UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarterly period ended March 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ________________
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 Identification No.)
incorporation or organization)
One Rockefeller Plaza, Rockefeller Center, New York, New York 10020
- ------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
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 ____
<PAGE>
Harris & Harris Group, Inc.
Form 10-Q, March 31, 1998
TABLE OF CONTENTS
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements . . . . . . . . . . . . . . . 1
Statements of Assets and Liabilities . . . . . . . . . . . 2
Statements of Operations . . . . . . . . . . . . . . . . . 3
Statements of Cash Flows . . . . . . . . . . . . . . . . . 4
Statements of Changes in Net Assets. . . . . . . . . . . . 5
Schedule of Investments. . . . . . . . . . . . . . . . . . 6
Notes to Financial Statements. . . . . . . . . . . . . . . 14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Financial Condition. . . . . . . . . . . . . . . . . . . . 21
Results of Operations. . . . . . . . . . . . . . . . . . . 23
Liquidity and Capital Resources. . . . . . . . . . . . . . 24
Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 3. Quantitative and Qualitative Disclosures
About Market Risk. . . . . . . . . . . . . . . . . . . . . 29
PART II OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . 30
Item 2. Changes in Securities . . . . . . . . . . . . . . 30
Item 3. Defaults Upon Senior Securities . . . . . . . . . 30
Item 4. Submission of Matters to a Vote of Security
Holders . . . . . . . . . . . . . . . . . . . . 30
Item 5. Other Information . . . . . . . . . . . . . . . . 30
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . 30
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . 31
Signature. . . . . . . . . . . . . . . . . . . . . . . . . 32
Harris & Harris Group, Inc.
Form 10-Q, March 31, 1998
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. 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 be read in conjunction with the audited
financial statements and notes thereto for the year ended December 31, 1997
contained in the Company's 1997 Annual Report.
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification of the Company in 1998 as a Regulated
Investment Company ("RIC") under Sub-Chapter M of the Internal Revenue
(the "Code"). (At that time, the Company was taxable under Sub-Chapter C of
the Code (a "C Corporation").) On April 8, 1998, the Company announced that
it had received a certification from the Securities and Exchange Commission
for 1997 relating to the Company's status under section 851(e) of the Code.
That certification was necessary for the Company to qualify as a RIC for
1998 and subsequent taxable years.
Pursuant to the Company's receipt of the section 851(e) certification,
the Company's Board of Directors declared a one-time cash dividend of $0.75
per share to meet one of the Company's requirements for qualification for
Sub-Chapter M tax treatment in 1998. The Company has requested rulings from
the Internal Revenue Service (the "IRS") regarding other issues relevant to
the Company's tax status as a RIC. (See Note 5 of Notes to Financial
Statements.) Although there is no assurance such rulings will be issued, the
management of the Company believes favorable rulings are likely.
The qualification of the Company as a RIC under Sub-Chapter M of the
Code depends on it satisfying certain technical requirements regarding its
income, investment portfolio, and distributions. (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Recent Developments".) There can be no assurance that the Company will
qualify for Sub-Chapter M treatment for 1998 or subsequent years.
Nevertheless, the Company's financial statements for 1998 assume that the
Company will qualify for such treatment and that the rulings requested from
the IRS will be issued.
1
<TABLE>
<CAPTION>
STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
<S> <C> <C>
March 31, 1998 December 31, 1997
(Unaudited) (Audited)
Investments, at value (See accompanying
schedule of investments and notes). . . . $ 35,676,498 $ 38,659,230
Cash and cash equivalents . . . . . . . . 163,534 145,588
Prepaid expenses. . . . . . . . . . . . . 112,353 85,126
Other assets. . . . . . . . . . . . . . . 215,273 383,840
------------- -------------
Total assets. . . . . . . . . . . . . . . $ 36,167,658 $ 39,273,784
============= =============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities. $ 814,923 $ 899,491
Deferred rent . . . . . . . . . . . . . . 49,349 51,662
Deferred income tax liability (Note 5). . 151,983 667,697
Note Payable (Note 6) . . . . . . . . . . 1,500,000 4,000,000
------------- -------------
Total liabilities . . . . . . . . . . . . 2,516,255 5,618,850
Commitments and contingencies (Note 6) ------------- -------------
Net assets. . . . . . . . . . . . . . . . $ 33,651,403 $ 33,654,934
------------- -------------
Net assets are comprised of:
Preferred stock, $0.10 par value,
2,000,000 shares authorized;
none issued. . . . . . . . . . . . . . $ 0 $ 0
Common stock, $0.01 par value, 25,000,000
shares authorized; 10,692,971 issued
and outstanding at 3/31/98 and
12/31/97 . . . . . . . . . . . . . . . 106,930 106,930
