SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1995
or
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File Number 0-11576
Harris & Harris Group, Inc.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
New York 13-3119827
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Rockefeller Plaza
Suite 1430
New York, New York 10020
----------------------------------------
(Address of principal executive offices)
(212) 332-3600
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. The number of shares of
common stock, par value $.01 per share, outstanding on October 25, 1995 was
10,333,902.
Harris & Harris Group, Inc.
Form 10-Q, September 30, 1995
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Statement of Assets and Liabilities. . . . . . . . . . . . . . . . 2
Statement of Operations. . . . . . . . . . . . . . . . . . . . . . 3
Statement of Cash Flows. . . . . . . . . . . . . . . . . . . . . . 4
Statement of Changes in Net Assets . . . . . . . . . . . . . . . . 5
Schedule of Investments. . . . . . . . . . . . . . . . . . . . . . 6 - 13
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . 14 - 18
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Financial Condition. . . . . . . . . . . . . . . . . . . . . . . . 19
Results of Operations. . . . . . . . . . . . . . . . . . . . . . . 20
Liquidity and Capital Resources. . . . . . . . . . . . . . . . . . 21
Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . 22
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . . . 22
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . 22
Item 4. Submission of Matters to a Vote of Security Holders. . . . 22
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . 22
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . 22
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Harris & Harris Group, Inc.
Form 10-Q, September 30, 1995
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
The information furnished in the accompanying financial statements
reflects all adjustments that are, in the opinion of management, necessary for
a fair presentation of the results for the interim period presented.
On June 30, 1994, the Company's shareholders approved a proposal to
allow the Company to make an election to become a Business Development Company
("BDC") under the Investment Company Act of 1940, as amended. The Company
made such election on July 26, 1995. The accompanying financial statements
represent the Company's first filing as a BDC. Certain information and
disclosures normally included in the financial statements in accordance with
generally accepted accounting principles have been condensed or omitted as
permitted by Regulation S-X and Regulation S-K. It is suggested that the
accompanying financial statements should be read in conjunction with the
audited financial statements and notes thereto for the year ended December 31,
1994 contained in the Company's 1994 Annual Report.
1
STATEMENT OF ASSETS AND LIABILITIES
ASSETS
<TABLE>
<CAPTION>
September 30, 1995 December 31, 1994
(Unaudited) (Audited)
<S> <C> <C>
Investments, at value
(See accompanying schedule of
investments and notes). . . . . . . $ 35,068,419 $ 26,034,803
Cash. . . . . . . . . . . . . . . . . 172,374 221,457
Receivable from brokers . . . . . . . 896,370 4,041,391
Interest receivable . . . . . . . . . 318,324 73,326
Notes receivable. . . . . . . . . . . 0 54,664
Taxes receivable. . . . . . . . . . . 918,938 1,257,903
Prepaid expenses. . . . . . . . . . . 24,530 65,220
Other assets. . . . . . . . . . . . . 351,542 295,309
----------- -----------
Total assets. . . . . . . . . . . . . $ 37,750,497 $ 32,044,073
=========== ===========
LIABILITIES & NET ASSETS
Accounts payable and
accrued liabilities . . . . . . . . $ 311,278 $ 365,261
Deferred rent . . . . . . . . . . . . 62,200 58,859
Deferred income tax liability (Note 6) 1,042,734 309,151
----------- -----------
Total liabilities . . . . . . . . . . 1,416,212 733,271
----------- -----------
Commitments and contingencies (Note 7)
Net assets. . . . . . . . . . . . . . $ 36,334,285 $ 31,310,802
=========== ===========
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;
