.
(4) These investments were made during 1996. Accordingly, the amounts
shown on the schedule represent the gross additions in 1996.
(5) No activity occurred in these investments during the year ended
December 31, 1996.
(6) Formerly named National Mentor Holding Corp., Magellan Health
Services, Inc. was later acquired by Charter Medical Corporation, which
subsequently changed its name to Magellan Health Services, Inc.
(7) These investments are development stage companies. A development
stage company is defined as a company that is devoting substantially all of
its efforts to establishing a new business, and either has not yet commenced
its planned principal operations or has commenced such operations but has not
realized significant revenue from them.
(8) Formerly named Princeton Electronic Billboard, Inc.
(9) Investments in unaffiliated companies consist of investments where
Harris & Harris Group, Inc. (the "Company ") owns less than 5 percent of the
investee company. Investments in non-controlled affiliated companies consist
of investments where the Company owns more than 5 percent but less than 25
percent of the investee company. Investments in controlled affiliated companies
consist of investments where the Company owns more than 25 percent of the
investee company.
(10) Genomica Corporation was cofounded by the Company, Cold Spring Harbor
Laboratory and Falcon Technology Partners, LP. Mr. G. Morgan Browne serves
on the Board of the Company and is Administrative Director of Cold Spring
Harbor Laboratory.
(11) Formerly named Intaglio, Ltd.
(12) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $2,706,451. The gross unrealized appreciation based
on tax cost for these securities is $3,735,334. The gross unrealized
depreciation on the cost for these securities is $268,290.
(13) The percentage ownership of each investee disclosed in the Schedule of
Investments expresses the potential common equity interest in each such
investee. The calculated percentage represents the amount of issuer's common
stock the Company owns or can acquire as a percentage of the issuer's total
outstanding common stock plus common shares reserved for issued and outstanding
warrants, convertible securities and stock options.
The accompanying notes are an integral part of this schedule.
35
FOOTNOTE TO SCHEDULE OF INVESTMENTS
ASSET VALUATION POLICY GUIDELINES
The Company's investments can be classified into five broad categories for
valuation purposes:
1) EQUITY-RELATED SECURITIES
2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR
RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR
PRODUCT DEVELOPMENT
3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS
The Investment Company Act of 1940 (the "1940 Act") requires periodic
valuation of each investment in the Company's portfolio to determine net
asset value. Under the 1940 Act, unrestricted securities with readily
available market quotations are to be valued at the current market value; all
other assets must be valued at "fair value" as determined in good faith by or
under the direction of the Board of Directors.
The Company's Board of Directors is responsible for 1) determining
overall valuation guidelines and 2) ensuring the valuation of investments
within the prescribed guidelines.
The Company's Investment and Valuation Committee, comprised of at
least three or more Board members, is responsible for reviewing and approving
the valuation of the Company's assets within the guidelines established by
the Board of Directors.
Fair value is generally defined as the amount that an investment could
be sold for in an orderly disposition over a reasonable time. Generally, to
increase objectivity in valuing the assets of the Company, external measures
of value, such as public markets or third party transactions, are utilized
whenever possible. Valuation is not based on long-term work-out value, nor
immediate liquidation value, nor incremental value for potential changes that
may take place in the future.
Valuation assumes that, in the ordinary course of its business, the
Company will eventually sell its investment.
36
The Company's valuation policy with respect to the five broad
investment categories is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are carried at fair value using one or more
of the following basic methods of valuation:
A. Cost: The cost method is based on the original cost to the Company.
This method is generally used in the early stages of a company's
development until significant positive or negative events occur subsequent
to the date of the original investment that dictate a change to another
valuation method. Some examples of such events are: 1) a major
recapitalization; 2) a major refinancing; 3) a significant third-party
transaction; 4) the development of a meaningful public market for the
company's common stock; 5) significant positive or negative changes in the
company's business.
B. Private Market: The private market method uses actual third-party
transactions in the company's securities as a basis for valuation, using
actual, executed, historical transactions in the company's securities by
responsible third parties. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a
basis for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by
the Company. The Company discounts market value for securities that are
subject to significant legal, contractual or practical restrictions,
including large blocks in relation to trading volume. Other securities,
for which market quotations are readily available, are carried at market
value as of the time of valuation.