Additional paid in capital. . . . . . . . 16,178,979 16,178,979
Accumulated net realized income . . . . . 11,552,730 12,028,191
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $2,008,941 at 3/31/98
and $2,817,898 at 12/31/97 . . . . . . 5,812,764 5,340,834
------------- -------------
Net assets. . . . . . . . . . . . . . . . $ 33,651,403 $ 33,654,934
------------- -------------
Total net assets and liabilities. . . . . $ 36,167,658 $ 39,273,784
============= =============
Shares outstanding. . . . . . . . . . . . 10,692,971 10,692,971
------------- -------------
Net asset value per outstanding share . . $ 3.15 $ 3.15
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
2
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
(Unaudited)
<S> <C> <C>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
Investment income:
Interest from:
Fixed-income securities. . . . . $ 192,291 $ 136,287
Affiliated companies . . . . . . 10,932 10,000
Other income . . . . . . . . . . 7,348 869
------------- -------------
Total investment income. . . . . 210,571 147,156
Expenses:
Salaries and benefits. . . . . . . 37,848 440,324
Administration and operations. . . 88,204 98,327
Professional fees. . . . . . . . . 89,026 88,097
Depreciation . . . . . . . . . . . 12,500 15,000
Rent . . . . . . . . . . . . . . . 38,808 39,497
Directors' fees and expenses . . . 28,742 35,848
Custodian fees . . . . . . . . . . 2,907 3,506
Interest expense (Note 6). . . . . 73,415 0
------------- -------------
Total expenses . . . . . . . . . . 371,450 720,599
Operating loss before income
taxes. . . . . . . . . . . . . . (160,879) (573,443)
Income tax (provision) benefit
(Note 5) . . . . . . . . . . . . (365,712) 198,881
------------- -------------
Net operating loss . . . . . . . . . (526,591) (374,562)
Net realized gain on investments:
Realized gain on sale of
investments. . . . . . . . . . . 78,661 623,108
------------- -------------
Total realized gain. . . . . . . 78,661 623,108
Income tax provision (Note 5). . . (27,531) (218,088)
------------- -------------
Net realized gain on investments . 51,130 405,020
------------- -------------
Net realized (loss) income . . . . . (475,461) 30,458
Net increase (decrease) in unrealized appreciation on investments:
Decrease as a result of investment
sales. . . . . . . . . . . . . . (87,898) (1,764,909)
Increase on investments held . . . 3,825,792 1,414,354
Decrease on investments held . . . (4,074,921) (2,253,670)
------------- -------------
Change in unrealized appreciation
on investments . . . . . . . . . (337,027) (2,604,225)
Income tax benefit (Note 5). . . . 808,957 911,479
------------- -------------
Net increase (decrease) in unrealized
appreciation on investments. . . 471,930 (1,692,746)
------------- -------------
Net decrease in net assets from operations:
Total. . . . . . . . . . . . . . . $ (3,531) $ (1,662,288)
============= =============
Per outstanding share. . . . . . . $ (0.00) $ (0.16)
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
3
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
(Unaudited)
<S> <C> <C>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
Cash flows (used in) provided by operating activities:
Net decrease in net assets
resulting from operations . . . . . . $ (3,531) $ (1,662,288)
Adjustments to reconcile net decrease
in net assets from operations to net
cash (used in) provided by operating
activities:
Net realized and unrealized loss (gain)
on investments. . . . . . . . . . . 258,366 1,981,117
Deferred income taxes . . . . . . . . (415,714) (908,469)
Depreciation. . . . . . . . . . . . . 12,500 15,000
Changes in assets and liabilities:
Receivable from brokers . . . . . . . 0 (25,374)
Prepaid expenses. . . . . . . . . . . (27,227) 20,976
Taxes receivable. . . . . . . . . . . 0 16,197
Other assets. . . . . . . . . . . . . 156,067 224,586
Accounts payable and accrued
liabilities . . . . . . . . . . . . (215,719) (28,297)
Payable to brokers. . . . . . . . . . 0 411,354
Deferred rent . . . . . . . . . . . . (2,313) (2,313)
Purchase of fixed assets. . . . . . . 0 (2,847)
------------- -------------
Net cash (used in) provided by
operating activities. . . . . . . . (237,571) 39,642
Cash provided by (used in) investing activities:
Net sale of short-term investments
and marketable securities . . . . . 2,877,319 1,709,625
Investment in private placements
and loans . . . . . . . . . . . . . (121,802) (1,745,585)
------------- -------------
Net cash provided by (used in)
investing activities. . . . . . . . 2,755,517 (35,960)
Cash flows used in financing activities:
Payment of note payable (Note 6). . . (2,500,000) 0
------------- -------------
Net cash used in financing activities (2,500,000) 0
Net increase in cash and cash equivalents:
Cash and cash equivalents at beginning
of the period . . . . . . . . . . . 145,588 155,440
Cash and cash equivalents at end of
the period. . . . . . . . . . . . . 163,534 159,122
------------- -------------
Net increase in cash and cash equivalents $ 17,946 $ 3,682
============= =============
Supplemental disclosures of cash flow information:
Income taxes paid . . . . . . . . . . $ 300 $ 5,909
Interest paid . . . . . . . . . . . . $ 44,180 $ 0
The accompanying notes are an integral part of these financial statements.