10,333,902 issued and 10,333,902
outstanding at 9/30/95
and 9,841,099 issued and 9,136,747
outstanding at 12/31/94. . . . . . 103,339 98,411
Additional paid in capital. . . . . . 15,397,385 11,543,948
Accumulated net realized income . . . 18,538,288 19,090,309
Accumulated unrealized appreciation
of investments, net of deferred
tax liability of $1,177,983 at
9/30/95 and $613,055 at 12/31/94. . 2,295,273 1,246,124
Treasury stock, at cost
(0 at 9/30/95; 704,352 shares
at 12/31/94). . . . . . . . . . . . 0 (557,707)
Reserve for restricted stock award
(Note 3). . . . . . . . . . . . . . 0 (110,283)
----------- -----------
Net assets . . . . . . . . . . . . . . $ 36,334,285 $ 31,310,802
=========== ===========
Shares outstanding . . . . . . . . . . 10,332,902 9,136,747
----------- -----------
Net asset value per outstanding share $ 3.52 $ 3.43
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, 1995 September 30, 1995
<S> <C> <C>
Investment income:
Interest from:
Fixed-income securities . . . . $ 754,706 $ 262,015
Unaffiliated companies . . . . . 1,004 0
Dividend income--Unaffiliated
companies. . . . . . . . . . . . 8,436 0
Other income . . . . . . . . . . . 1,782 0
----------- -----------
Total income . . . . . . . . . . 765,928 262,015
Expenses:
Salaries and benefits. . . . . . . 1,137,926 376,545
Administration and operations. . . 305,504 91,347
Professional fees. . . . . . . . . 283,117 133,027
Depreciation and amortization. . . 155,980 15,000
Rent . . . . . . . . . . . . . . . 87,391 29,797
Directors' fees and expenses . . . 25,793 12,907
Custodian fees . . . . . . . . . . 9,704 3,326
----------- -----------
Total expenses . . . . . . . . . 2,005,415 661,949
----------- -----------
Operating loss before income taxes (1,239,487) (399,934)
Income tax benefit (Note 6). . . . 690,449 103,523
----------- -----------
Net operating loss . . . . . . . . . (549,038) (296,411)
Net realized gain (loss) on investments:
Realized (loss) gain on sale of
investments. . . . . . . . . . . (4,589) 200,895
----------- -----------
Total realized (loss) gain . . . (4,589) 200,895
Income tax benefit (provision)
(Note 6) . . . . . . . . . . . . 1,606 (70,313)
----------- -----------
Net realized gain (loss) on
investments. . . . . . . . . . . (2,983) 130,582
----------- -----------
Net realized loss. . . . . . . . . . (552,021) (165,829)
----------- -----------
Net increase (decrease) in unrealized
appreciation on investments:
Increase as a result of investment
sales. . . . . . . . . . . . . . 291,277 0
Decrease on investments held . . . (456,185) (709,516)
Increase on investments held . . . 1,778,984 856,888
----------- -----------
Total unrealized appreciation
on investments . . . . . . . . 1,614,076 147,372
Income tax provision (Note 6). . . (564,927) (51,610)
----------- -----------
Net increase in unrealized
appreciation on investments. . . 1,049,149 95,762
----------- -----------
Net increase (decrease) in net
assets from operations . . . . . . $ 497,128 $ (70,067)
=========== ===========
Increase in net assets per
outstanding share. . . . . . . . . $ 0.05 $ 0.00
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, 1995 September 30, 1995
<S> <C> <C>
Cash flows provided (used) by
operating activities:
Net increase (decrease) in net
assets resulting from
operations. . . . . . . . . . . $ 497,128 $ (70,067)
Adjustments to reconcile increase
(decrease) in net assets from
operations to net cash provided
(used) by operating activities:
Net realized and unrealized
gain on investments . . . . . (1,609,487) (348,267)
Deferred income taxes . . . . . 733,583 31,710
Depreciation and amortization . 155,980 15,000
Other . . . . . . . . . . . . . 23,340 7,967
Changes in assets and liabilities:
Receivable from brokers . . . . 3,145,021 (896,370)
Prepaid expenses. . . . . . . . 40,690 18,036
Interest receivable . . . . . . (244,998) (156,706)
Taxes receivable. . . . . . . . 338,965 1,186,366
Other assets. . . . . . . . . . (95,335) (81,929)
Accounts payable and accrued
liabilities . . . . . . . . . (53,983) (554,636)
Collection on note receivable . 54,664 0