Market value for securities traded on securities exchanges or on the
NASDAQ National Market System is the last reported sales price on the day
of valuation. For other securities traded in the over-the-counter market
and listed securities for which no sale was reported on that day, market
value is the mean of the closing bid price and asked price on that day.
This method is the preferred method of valuation when there is an
established public market for a company's securities, as that market
provides the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private
market in the company's securities or when the factual information
available to the Company dictates that an investment should no longer be
valued under either the cost or private market method. This valuation
method is inherently imprecise and ultimately the result of reconciling the
judgments of the Company's Investment and Valuation Committee members,
based on the data available to them. The resulting valuation, although
stated as a precise number, is necessarily within a range of values that
vary depending upon the significance attributed to the various factors
being considered. Some of the factors considered may include the financial
condition and operating results of the company, the long-term potential of
the business of the company, the values of similar securities issued by
companies in similar businesses, the proportion of the company's securities
owned by the Company and the nature of any rights to require the company to
register restricted securities under applicable securities laws.
37
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT
IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on the original cost to the Company.
Such method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and development in
technology or product development until significant positive or adverse
events occur subsequent to the date of the original investment that dictate
a change to another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development
in technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an
investment after analysis of the best available outside information where
the factual information available to the Company dictates that an
investment should no longer be valued under either the cost or private
market method. This valuation method is inherently imprecise and ultimately
the result of reconciling the judgments of the Company's Investment and
Valuation Committee members. The resulting valuation, although stated as a
precise number, is necessarily within a range of values that vary depending
upon the significance attributed to the various factors being considered.
Some of the factors considered may include the results of research and
development, product development progress, commercial prospects, term of
patent and projected markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
38
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services
that provide market quotations based primarily on quotations from dealers
and brokers, market transactions, and other sources.
J. Other Fixed-Income Securities that are not readily marketable are
valued at fair value by the Investment and Valuation Committee.
SHORT-TERM FIXED-INCOME INVESTMENTS
K. Short-Term Fixed-Income Investments are valued at market value at
the time of valuation. Short-term debt with remaining maturity of 60 days
or less is valued at amortized cost.
ALL OTHER INVESTMENTS
L. All Other Investments are reported at fair value as determined in
good faith by the Investment and Valuation Committee.
The reported values of securities for which market quotations are not
readily available and for other assets reflect the Investment and Valuation
Committee's judgment of fair values as of the valuation date using the
outlined basic methods of valuation. They do not necessarily represent an
amount of money that would be realized if the securities had to be sold in
an immediate liquidation. The Company makes many of its portfolio
investments with the view of holding them for a number of years, and the
reported value of such investments may be considered in terms of
disposition over a period of time. Thus valuations as of any particular
date are not necessarily indicative of amounts that may ultimately be
realized as a result of future sales or other dispositions of investments
held.
39
NOTES TO FINANCIAL STATEMENTS
NOTE 1. THE COMPANY
Harris & Harris Group, Inc. (the "Company") is a venture capital
investment company operating as a business development company ("BDC") under
the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type
of investment company under the 1940 Act. The Company operates as an
internally managed investment company whereby its officers and employees,
under the general supervision of its Board of Directors, conduct its
operations.
The Company elected to become a BDC on July 26, 1995, after receiving the
necessary approvals. From July 31, 1992 until the election of BDC status, the
Company operated as a closed-end, non-diversified, investment company under the
1940 Act. Upon commencement of operations as an investment company, the Company
revalued all of its assets and liabilities at fair value as defined in the 1940
Act. Prior to such time, the Company was registered and filed under the
reporting requirements of the Securities and Exchange Act of 1934 as an
operating company and, while an operating company, operated directly and
through subsidiaries.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed in
the preparation of the financial statements:
Cash and Cash Equivalents. Cash and cash equivalents include money market
instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "fair value"
as defined in the 1940 Act and in the applicable regulations of the Securities
and Exchange Commission. All assets are valued at fair value as determined in
good faith by, or under the direction of, the Board of Directors. See the Asset
Valuation Policy Guidelines in the Footnote to Schedule of Investments.
Securities Transactions. Securities transactions are accounted for on the
date the securities are purchased or sold (trade date); dividend income is
recorded on the ex-dividend date; and interest income is accrued as earned.