</TABLE>
4
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
<S> <C> <C>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
Changes in net assets from operations:
Net operating loss. . . . . . . . $ (526,591) $ (374,562)
Net realized gain on investments. 51,130 405,020
Net decrease in unrealized
appreciation on investments as
a result of sales . . . . . . . (87,898) (1,147,190)
Net increase (decrease) in
unrealized appreciation on
investments held. . . . . . . . 559,828 (545,556)
------------- -------------
Net decrease in net assets resulting
from operations . . . . . . . . (3,531) (1,662,288)
------------- -------------
Net decrease in net assets . . . . . (3,531) (1,662,288)
Net assets:
Beginning of the period . . . . . 33,654,934 35,932,603
------------- -------------
End of the period . . . . . . . . $ 33,651,403 $ 34,270,315
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
5
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS MARCH 31, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated Companies (12)(13)(14)
- -- 16.0% of total investments
Publicly Traded Portfolio (Common stock unless
noted otherwise) -- 13.4% of total investments
Oil and Gas Related
CORDEX Petroleums Inc. (1)
Argentine and Chilean oil and
gas exploration
Class A Common Stock . . . . . . . . .(C) 4,052,080 $ 145,342
Biotechnology and Healthcare Related
Alliance Pharmaceutical Corp. (1)(4) . .(C) 57,500 434,843
Fuisz Technologies, Ltd. (1) . . . . . .(C) 125,000 1,554,688
Guilford Pharmaceuticals Inc. (1). . . .(C) 10,000 220,000
Energy Research Corporation (1) --
Fuel cell energy . . . . . . . . . . . .(C) 55,000 1,471,250
Princeton Video Image, Inc. (1)(2)(7)
-- Real time sports and entertainment
advertising -- 1.4% of fully diluted
equity . . . . . . . . . . . . . . . . .(C) 150,200 966,536
----------
Total Publicly Traded Portfolio
(cost: $3,579,097) . . . . . . . . . . . . . . . . . . . . . . . $4,792,659
Private Placement Portfolio (Illiquid) --
2.6% of total investments
Exponential Business Development
Company (1)(2)(5) -- Venture capital
partnership focused on early stage companies
Limited partnership interest . . . . . .(A) -- $ 25,000
MedLogic Global Corporation (1)(2) --
Medical cyanoacrylate adhesive --
0.51% of fully diluted equity
Series B Convertible Preferred Stock . .(A) 60,319
Common Stock . . . . . . . . . . . . . .(D) 25,798 891,700
----------
Total Private Placement Portfolio (cost: $1,058,775) . . . . . . $ 916,700
----------
Total Investments in
Unaffiliated Companies (cost: $4,637,872) . . . . . . . . . . . $5,709,359
The accompanying notes are an integral part of this schedule.
</TABLE>
6
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS MARCH 31, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled Affiliates (12)(14)
- -- 40.6% of total investments
Publicly Traded Portfolio -- 8.6% of total investments
Nanophase Technologies Corporation
(1)(2)(6)(8) -- Manufactures and
markets inorganic crystals of
nanometric dimensions -- 5.08% of
fully diluted equity Common Stock. . . .(C) 730,916 $3,051,400
----------
Total Publicly Traded Portfolio (cost: $1,626,204) . . . . . . . $3,051,400
Private Placement Portfolio (Illiquid) --
32.0% of total investments
Genomica Corporation (1)(2)(5)(6)(9)
-- Develops software that enables
the study of complex genetic diseases --
10.7% of fully diluted equity
Common Stock . . . . . . . . . . . . . .(A) 199,800
Series A Voting Convertible Preferred
Stock. . . . . . . . . . . . . . . . . .(A) 1,660,200 $1,000,304
NBX Corporation (1)(2)(6)(10) --
Exploits innovative distributed
computing technology for use in small
business telephone systems -- 14.8% of
fully diluted equity Series A
Convertible Preferred Stock. . . . . . .(B) 500,000
Series C Convertible Preferred Stock . .(B) 240,793
Series D Convertible Preferred Stock . .(A) 59,965 4,540,298
Promissory Note -- 8% due March 16,
2001 . . . . . . . . . . . . . . . . . .(A) $ 10,000 10,000
PHZ Capital Partners Limited Partnership
(2) -- Organizes and manages investment
partnerships -- 20.0% of fully diluted
equity
Limited partnership interest . . . . . .(D) -- 1,405,622
Demand Promissory Note -- 8% . . . . . .(A) $ 500,000 500,000
PureSpeech, Inc. (1)(2)(6) -- Develops
and markets innovative speech
recognition technology -- 8.0% of
fully diluted equity
Series A Convertible Preferred Stock . .(D) 190,476
Convertible Promissory Note. . . . . . .(D) $ 243,980 1,713,370
Questech Corporation (1)(2)(6) --
Manufactures and markets proprietary
decorative tiles and signs -- 15.1% of
fully diluted equity
Common Stock . . . . . . . . . . . . . .(D) 565,792 2,263,168
Warrants at $4.00 expiring 11/28/01. . .(A) 166,667 167
-----------
Total Private Placement Portfolio (cost: $7,247,240). . . . . . $11,432,929
-----------
Total Investments in Non-Controlled Affiliates
(cost: $8,873,444). . . . . . . . . . . . . . . . . . . . . . . $14,484,329
The accompanying notes are an integral part of this schedule.