Purchase of fixed assets. . . . (6,594) (2,715)
----------- -----------
Net cash provided (used) by
operating activities 2,978,974 (851,611)
Cash (used) provided by investing activity:
Net (purchase) sale of short-term
investments . . . . . . . . . . (2,610,755) 2,741,867
Purchase of investments . . . . . (6,573,485) (2,844,195)
Proceeds from sale of investments 1,740,112 896,374
----------- -----------
Net cash (used) provided by
investing activities. . . . . . (7,444,128) 794,046
Cash flows provided by financing activities:
Purchase of stock. . . . . . . . . (646,430) 0
Proceeds from exercise of stock
options. . . . . . . . . . . . . 62,500 0
Proceeds from private placement of
common stock (Note 4). . . . . . 5,000,001 0
----------- -----------
Net cash provided by financing
activities . . . . . . . . . . . 4,461,071 0
----------- -----------
Net decrease in cash . . . . . . . . (49,083) (57,565)
Cash at beginning of period. . . . . 221,457 229,939
----------- -----------
Cash at end of period. . . . . . . . $ 172,374 $ 172,374
=========== ===========
Supplemental disclosures of cash
flow information:
Income taxes paid. . . . . . . . . $ 8,323 $ 0
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
STATEMENT OF CHANGES IN NET ASSETS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, 1995 September 30, 1995
<S> <C> <C>
Changes in net assets from operations:
Net operating loss . . . . . . . . $ (549,038) $ (296,411)
Net realized (loss) gain on
investments. . . . . . . . . . . (2,983) 130,582
Net increase in unrealized
appreciation on investments
as a result of sales . . . . . . 189,330 0
Net increase in unrealized
appreciation on investments held 859,819 95,762
----------- -----------
Net increase (decrease) in net
assets resulting from operations 497,128 (70,067)
Capital stock transactions:
Purchase of stock. . . . . . . . . (646,430) 0
Restricted stock award . . . . . . 110,284 0
Proceeds from exercise of
stock options. . . . . . . . . . 62,500 0
Proceeds from private placement
of common stock . . . . . . . . 5,000,001 0
----------- -----------
Net increase from capital
stock transactions . . . . . . . 4,526,355 0
----------- -----------
Net increase (decrease)
in net assets. . . . . . . . . . . 5,023,483 (70,067)
----------- -----------
Net assets:
Beginning of period. . . . . . . . 31,310,802 36,404,352
----------- -----------
End of period. . . . . . . . . . . $ 36,334,285 $ 36,334,285
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
Method of
Valuation (3) Shares Value
<S> <C> <C> <C>
Investments in Unaffiliated Companies (8)
21.2% of total investments
Publicly-Traded Portfolio (Common Stock
unless noted otherwise)
Oil and Gas Related -- 1.9%
CORDEX Petroleums Inc. (1)(5)
Argentinian oil and gas exploration
Class A Common Stock. . . . . . . . . . . (C) 4,052,080 $ 673,721
Biotechnology and Healthcare Related -- 14.9%
Alliance Pharmaceutical Corporation (1)(4).(C) 100,000 1,085,625
Charter Medical Corporation (1)(2)(5)(6). .(C) 108,736 2,080,483
Guilford Pharmaceuticals (1)(4)(7). . . . .(C) 200,000 2,040,000
Investment Companies -- 0.4%
Rand Capital Corp.. . . . . . . . . . . . .(C) 21,875 140,273
-----------
Total Publicly-Traded Portfolio (cost: $3,447,464) . . . . . . . $ 6,020,102
Private Placement Portfolio (Illiquid) -- 4.0%
CORDEX Petroleums Inc. (1)(2)(5)
Argentinian oil and gas exploration
Special Warrants . . . . . . . . . . . . . (C) 1,667,000 $ 63,961
Exponential Business Development Company (1)(2)(4)
Venture capital partnership
focused on early stage companies
Limited partnership interest . . . . . . . (A) - - 25,000
Princeton Electronic Billboard, Inc. (1)(2)(5)(7)
Real time sports and
entertainment advertising
4.22% of fully-diluted equity. . . . . . . (B) 24,600 615,000
Warrants: 43,800 at $12.50 expiring 5/96;
6,700 at $2.25 expiring 8/97 . . . . . . . (D) 50,500 699,925
-----------
Total Private Placement Portfolio (cost: $120,500) . . . . . . . $ 1,403,886
-----------
Total Investments in
Unaffiliated Companies (cost: $3,567,964). . . . . . . . . . . $ 7,423,988
-----------
</TABLE>
The accompanying notes are an integral part of this schedule.