Realized gains and losses on investment transactions are determined on the
first-in, first-out basis for financial reporting and tax basis.
Income Taxes. The Company records income taxes using the liability method
in accordance with the provision of Statement of Financial Accounting Standards
No. 109. Accordingly, deferred tax liabilities have been established to reflect
temporary differences between the recognition of income and expenses for
financial reporting and tax purposes, the most significant difference of which
relates to the Company's unrealized appreciation on investments.
40
Reclassifications. Certain reclassifications have been made to the
December 31, 1994 and December 31, 1995 financial statements to conform to the
December 31, 1996 presentation.
Estimates by Management. The preparation of the financial statements in
conformity with Generally Accepted Accounting Principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of December 31,1996 and 1995, and the reported amounts of
revenues and expenses for the three years ended December 31, 1996. Actual
results could differ from these estimates.
NOTE 3. STOCK OPTION PLAN AND WARRANTS OUTSTANDING
On August 3, 1989, the shareholders of the Company approved the 1988 Long
Term Incentive Compensation Plan. On June 30, 1994, the shareholders of the
Company approved various amendments to the 1988 Long Term Incentive
Compensation Plan: 1) to conform to the provisions of the Business Development
Company regulations under the 1940 Act, which allow for the issuance of stock
options to qualified participants; 2) to increase the reserved shares under
the amended plan; 3) to call the plan the 1988 Stock Option Plan, as Amended
and Restated (the "1988 Plan"); and 4) to make various other amendments. On
October 20, 1995, the shareholders of the Company approved an amendment to the
1988 Plan authorizing automatic 20,000 share grants of non-qualified stock
options to newly elected non-employee directors of the Company.
Under the 1988 Plan, the number of shares of common stock of the Company
reserved for issuance is equal to 20 percent of the outstanding shares of
common stock of the Company at the time of grant. However, so long as
warrants, options, and rights issued to persons other than the Company's
directors, officers, and employees at the time of grant remain outstanding,
the number of reserved shares under the 1988 Plan may not exceed 15 percent of
the outstanding shares of common stock of the Company at the time of grant,
subject to certain adjustments.
The 1988 Plan provides for the issuance of incentive stock options and
non-qualified stock options to eligible employees as determined by the
Compensation Committee of the Board (the "Committee"), which is composed of
four non-employee directors. The Committee also has the authority to construe
and interpret the 1988 Plan, to establish rules for the administration of the
1988 Plan and, subject to certain limitations, to amend the terms and
conditions of any outstanding awards. Options may be exercised for up to 10
years from the date of grant at prices not less than the fair market value of
the Company's common stock at the date of grant. The 1988 Plan provides that
payment by the optionee upon exercise of an option may be made using cash or
Company stock held by the optionee.
41
The Company accounts for the 1988 Plan under APB Opinion No. 25, under
which no compensation cost has been recognized. Had compensation cost for the
1988 Plan been determined consistent with the fair value method required by FASB
Statement No. 123 ("FASB No. 123"), the Company's net realized (loss) income and
net asset value per share would have been reduced to the following pro forma
amounts:
1996 1995
Net Realized (Loss) Income:
As Reported $ (3,756,240) $ 271,940
Pro Forma $ (4,197,096) $ (88,752)
Net Asset Value per share:
As Reported $3.44 $3.54
Pro Forma $3.40 $3.51
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
1996 1995
Stock volatility 0.60 0.59
Risk-free interest rate 6.8% 6.5 %
Option term in years 7 7
Stock dividend yield - - - -
Because the FASB No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost and related impact on net realized (loss) income and net asset value per
share may not be representative of that value to be expected in future years.
The Company may grant options for up to 2,088,536 shares under the 1988
Plan. The Company has granted options on 1,317,605 shares through December 31,
1996. Under the 1988 Plan, the option exercise price equals the stock's market
price on date of grant. The options granted vest over a five year period and
expire after 10 years.