</TABLE>
7
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS MARCH 31, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in
Controlled Affiliates (12)(14) (Illiquid)
- -- 10.5% of total investments
BioSupplyNet, Inc. (1)(2)(6)(11) --
Expands commercially the print
and World Wide Web product directories
developed by Cold Spring Harbor
Laboratory Press -- 44.4% fully
diluted equity
Series A Convertible Preferred Stock . .(A) 775,000 $ 775,000
Revolving Credit Facility (Note 6) . . .(A) $ 110,000 110,000
MultiTarget, Inc. (1)(2)(6) --
Developing intellectual property
related to localized treatment of cancer --
37.5% of fully diluted equity
Series A Convertible Preferred Stock . .(A) 375,000 210,000
NeuroMetrix, Inc. (1)(2)(6) -- Developing
devices for: 1) diabetics to monitor
their blood glucose and 2) detection of
carpal tunnel syndrome -- 29.0% of
fully diluted equity
Series A Convertible Preferred Stock . .(B) 175,000
Series B Convertible Preferred Stock . .(B) 125,000
Series C Convertible Preferred Stock . .(A) 229,620 2,648,100
-----------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $2,605,000) . . . . . . . . . $ 3,743,100
U.S. Government Obligations -- 32.9% of total investments
U.S. Treasury Bill dated 04/03/97 due date
04/02/98 -- 5.2% yield. . . . . . . . .(K) $ 250,000 249,963
U.S. Treasury Bill dated 10/23/97 due date
04/23/98 -- 5.2% yield. . . . . . . . .(K) $ 7,550,000 7,525,387
U.S. Treasury Bill dated 12/04/97 due date
06/04/98 -- 5.0% yield. . . . . . . . .(K) $ 4,000,000 3,964,360
-----------
Total Investments in U.S. Government Obligations
(cost: $11,738,477) . . . . . . . . . . . . . . . . . . . . . . $11,739,710
-----------
Total Investments -- 100% (cost: $27,854,793) . . . . . . . . . $35,676,498
===========
The accompanying notes are an integral part of this schedule.
</TABLE>
8
SCHEDULE OF INVESTMENTS MARCH 31, 1998
(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 Method
of Valuation A to L.
(4) These investments were made during 1998. Accordingly, the amounts shown
on the schedule represent the gross additions in 1998.
(5) No changes in valuation occurred in these investments during the three
months ended March 31, 1998.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of its
efforts to establishing a new business, and either has not yet commenced
its planned principal operations or has commenced such operations but
has not realized significant revenue from them.
(7) Formerly named Princeton Electronic Billboard, Inc. As of March 31,
1998, the market price per share of Princeton Video Image, Inc. ("PVII")
was $8.125. As of May 8, 1998, the market price was $5.563 and the
Company valued its holding at $674,656. The Company is subject to a
lock-up agreement on the stock, which expires December 16, 1998.
(8) As of March 31, 1998, the market price per share of Nanophase
Technologies Corporation ("NANX") was $5.375. As of May 8, 1998, the
market price per share was $7.00,and the Company valued its holding at
$4,054,757. The Company is subject to a lock-up agreement on the stock,
which expires on May 26, 1998.
(9) 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 Directors of the Company and is Administrative
Director of Cold Spring Harbor Laboratory.
(10) Formerly named PowerVoice Technologies, Inc.
(11) BioSupplyNet, Inc. was cofounded by the Company, Cold Spring Harbor
Laboratory and other investors. Mr. G. Morgan Browne serves on the
Board of Directors and is Administrative Director of Cold Spring Harbor
Laboratory.
(12) Investments in unaffiliated companies consist of investments in which
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.
(13) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $4,745,549. The gross unrealized
appreciation based on tax cost for these securities is $1,569,243.
The gross unrealized depreciation based on the tax cost for these
securities is $605,433.
(14) The percentage ownership of each investee company disclosed in the
Schedule of Investments expresses the potential common equity interest
in each such investee. The calculated percentage represents the amount
of the issuer's common stock the Company owns or can acquire as a
percentage of the issuer's total outstanding common stock plus common
shares reserved for issued and outstanding warrants, convertible
securities and stock options.
The accompanying notes are an integral part of this 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 (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: 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 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
11
proportion of the company's securities owned by the Company and the nature
of any rights to require the company to register restricted securities under
applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT
IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following basic
methods of valuation:
E. Cost: The cost method is based on the original cost to the Company.
Such method is generally used in the early stages of commercializing or
developing intellectual property or patents or research and development in
technology or product development until significant positive or adverse events
occur subsequent to the date of the original investment that dictate a change
to another valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and development
in technology or product development as a basis for valuation, using actual
executed historical transactions by responsible third parties. The private
market method may also use, where applicable, unconditional firm offers by
responsible third parties as a basis for valuation.
G. Analytical Method: The analytical method is used to value an investment
after analysis of the best available outside information where the factual
information available to the Company dictates that an investment should no
longer be valued under either the cost or private market method. This
valuation method is inherently imprecise and ultimately the result of
reconciling the judgments of the Company's Investment and Valuation Committee
members. The resulting valuation, although stated as a precise number, is
necessarily within a range of values that vary depending upon the
significance attributed to the various factors being considered. Some of the
factors considered may include the results of research and development,
product development progress, commercial prospects, term of patent and
projected markets.
LONG-TERM FIXED-INCOME SECURITIES
H. Fixed-Income Securities for which market quotations are readily
available are carried at market value as of the time of valuation using the
most recent bid quotations when available.
Securities for which market quotations are not readily available are
carried at fair value using one or more of the following basic methods of
valuation:
I. Fixed-Income Securities are valued by independent pricing services
that provide market quotations based primarily on quotations from dealers
and brokers, market transactions, and other sources.