6
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
Method of Shares/
Valuation (3) Principal Value
<S> <C> <C> <C>
Private Placement in Non-Controlled
Affiliates (Illiquid) -- 21.1%
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) - - $ 65,000
Gel Sciences, Inc. (1)(2)(4)(7)
Develops engineered response gels
for controlled release systems
11.1% of fully-diluted equity
Series B Preferred Stock and 72,728
Warrants at $.55 expiring 2/01/00 . . . . . . .(A) 1,181,819 650,000
Harber Brothers Productions, Inc. (1)(2)(4)(7)
Finances, produces and markets media products
that combine entertainment, music, learning
and interactivity -- 18.7% of fully-diluted
equity Series A Voting Convertible
Preferred Stock. . . . . . . . . . . . . . . . (A) 967,500 967,500
Highline Capital Management, LLC. (1)(2)(4)(7)
Organizes and manages investment partnership
24.9% of fully-diluted equity. . . . . . . . . (A) - - 500,000
Intaglio, Ltd. (1)(2)
Manufactures and markets proprietary decorative
tiles and signs -- 20.24% of fully-diluted
equity Common Stock . . . . . . . . . . . . . .(B) 565,792 2,263,168
Warrants at $4.00 expiring 11/28/01 . . . . . .(A) 166,667 167
Micracor, Inc. (1)(2)(5)(7)
Designs and manufactures advanced solid
state photonic systems -- 8.9% of fully-diluted
equity Series F Preferred Stock -- 444,444
shares and 1,199,999 Warrants at $2.25
expiring 7/20/99. . . . . . . . . . . . . . . .(A) - - 1,000,000
Nanophase Technologies Corporation (1)(2)(5)(7)
Manufactures and markets inorganic crystals
of nanometric dimensions 5.71% of
fully-diluted equity Series D Convertible
Preferred Stock . . . . . . . . . . . . . . . .(A) 562,204 562,204
PHZ Capital Partners Limited Partnership (1)(2)(4)(7)
Organizes and manages investment partnership. .(A) - - 720,000
24.9% fully-diluted interest
One year 8% note due 9/22/96. . . . . . . . . .(A) $ 500,000 500,000
Sonex International Corporation (1)(2)(5)
Manufactures and markets an ultrasonic
toothbrush for home use 17.8% of fully-diluted
equity Series A Non-voting Convertible
Preferred Stock . . . . . . . . . . . . . . . .(D) 588,935 167,963
Common Stock. . . . . . . . . . . . . . . . . .(D) 34,000 9,697
-----------
Total Private Placement Portfolio
in Non-Controlled Affiliates (cost: $9,680,707) . . . . . . . $ 7,405,699
-----------
</TABLE>
The accompanying notes are an integral part of this schedule.
7
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
Method of
Valuation (3) Shares Value
<S> <C> <C> <C>
Private Placement Portfolio in
Controlled Affiliates (Illiquid) -- 11.4%
nFX Corporation (1)(2)(5)(7)
Develops neural-network software
33.66% of fully-diluted equity
Series A Voting Convertible Preferred Stock. . .(B) 1,294,288 $ 2,888,980
Series B Voting Convertible Preferred Stock. . .(B) 492,800 1,099,979
-----------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $2,096,720). . . . . . . . . . $ 3,988,959
-----------
U.S. Government Obligations -- 46.3%
U.S. Treasury Bill dated 4/13/95 due date
10/12/95 -- 5.9% yield . . . . . . . . . . . . .(A) $ 2,624,192
U.S. Treasury Bill dated 11/17/94 due date
11/16/95 -- 5.9% yield . . . . . . . . . . . . .(A) 4,372,145
U.S. Treasury Bill dated 06/22/95 due date
12/21/95 -- 5.5% yield . . . . . . . . . . . . .(A) 2,189,712
U.S. Treasury Bill dated 01/5/95 due date
03/14/96 -- 5.4% yield . . . . . . . . . . . . .(A) 973,661
U.S. Treasury Bill dated 07/28/95 due date
01/25/96 -- 5.6% yield . . . . . . . . . . . . .(A) 1,361,992
U.S. Treasury Bill dated 05/14/95 due date
05/02/96 -- 5.9% yield . . . . . . . . . . . . .(A) 4,728,071
-----------
Total Investments in U.S. Government Obligations
(cost: $16,249,773). . . . . . . . . . . . . . . . . . . . . . $ 16,249,773
-----------
Total Investments -- 100% (cost: $31,595,163). . . . . . . . . . $ 35,068,419
===========
</TABLE>
The accompanying notes are an integral part of this schedule.