42
A summary of the status of the Company's 1988 Plan at December 31, 1996
and 1995 and changes during the years then ended is presented in the table and
narrative below:
December 31, 1996 December 31, 1995
Shares Weighted Shares Weighted
Average Average
------ -------- ------ --------
Exercise Exercise
Price Price
Outstanding at
beginning of year 1,050,000 $4.445 678,102 $1.998
Granted 160,000 $5.008 742,000 $5.375
Exercised 50,000 $1.750 370,102 $1.778
Forfeited 80,000 $5.375 - -
Expired - - - -
Outstanding at end of year 1,080,000 $4.584 1,050,000 $4.445
Exercisable at end of year 390,000 $3.334 375,212 $2.788
Weighted average fair value of
options granted $3.222 - $3.424 -
The range of exercise prices for the outstanding options as of December
31, 1996 are: 8,000 options at $1.1875, with a remaining life of 4.7 years;
150,000 options at $1.625, with a remaining life of 2.3 years; 180,000
options at $3.00 to $3.75, with an average exercise price of $3.375 and an
average remaining life of 5.1 years; 742,000 options at $5.375 to $7.00, with
an average exercise price of $5.485 and an average remaining life of 8.4 years.
As of December 31, 1996, there were outstanding warrants to purchase
237,605 shares of common stock at a price of $2.0641 per share expiring in 1999.
NOTE 4. CAPITAL STOCK TRANSACTIONS
On May 18, 1995, the Company completed a $5,000,001 private placement to
subsidiaries of American Bankers Insurance Group of 1,075,269 unregistered
shares of its common stock at $4.65 per share, which was the average closing
price of Harris & Harris Group on the NASDAQ National Market System during the
prior ten trading days. As part of the transaction, American Bankers has been
granted certain registration rights and has executed a standstill agreement.
43
NOTE 5. EMPLOYEE BENEFITS
As of August 15, 1990, the Company entered into a non-competition,
employment and severance contract with its Chairman, Charles E. Harris,
pursuant to which he is to receive compensation in the form of salary and
other benefits. This contract was amended on June 30, 1992, January 3, 1993,
and June 30, 1994. The term of the contract expires on December 31, 1999.
Base salary is to be increased annually to reflect inflation and in
addition may be increased by such amount as the Compensation Committee of the
Board of Directors of the Company deems appropriate.
In addition, Mr. Harris would be entitled, under certain circumstances, to
receive severance pay under the employment and severance contracts.
As of January 1, 1989, the Company adopted an employee benefits program
covering substantially all employees of the Company under a 401(k) Plan and
Trust Agreement. During 1996, contributions to the plan that have been charged
to operations totaled $40,254.
On June 30, 1994, the Company adopted a plan to provide medical and health
coverage for retirees, their spouses and dependents who, at the time of their
retirement, have ten years of service with the Company and have attained 50
years of age or have attained 45 years of age and have 15 years of service
with the Company. On February 10, 1997, the Company amended this plan to
include employees who "have seven full years of service and have attained 58
years of age." The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of December 31,
1996, the Company had a reserve of $206,630 for the plan.
NOTE 6. INCOME TAXES
The Company has not elected tax treatment available to regulated
investment companies under Sub-Chapter M of the Internal Revenue Code.
Accordingly, for federal and state income tax purposes, the Company is taxed
at statutory corporate rates on its income, which enables the Company to
offset any future net operating losses against prior years' net income. The
Company may carry back operating losses against net income three years and
carry forward such losses fifteen years.
44
For the years ended December 31, 1996, 1995 and 1994, the Company's income
tax (benefit) provision was allocated as follows:
1996 1995 1994
Investment Operations $ (680,834) $(597,215) $(1,265,648)
Realized (loss) gain on investments (1,327,401) 738,419 (168,252)
Increase (decrease) in unrealized
appreciation on investments 1,597,748 85,195 (256,694)
------------ ---------- ------------
Total income tax (benefit) provision $ (410,487) $ 226,399 $(1,690,594)
============ ========== ============
The above tax (benefit) provision consists of the following:
Current -- Federal $(2,047,304) $ (38,319) $(1,281,939)
Deferred -- Federal 1,636,817 264,718 (408,655)
------------ ---------- ------------
Total income tax (benefit) provision $ (410,487) $ 226,399 $(1,690,594)
============ ========== ============
The Company's deferred tax liability at December 31, 1996 and 1995 consists
of the following:
1996 1995
Unrealized appreciation on investments $ 2,295,998 $ 698,250
Medical retirement benefits (72,320) (72,320)
Other (36,231) (75,300)
----------- ---------
Net deferred income tax liability $ 2,187,447 $ 550,630
=========== =========
NOTE 7. COMMITMENTS AND CONTINGENCIES
During 1993, the Company signed a ten-year lease with sublet
provisions for office space. In 1995, this lease was amended to include
additional office space. Rent expense under this lease for the year ended
December 31, 1996, was $160,601. Future minimum lease payments in each of the
following years are: 1997 -- $164,484; 1998 -- $168,768; 1999 -- $176,030;
2000 -- $178,561; 2001 -- $178,561; thereafter $280,507.