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
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"). The Company operates as an
internally managed investment company whereby its officers and employees,
under the general supervision of its Board of Directors, conduct its
operations.
The Company elected to become a BDC on July 26, 1995, after receiving
the necessary approvals. From September 30, 1992 until the election of BDC
status, the Company operated as a closed-end, non-diversified, investment
company under the 1940 Act. Upon commencement of operations as an investment
company, the Company revalued all of its assets and liabilities at fair value
as defined in the 1940 Act. Prior to such time, the Company was registered
and filed under the reporting requirements of the Securities and Exchange
Act of 1934 as an operating company and, while an operating company,
operated directly and through subsidiaries. As a BDC, the Company continues
to be subject to such reporting requirements.
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification in 1998 as a RIC under Sub-Chapter M of the
Code. As a RIC, the Company must, among other things, distribute at least
90 percent of its taxable net income and may either distribute or retain its
taxable net realized capital gains on investments. (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations
- - Recent Developments.") There can be no assurance that the Company will
qualify as a RIC or that if it does qualify, it will continue to qualify.
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 bases.<PAGE>
14
Income Taxes. Prior to January 1, 1998, the Company recorded income
taxes using the liability method in accordance with the provision of Statement
of Financial Accounting Standards No. 109. Accordingly, deferred tax
liabilities had been established to reflect temporary differences between the
recognition of income and expenses for financial reporting and tax purposes,
the most significant difference of which relates to the Company's unrealized
appreciation on investments.
The March 31, 1998 financial statements do not include a provision for
deferred taxes on unrealized gains other than the provision for taxes on the
unrealized gains as of December 31, 1997, net of the operating and capital
loss carryforwards incurred by the Company through December 31, 1997.
(See Note 5. Income Taxes.)
Reclassifications. Certain reclassifications have been made to the
December 31, 1997 financial statements to conform to the March 31, 1998
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 March 31, 1998 and December 31,1997, and the reported amounts
of revenues and expenses for the three months ended March 31, 1998 and
March 31, 1997. 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 ofnon-qualified stock
options to newly elected non-employee directors of the Company.
The Company's 1988 Plan was cancelled as of December 31, 1997, canceling
all outstanding stock options and eliminating all potential stock option
grants. As of January 1, 1998, the Company adopted the Harris & Harris Group,
Inc. Employee Profit-Sharing Plan ("Plan") that provides for profit-sharing
equal to 20 percent of net after-tax income, with the exception of unrealized
gains as of September 30, 1997, on which gains the Company will not pay
employee profit-sharing. For the three months ended March 31, 1998, the
Company had accrued $225,045 under the Plan.
15
The Company accounted 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:
<TABLE>
<S> <C>
March 31, 1997
Net Realized (Loss) Income:
As Reported $30,458
Pro Forma $(111,958)
Net Asset Value per share:
As Reported $3.28
Pro Forma $3.27
</TABLE>
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:
<TABLE>
<S> <C>
March 31, 1997
Stock volatility 0.60
Risk-free interest rate 6.3%
Option term in years 7
Stock dividend yield - -
</TABLE>
The FASB No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995.
16
A summary of the status of the Company's 1988 Plan at March 31, 1997 and
changes during the three months then ended is presented in the table and
narrative below:
<TABLE>
<S> <C> <C>
March 31, 1997
---------------------------------
Weighted Average
________________
Shares Exercise Price
Outstanding at
beginning of period 1,080,000 $4.58
Granted 300,000 $3.88
Exercised - - - -
Forfeited 200,000 $5.37
Expired - - - -
Canceled - - - -
Outstanding at
end of period 1,180,000 $4.27
Exercisable at
end of period 403,000 $3.42
Weighted average fair
value of options granted $2.50 - -
</TABLE>
NOTE 4. EMPLOYEE BENEFITS
The Company has an employment and severance contract ("Employment
Contract") with its Chairman, Charles E. Harris, pursuant to which he is to
receive compensation in the form of salary and other benefits. On January 1,
1998 Mr. Harris' Employment Contract was amended to reduce his salary to
$200,000 and to allow him to participate in other business opportunities and
investments. 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. The Company's contribution to the plan is determined by
the Compensation Committee in the fourth quarter.
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
17
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
March 31, 1998, the Company had a reserve of $232,415 for the plan.
NOTE 5. INCOME TAXES
For the three months ended March 31, 1998 and 1997, the Company's income
tax benefit was allocated as follows:
<TABLE>
<S> <C> <C>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
Investment operations $ (365,712) $ 198,881
Realized (loss) gain on investments (27,531) (218,088)
Decrease in unrealized
appreciation on investments 808,957 911,479
---------------- ---------------
Total income tax benefit $ 415,714 $ 892,272
================ ===============
The above tax benefit consists of the following:
Current -- Federal $ (100,000) $ (16,197)
Deferred -- Federal 515,714 908,469
----------------- ---------------
Total income tax benefit $ 415,714 $ 892,272
================= ===============
</TABLE>
The Company's net deferred tax liability at March 31, 1998 and December
31, 1997 consists of the following:
<TABLE>
<S> <C> <C>
March 31, 1998 December 31, 1997
Unrealized appreciation on investments $ 2,008,941 $ 2,817,898
Net operating loss and capital carryforward (1,856,958) (1,856,958)
Medical retirement benefits - - (81,345)
Other - - (211,898)
------------ -------------
Net deferred income tax liability $ 151,983 $ 667,697
============ =============
</TABLE>
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification in 1998 as a RIC under Sub-Chapter M of the
Code. As a RIC, the Company annually must distribute at least 90 percent of
its investment company taxable income as a dividend and may either distribute
or retain its taxable net capital gains from investments. There can be no
assurance that the Company will qualify as a RIC or that, if it does qualify,
it will continue to qualify. To initially qualify as a RIC, the Company must
pay a dividend to shareholders equal to the Company's pre-RIC cumulative
realized earnings and profits ("E&P"). On April 9, 1998, the Company
declared a one-time cash dividend of $0.75 per share to meet this requirement
(for a total of $8,019,728). Continued qualification as a RIC requires the
Company to satisfy certain portfolio diversification requirements in
future years. The Company's ability to satisfy those requirements may
not be controllable by the Company. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Recent
Developments.")