8
SCHEDULE OF INVESTMENTS SEPTEMBER 30, 1995
(UNAUDITED)
Notes to Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last twelve months are considered to
be non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Schedule of Investments for a description of the
Methods of Valuation A to L.
(4) These investments were made during 1995. Accordingly the amounts
shown on the schedule represent the gross additions in 1995.
(5) No activity occurred in these investments during the nine months ended
September 30, 1995.
(6) Formerly National Mentor, Inc.
(7) These investments are in 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) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $3,675,641. The gross unrealized appreciation
based on tax cost for these securities is $3,748,347.
The accompanying notes are an integral part of this schedule.
9
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, as amended (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.
The Company's valuation policy with respect to the five broad investment
categories is as follows:
10
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: l) 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) material 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. 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; other securities traded in the over-the-counter market and listed
securities for which no sale was reported on that day 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.
11
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 most
recent bid quotations when available.
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services that
provide market quotations based primarily on quotations from dealers and
brokers, market transactions, and other sources.
12
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.
13
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. THE COMPANY
On July 31, 1992, Harris & Harris Group, Inc. (the "Company") filed with
the Securities and Exchange Commission (the "Commission") a notification of
registration under Section 8(a) of the Investment Company Act of 1940, as
amended, (the "1940 Act"), and registered as a closed-end, non-diversified
investment company. The Company commenced operations as an investment company
at the close of business on September 30, 1992 and, accordingly, revalued all
of its assets and liabilities at fair value. 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.
On June 30, 1994, the Company's shareholders approved a proposal to
allow the Company to make an election to become a Business Development Company
("BDC") under the 1940 Act. The Company made such election on July 26, 1995.
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.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed
in the preparation of the financial statements:
Portfolio Investment Valuations. Investments are stated at "fair value"
as defined in the 1940 Act and in the applicable regulations of the
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 expense for financial reporting and tax
purposes, the most significant difference of which relates to the Company's
unrealized appreciation on investments.
Reclassifications. Certain reclassifications have been made to the
December 31, 1994 financial statements to conform to the September 30, 1995
presentation.
14
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 a business development
company, 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 grant of non-qualified stock options to certain non-
employee directors of the Company. This amendment is subject to the receipt
of an exemptive order from the Securities and Exchange Commission.
Under the 1988 Plan, the number of shares of common stock of the Company
reserved for issuance is equal to 20% 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% 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 a committee
(the "Committee") composed of three 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.
15
The following table summarizes changes in outstanding stock options under
the 1988 Plan:
<TABLE>
<CAPTION> Option Exercise
Number of Shares Price Per Share
<S> <C> <C>
Outstanding at December 31, 1994 678,102 $ 1.1875 - 3.750
Issued 740,000 5.375
Canceled 0 0
Exercised 370,102 $ 1.2500 - 2.500
----------
Outstanding at September 30, 1995 1,048,000 $ 1.1875 - 5.375
==========
</TABLE>
On June 30, 1995 pursuant to the 1988 Plan, the Company issued 136,454
common shares under two restricted stock awards, which vested on such date,
net of shares withheld to fulfill tax obligations.
During the three months ended September 30, 1995, the Chairman of the
Company exercised a total of 173,349 stock options, at an average price of
$1.87, by exchanging 64,703 shares of the Company's stock owned by him.
As of September 30, 1995, there were outstanding warrants to purchase
343,763 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 private placement to subsidiaries
of American Bankers Insurance Group, of $5,000,001 of its unregistered common
stock, or 1,075,269 shares 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.
This transaction was approved by the Board of Directors of the Company and is
in lieu of the private placement of 10-year debt and 10-year common stock
purchase warrants announced on August 17, 1994.