The Company has guaranteed a three-year lease obligation of approximately
$21,000 per annum for the office space of one of its investees, Highline
Capital Management LLC.
In December 1993, the Company and MIT announced the establishment by the
Company of the Harris & Harris Group Senior Professorship at MIT. Prior to the
arrangement for the establishment of this Professorship, the Company had made
gifts of stock in start-up companies to MIT. These gifts, together with the
contribution of $700,000 in cash in 1993, which was expensed by the Company in
1993, were used to establish this named chair.
The Company contributed to MIT securities with a cost basis of $3,280,
$20,000 and $20,000 in 1993, 1994, and 1995 respectively. These contributions
will be applied to the MIT Pledge at their market value at the time the shares
become publicly traded or otherwise monetized in a commercial transaction and
are free from restriction as to sale by MIT.
45
At December 31, 1996, the Company would have to fund additional cash
and/or property that would have to be valued at a total of $756,720 by
December, 1998, in order for the Senior Professorship to become permanent.
NOTE 8. SUBSEQUENT EVENTS
In January 1997, the Company signed loan agreements with two of its
investee companies for up to $750,000. In addition, the Company has guaranteed
a bonus of up to $100,000 to the key employees of one of its investee companies.
Also in January 1997, the Company made a follow-on investment of $850,000
in PowerVoice Technologies. In addition, the Company invested $500,000 in
Highline Offshore Investors.
46
SELECTED PER SHARE DATA AND RATIOS
Per share operating performance:
Year Ended Year Ended Year Ended Year Ended 3 Months Ended
December 31, December 31, December 31, December 31, December 31,
1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ --------------
Net asset value,
beginning
of period $ 3.54 $ 3.43 $ 3.66 $ 2.71 $ 2.90
Net operating
loss (0.12) (0.11) (0.25) (0.19) (0.02)
Net realized
(loss) gain (0.24) 0.14 0.01 2.75 (0.02)
Net increase
(decrease) in
unrealized
appreciation
as a result
of sales 0.16 (0.01) (0.11) (1.78) (0.01)
Net increase
(decrease)in
unrealized
appreciation
on investments
held 0.13 0.03 0.01 0.25 (0.14)
Net (decrease)
increase from
capital stock
transactions (0.03) 0.06 0.11 (0.08) 0
------------ ------------ ------------ ------------ --------------
Net asset
value, end
of period $ 3.44 $ 3.54 $ 3.43 $ 3.66 $ 2.71
============ ============ ============ ============ ===============
Market value
per share,
end of
period $ 3.75 $ 7.875 $ 6.375 $ 8.250 $ 4.375
Deferred
income tax
per share $ 0.21 $ 0.050 $ 0.030 $ 0.080 $ 0.760
Ratio of expenses
to average
net assets 8.1% 8.3% 13.6% 11.3% 2.0%
Ratio of net
operating loss
to average
net assets 3.5% 3.2% 7.1% 6.0% 6.7%
Investment return
based on:
Stock price (52.4)% 23.5% (22.7)% 88.6% 49.0%
Net asset value (2.8)% 3.2% (6.3)% 35.0% (6.5)%
Portfolio turnover 51.2% 51.2% 136.4% 118.1% 8.7%
Net assets, end
of period $ 35,932,603 $ 36,561,909 $ 31,310,802 $ 32,749,297 $ 22,653,343
Number of
shares
outstanding 10,442,682 10,333,902 9,136,747 8,944,828 8,350,999
The accompanying notes are an integral part of this schedule.
47