The Company incurred ordinary and capital losses for a total of
approximately $5.3 million during its C Corporation taxable years that remain
available for use and may be carried forward to its 1998 and subsequent
taxable years. Ordinarily, a corporation that elects to qualify as a RIC
may not use its loss carryforwards from C Corporation taxable years to offset
RIC investment company taxable income or net capital gains. In addition,
a corporation that elects to qualify as a RIC continues to be taxable as a C
Corporation on any gains realized within 10 years of its qualification as a
RIC from sales of assets that were held by the corporation on the effective
date of the election ("C Corporation Assets") to the extent of any gain built
into the assets on such date ("Built-In Gain"). The Company has filed a
private ruling request with the Internal Revenue Service ("IRS") asking the
IRS to rule that the Company can carry forward its C Corporation losses to
offset any Built-In Gains resulting from sales of its C Corporation Assets,
thereby enabling the Company to retain some or all of the proceeds from
such sales without disqualifying itself as a RIC or incurring corporate level
income tax. The Company intends to use the $5.3 million loss carryforward to
reduce the taxes due to Built-In Gains. The increase in NAV per share as a
result of including the ordinary and capital loss carryforwards in the
March 31, 1998 financial statements is approximately $0.17.
In addition, because a RIC is not permitted to have, as of the close
of any RIC taxable year, E&P accumulated during any C Corporation taxable year,
the Company has also requested a ruling that its sale of C Corporation Assets
with Built-In Gains during RIC taxable years will not generate C Corporation
E&P. Although there is no guarantee that the IRS will rule favorably on the
Company's request for rulings, the management of the Company believes that
favorable rulings are likely.
The Company's net deferred income tax liability would have been
approximately $525,000 had it continued to account for its taxes as a C
Corporation.
NOTE 6. 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 three months
ended March 31, 1998 and 1997, was $38,808 and $39,497, respectively. Future
minimum lease payments in each of the following years are: 1999 -- $176,030;
2000 -- $178,561; 2001 -- $178,561; 2002 -- $178,561; 2003 -- $101,946.
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
19
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 March 31, 1998, the Company
would have to fund additional cash and/or property that would have to
be valued at a total of approximately $750,000 by December 1998, in order
for the Senior Professorship to become permanent.
In June 1997, the Company agreed to provide one of its investee
companies with a $450,000 revolving line of credit, of which $110,000 had
been used through March 31, 1998. The purpose of this line of credit, which
will be secured by accounts receivable, is to provide for seasonal cash flow.
To the extent that this line of credit is utilized, the Company will also
receive warrants to purchase common stock.
In December 1997, the Company signed a Demand Promissory Note for a
$4,000,000 line of credit with J.P. Morgan collateralized by the Company's
U.S. Treasury obligations. In March 1998 the line of credit was increased
to $6,000,000. As of December 31, 1997, the Company had borrowed $4,000,000
against the line of credit. From December 31, 1997 to January 2, 1998, the
rate on the line of credit was prime (8.5 percent). From January 2, 1998 to
April 2, 1998, the interest rate on the line of credit was libor plus
1.5 (7.3125 percent). In March 1998, the Company paid down $2,500,000; in
April 1998, the Company paid the remaining balance.
On April 9, 1998 the Company announced that it had received under
section 851(e) of the Code certification from the Securities and Exchange
Commission for 1997, and accordingly, the Company's Board of Directors declared
a one-time cash dividend of $0.75 per share (for a total of $8,019,728) to
meet one of the Company's requirements for qualification for Sub-Chapter M tax
treatment in 1998. The dividend will be paid on May 12, 1998. There can be
no assurance that the Company will qualify for Sub-Chapter M tax treatment in
1998 or subsequent periods.
NOTE 7. SUBSEQUENT EVENTS
On April 15, 1998, the Company announced that the Board of Directors had
approved the repurchase of up to 700,000 shares of Company stock in the open
market. As of May 8, 1998, the Company had repurchased a total of 27,500
shares for a total of $83,875 or an average of $3.05 per share.
Also on April 15, 1998, the Company announced the close of the sale of
PureSpeech, Inc. to Voice Control Systems, Inc. (Nasdaq National Market
Symbol: "VCSI"). In this transaction, the Company is receiving 268,239 Voice
Control Systems common shares, including 56,171 shares purchased for $82,953
through exercise of warrants on April 2, 1998. Ten percent of the shares of
VCSI owned by the Company are subject to escrow for one year to cover
breaches of representations or warranties by PureSpeech. All of the
Company's VCSI shares are restricted under Rule 144, but the Company has a
demand registration right.