16
NOTE 5. EMPLOYEE BENEFITS
As of August 15, 1990, the Company entered into non-competition,
employment and severance contracts with its Chairman, Charles E. Harris, and
with its Executive Vice President, C. Richard Childress, pursuant to which they
are to receive compensation in the form of salaries and other benefits. These
contracts were amended on June 30, 1992, January 3, 1993, and June 30, 1994.
The term of the contracts expires on December 31, 1999.
Base salaries are to be increased annually to reflect inflation and in
addition may be increased by such amounts as the Board of Directors of the
Company (the "Board") deems appropriate.
In addition, Messrs. Harris and Childress are entitled under certain
circumstances to receive severance pay under the employment and severance
contracts.
As of January 1, 1989, the Company adopted an employee benefits program
covering substantially all employees of the Company under a 401(k) Plan and
Trust Agreement. The Company's contributions to the plan are determined by the
Compensation Committee in the fourth quarter. As such contributions are
indeterminable until then, no accruals are made in prior periods.
On June 30, 1994, the Company adopted a plan to provide medical and
health insurance for retirees, their spouses and dependents who, at the time of
their retirement, have ten years of service with the Company and have attained
50 years of age or have attained 45 years of age and have 15 years of service
with the Company. The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided a reserve of $176,520 that was charged to
operations for the period ending June 30, 1994 for estimated future benefits
under the described plan.
NOTE 6. INCOME TAXES
The Company is not entitled to the tax treatment available to regulated
investment companies under Subchapter 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 year's net income.
For the nine months ended and three months ended September 30, 1995, the
Company's income tax benefit was allocated as follows:
<TABLE>
<CAPTION>
Nine months Three months
ended 9/30/95 ended 9/30/95
<S> <C> <C>
Investment operations. . . . . . . . . . ($690,449) ($103,523)
Realized (loss) gain on investments. . . (1,606) 70,313
Increase in unrealized appreciation on
investments. . . . . . . . . . . . . . 564,927 51,610
---------- ----------
Total income tax (benefit) provision . . ($127,128) $ 18,400
========== ==========
</TABLE>
17
The above tax benefit consists of the following:
<TABLE>
<CAPTION>
Nine months Three months
ended 9/30/95 ended 9/30/95
<S> <C> <C>
Current -- Federal . . . . . . . . . . . ($860,710) ($13,309)
Deferred -- Federal. . . . . . . . . . . 733,582 31,709
---------- ---------
Total income tax (benefit) provision . . ($127,128) $ 18,400
========== =========
</TABLE>
The effective tax rate differs from the Federal statutory rate primarily
as a result of tax deductable expenses not allowed for book.
The Company's deferred tax liability at September 30, 1995 consists of
the following:
<TABLE>
<CAPTION>
<S> <C>
Unrealized appreciation on investments. . $ 1,177,983
Medical retirement benefits . . . . . . . (61,782)
Other . . . . . . . . . . . . . . . . . . (73,467)
-----------
Net deferred income tax liability . . . . $ 1,042,734
===========
</TABLE>
NOTE 7. COMMITMENTS AND CONTINGENCIES
During 1993, the Company signed a ten-year lease with sublet provisions
for its office space. Rent expense under this lease for the three and nine
months ended September 30, 1995, amounted to $29,797 and $87,391, respectively.
Future minimum lease payments in each of the following years are: 1996 --
$154,203; 1997 -- $164,484; 1998 -- $168,768; 1999 -- $176,030; 2000 --
$178,560; thereafter $459,067.
The Company has guaranteed a three-year lease obligation for office space
of one of its investees, Highline Capital Management LLC. (approximately
$21,000 per annum).
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 $3,280, $20,000 and $20,000 in 1993,
1994, and 1995 year to date, respectively. These amounts represent the cost
basis to the Company of the securities donated. These contributions will be
applied to the MIT Pledge at their market value at the time the shares become
publicly traded or otherwise monetized in a commercial transaction and are free
from restriction as to sale by MIT.