20
Item 2. Management's Discussion and Analysis of Financial Condition
and Results 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 (decrease) increase 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 benefit. The second element is "Net realized (loss) gain
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 (loss) income."
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 (loss) gain on investments" and "Net increase (decrease)
in unrealized appreciation on investments" are directly related. When a
security is sold to realize a (loss) gain, net unrealized appreciation
(increases) decreases and net realized gain (decreases) increases.
Financial Condition
The Company's total assets and net assets were, respectively,
$36,167,658 and $33,651,403 at March 31, 1998, compared to $39,273,784 and
$33,654,934 at December 31, 1997. Net asset value per share was $3.15
at March 31, 1998 and December 31, 1997. The Company's shares outstanding
were 10,692,971 as of March 31, 1998 and December 31, 1997.
The Company's financial condition is dependent on the success of its
investments. The Company has invested a substantial portion of its assets
in private development stage or start-up companies. These private businesses
tend to be thinly capitalized, unproven, small companies that lack management
depth or have no history of operations. At March 31, 1998, approximately 45
percent of the Company's $36.2 million in total assets consisted of investments
at fair value in private businesses, of which net unrealized appreciation was
approximately $5.2 million before taxes. At December 31, 1997, approximately
34 percent of the Company's $39.3 million in total assets consisted of
investments at fair value in private businesses, of which net unrealized
appreciation was approximately $2.5 million.
21
A summary of the Company's investment portfolio is as follows:
<TABLE>
<S> <C> <C>
March 31, 1998 December 31, 1997
Investments, at cost $ 27,854,793 $ 30,500,498
Unrealized appreciation 7,821,705 8,158,732
----------- -----------
Investments, at fair value $ 35,676,498 $ 38,659,230
=========== ===========
</TABLE>
The accumulated unrealized appreciation on investments net of deferred
taxes is $5,812,764 at March 31, 1998, versus $5,340,834 at December 31, 1997.
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 three months ended
March 31, 1998:
<TABLE>
<S> <C>
Follow-on Investments: Amount
MultiTarget, Inc. $ 51,802
-----------
Sub-total $ 51,802
Loans:
BioSupplyNet, Inc. $ 60,000
NBX Corporation 10,000
-----------
Sub-total $ 70,000
-----------
Total $ 121,802
===========
</TABLE>
22
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 from fixed-income securities of $192,291
and $136,287 for the three months ended March 31, 1998 and 1997, respectively.
The increase is due to the additional funds the Company had available for
investment in fixed-income securities in 1998 as a result of the funds borrowed
against the JP Morgan line of credit.
Operating expenses were $371,450 and $720,599 for three months ended
March 31, 1998 and 1997, respectively. The decrease is primarily due to: the
reversal of $198,763 for the Company's profit-sharing plan accrual made in the
fourth quarter of 1997, a decrease in salaries as a result of reduced staff and
a decrease in overall expenses as a result of the Company's effort to cut
expenses. The decreases were offset by the interest expense on the funds drawn
on the JP Morgan line of credit. 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 $160,879 and $573,443 for the
three months ended March 31, 1998 and 1997, respectively.
For a discussion of the tax benefit and provision in the first quarter of
1998, see Note 5 of Notes to Financial Statements.
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 Portfolio Securities:
During the three months ended March 31, 1998 and 1997, the Company sold
various investments, realizing net gains of $78,661 and $623,108, respectively.
23
Unrealized Appreciation and Depreciation of Portfolio Securities:
Net unrealized appreciation on investments before taxes decreased by
$337,027 during the three months ended March 31, 1998, from $8,158,732 to
$7,821,705, primarily as a result of increased valuations on NeuroMetrix,
Inc.; PureSpeech,Inc.; Energy Research Corporation and Fuisz Technologies
Corporation. These gains were offset primarily by decreased valuations in
Nanophase Technologies Corporation, Princeton Video Image, Inc. and MedLogic
Global Corporation.
Net unrealized appreciation on investments before taxes decreased
$2,604,225 during the three months ended March 31, 1997 from $6,667,589 to
$4,063,364, owing primarily to decreased valuations on Harber Brothers
Productions, Inc. and PureSpeech, Inc.
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable securities
(the primary measure of liquidity) at March 31, 1998 of $18,247,303 (net of
$1,500,000 drawn from the JP Morgan line of credit) versus $21,693,067 (net
of $4,000,000 drawn from the J.P. Morgan line of credit) at December 31, 1997.
Included in marketable securities are the Company's holdings in Nanophase
Technologies Corporation of $3,051,400 and Princeton Video Image, Inc. of
$966,536. Both holdings are subject to lock-up agreements and are valued at
March 31, 1998 at discounts from market value: a 22 percent discount in the
case of Nanophase Technologies Corporation and a 21 percent discount in the
case of Princeton Video Image, Inc.
As of March 31, 1998, the Company had a $6,000,000 line of credit in
place with J.P. Morgan, of which the Company had borrowed $1,500,000.
Management believes that its cash, receivables and marketable securities
provide the Company with sufficient liquidity for its operations.