At September 30, 1995, 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.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition
At September 30, 1995, the Company's total assets and net assets were
respectively, $37,750,497 and $36,334,285, versus $38,335,522 and $36,404,352
at June 30, 1995 and $32,044,073 and $31,310,802 at December 31, 1994. Until
the Company became a BDC, it reported results only semi-annually. Thus
financial information for September 30, 1994 is not available. Net asset value
per share was $3.52 at September 30, 1995, versus $3.56 at June 30, 1995 and
$3.43 at December 31, 1994.
The Company's financial condition is affected by the business success of
its investee companies. The Company has 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 and have not attained profitability
or have no history of operations. At September 30, 1995, 33.7 percent of the
Company's $38 million in total assets consisted of investments at fair value in
private businesses, of which net unrealized appreciation was $0.8 million. At
December 31, 1994, 35 percent of the Company's $32 million in total assets
consisted of investments at fair value in private businesses, of which net
unrealized appreciation was $2.1 million. The Company's total investment
portfolio also includes cash and marketable securities. Currently, a portion
of the Company's holdings in marketable securities have venture-capital
characteristics.
A summary of the Company's investment portfolio is as follows:
<TABLE>
<CAPTION>
September 30, 1995 December 31, 1994
<S> <C> <C>
Investments, at cost $ 31,595,163 $ 24,175,624
Unrealized appreciation $ 3,473,256 $ 1,859,179
----------- -----------
Investments, at fair value $ 35,068,419 $ 26,034,803
</TABLE>
Following an initial investment in a private company, the Company may
make additional investments in such investee in order to increase its ownership
percentage, to exercise warrants or options that were acquired in a prior
financing, to preserve the Company's proportionate ownership in a subsequent
financing or in 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 be in a position 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 if the
follow-on investment opportunity appears attractive.
The following table is a summary of the cash investment changes in the
Company's private placement portfolio during the nine months ended September
30, 1995:
<TABLE>
<CAPTION>
Amount
<S> <C>
Harber Brothers Productions, Inc. (1) $ 967,500
Gel Sciences, Inc. (1) 650,000
Highline Capital Management (1) 500,000
Intaglio, Ltd. (2) 209,836
PHZ Capital Partners (1) 1,220,000
----------
$ 3,547,336
==========
</TABLE>
(1) New investee company
(2) Addition to existing investment in an investee company
Results of Operations
Investment Income and Expenses:
For the nine months ended September 30, 1995, investment income totaled
$765,928, while operating expenses totaled $2,005,415, resulting in a operating
loss before income taxes of $1,239,487. The Company has in the past relied, and
continues to rely to a large extent, upon proceeds from sales of investments
rather than investment income to defray a significant portion of its operating
expenses. Because such sales cannot be predicted with certainty, the Company
attempts to maintain adequate working capital to provide for fiscal periods
when there are no such sales.
Realized Gains and Losses on Sales of Portfolios Securities:
During the nine months ended September 30, 1995, the Company sold various
public securities realizing a net capital loss of $4,589.
Unrealized Appreciation and Depreciation of Portfolio Securities:
Net unrealized appreciation on investments increased $1,614,076 during
the nine months ended September 30, 1995, from $1,859,179 to $3,473,256, owing
primarily to increased valuations for Cordex Petroleums, Inc., Intaglio, Ltd.,
Alliance Pharmaceutical Corporation, Guilford Pharmaceuticals, Inc. and Charter
Medical Corporation, offset by the decreased valuation of Sonex International
Corporation.
20
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable securities
(the primary measure of liquidity) at September 30, 1995 of $24,639,841, versus
$25,823,131 at June 30, 1995 and $20,465,118 at December 31, 1994. The
Company's liquidity was increased by a $5,000,001 private placement of
1,075,269 shares of the Company's unregistered common stock with subsidiaries
of American Bankers Insurance Group, Inc. on May 18, 1995. Management believes
that its cash, receivables and marketable securities provide it with sufficient
liquidity for its operations.
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 due to the nature of the
company's investment portfolio. There are significant risks inherent in the
registrant's venture capital business. The Company has invested and will
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 and have not
attained profitability or have no history of operations. Because of the
speculative nature and the lack of public market for these investments, there
is significantly greater risk of loss than is the case with traditional
investment securities. The Company expects that some of its venture capital
investments will be a complete loss or will be unprofitable and that some will
appear to be likely to become successful but never realize that potential. The
Company has and shall continue to be risk seeking rather than risk adverse in
its approach to its 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
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.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index for Exhibits to the Form 10Q.
(b) None
EXHIBIT INDEX
Item Number (of Item 601 of Regulation S-K)
27. Financial Data Schedule
22
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its hehalf by the
undersigned, thereunto duly authorized.
Harris & Harris Group, Inc.
By: /s/ Rachel M. Pernia
----------------------
Rachel M. Pernia, Vice President,
Treasurer, Controller and Principal
Accounting Officer
Date: November 14, 1995
23
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000893739
<NAME> HARRIS & HARRIS GROUP, INC.
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1995
<PERIOD-END> SEP-30-1995 SEP-30-1995
<INVESTMENTS-AT-COST> 31,595,163 31,595,163
<INVESTMENTS-AT-VALUE> 35,068,419 35,068,419
<RECEIVABLES> 2,133,632 2,133,632
<ASSETS-OTHER> 376,073 376,073
<OTHER-ITEMS-ASSETS> 0 0
<TOTAL-ASSETS> 37,750,497 37,750,497
<PAYABLE-FOR-SECURITIES> 0 0
<SENIOR-LONG-TERM-DEBT> 0 0
<OTHER-ITEMS-LIABILITIES> 1,416,212 1,416,212
<TOTAL-LIABILITIES> 1,416,212 1,416,212
<SENIOR-EQUITY> 0 0
<PAID-IN-CAPITAL-COMMON> 15,397,385 15,397,385
<SHARES-COMMON-STOCK> 10,333,902 10,333,902
<SHARES-COMMON-PRIOR> 9,136,747 9,136,747
<ACCUMULATED-NII-CURRENT> 0 0
<OVERDISTRIBUTION-NII> 0 0
<ACCUMULATED-NET-GAINS> 18,538,288 18,538,288
<OVERDISTRIBUTION-GAINS> 0 0
<ACCUM-APPREC-OR-DEPREC> 3,473,256 3,473,256
<NET-ASSETS> 36,334,285 36,334,285
<DIVIDEND-INCOME> 8,436 0
<INTEREST-INCOME> 755,710 262,015
<OTHER-INCOME> 1,782 0
<EXPENSES-NET> 2,005,415 661,949
<NET-INVESTMENT-INCOME> 765,928 262,015
<REALIZED-GAINS-CURRENT> (4,589) 200,895
<APPREC-INCREASE-CURRENT> 1,614,076 147,372
<NET-CHANGE-FROM-OPS> 497,128 (70,067)
<EQUALIZATION> 0 0
<DISTRIBUTIONS-OF-INCOME> 0 0
<DISTRIBUTIONS-OF-GAINS> 0 0
<DISTRIBUTIONS-OTHER> 0 0
<NUMBER-OF-SHARES-SOLD> 0 0
<NUMBER-OF-SHARES-REDEEMED> 0 0
<SHARES-REINVESTED> 0 0
<NET-CHANGE-IN-ASSETS> 5,023,483 (70,067)
<ACCUMULATED-NII-PRIOR> 0 0
<ACCUMULATED-GAINS-PRIOR> 19,090,309 19,090,309
<OVERDISTRIB-NII-PRIOR> 0 0
<OVERDIST-NET-GAINS-PRIOR> 0 0
<GROSS-ADVISORY-FEES> 0 0
<INTEREST-EXPENSE> 0 0
<GROSS-EXPENSE> 0 0
<AVERAGE-NET-ASSETS> 33,822,545 33,822,545
<PER-SHARE-NAV-BEGIN> 3.43 3.56
<PER-SHARE-NII> 0 0
<PER-SHARE-GAIN-APPREC> 0 0
<PER-SHARE-DIVIDEND> 0 0
<PER-SHARE-DISTRIBUTIONS> 0 0
<RETURNS-OF-CAPITAL> 0 0
<PER-SHARE-NAV-END> 3.52 3.52
<EXPENSE-RATIO> 0 0
<AVG-DEBT-OUTSTANDING> 0 0
<AVG-DEBT-PER-SHARE> 0 0
</TABLE>