On May 12, 1998, the Company will pay out a one-time cash dividend of
$0.75 per share for a total of $8,019,728, to meet one of the requirements
for qualification for Sub-Chapter M tax treatment in 1998.
Recent Developments
The Company intends to elect to be treated as a RIC for federal income
tax purposes for 1998 and to try to continue to maintain that status. (See
Item 1. Financial Statements.) As a qualifying RIC, if the Company
distributes to stockholders annually in a timely manner at least 90% of its
"investment company taxable income," as defined in the Code (i.e., net
investment income, including accrued original issue discount, and net short-
term capital gains) (the "90% Distribution Requirement"), it will not be
subject to federal income tax on the portion of its investment company
taxable income and net capital gains (net long-term capital gain in excess
of net short-term capital loss) distributed to stockholders. In addition, if
the Company distributes in a timely manner 98% of its capital gain net
income for each one-year period ending on December 31, and distributes 98%
of its net ordinary income for each calendar year (as well as any income not
distributed in prior years),
24
it will not be subject to the 4% nondeductible federal excise tax imposed
with respect to certain undistributed income of RICs. The Company
generally will endeavor to distribute to stockholders all of its investment
company taxable income and its net capital gain, if any, for each taxable
year so that such Company will not incur income and excise taxes on its
earnings.
In order to qualify as a RIC for federal income tax purposes, the
Company must, among other things: (a) continue to qualify as a BDC under the
1940 Act, (b) derive in each taxable year at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, gains from
the sale of stock or securities, or other income derived with respect to its
business of investing in such stock or securities (the "90% Income Test"); and
(c) adequately diversify its holdings pursuant to detailed rules set forth in
section 851 of the Code.
If the Company acquires or is deemed to have acquired debt obligations
that were issued originally at a discount or that otherwise are treated under
applicable tax rules as having original issue discount, the Company will be
required to include in income each year a portion of the original issue
discount that accrues over the life of the obligation regardless of whether
cash representing such income is received in the same taxable year and to
make distributions accordingly.
Although it does not presently expect to do so, the Company is authorized
to borrow funds and to sell assets in order to satisfy distribution
requirements. However, under the 1940 Act, the Company is not permitted to make
distributions to stockholders while the Company's debt obligations and other
senior securities are outstanding unless certain "asset coverage" tests are
met. Moreover, the Company's ability to dispose of assets to meet its
distribution requirements may be limited by other requirements relating to its
status as a RIC, including the diversification requirements. If the Company
disposes of assets in order to meet distribution requirements, the Company
may make such dispositions at times which, from an investment standpoint,
are not advantageous.
If the Company fails to satisfy the 90% Distribution Requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in such year on all of its taxable income, regardless of whether the
Company makes any distributions to its stockholders. In addition, in that case,
all of the Company's distributions to its stockholders will be characterized as
ordinary income (to the extent of the Company's current and accumulated
earnings and profits). In contrast, as is explained below, if the Company
qualifies as a RIC, a portion ofits distributions may be characterized as
long-term capital gain in the hands of stockholders.
Other than distributions properly designated as "capital gain dividends"
as is described below, dividends to stockholders of the investment company
taxable income of the Company will be taxable as ordinary income to
stockholders to the extent of the Company's current or accumulated earnings and
profits, whether paid in cash or reinvested in additional shares.
Distributions of the Company's net capital gain properly designated by the
Company as "capital gain dividends" will be taxable to stockholders as a
long-term capital gain regardless of the stockholder's holding
period for his or her shares. Distributions in excess of the Company's
25
earnings and profits will first reduce the adjusted tax basis of the
stockholder's shares and, after the adjusted basis is reduced to zero, will
constitute capital gains to the stockholder. For a summary of the tax rates
applicable to capital gains, including capital gains dividends, see
discussion below.
To the extent that the Company retains any net capital gain, it may
designate such retained gain as "deemed distributions" and pay a tax thereon
for the benefit of its stockholders. In that event, the stockholders will be
required to report their share of retained net capital gain on their tax
returns as if it had been distributed to them and report a credit, or claim a
refund, for the tax paid thereon by the Company. The amount of the deemed
distribution net of such tax will be added to the stockholder's cost basis
for his or her shares. Since the Company expects to pay tax on net capital
gain at its regular corporate capital gain tax rate, and since that rate is
in excess of the maximum rate currently payable by individuals on net capital
gain, the amount of tax that individual stockholders will be treated as
having paid will exceed the amount of tax that such stockholders
would be required to pay on net capital gain.
Stockholders who are not subject to federal income tax or tax on capital
gains should be able to file a Form 990T or an income tax return on the
appropriate form that allows them to recover the taxes paid on their behalf.
Any dividend declared by the Company in October, November, or December of
any calendar year, payable to stockholders of record on a specified date in
such a month and actually paid during January of the following year, will be
treated as if it had been received by the stockholders on December 31 of the
year in which the dividend was declared.
Investors should be careful to consider the tax implications of buying
shares just prior to a distribution. Even if the price of the shares includes
the amount of the forthcoming distribution, the stockholder generally will be
taxed upon receipt of the distribution and will not be entitled to offset the
distribution against the tax basis in his or her shares.
A stockholder may recognize taxable gain or loss if he or she sells or
exchanges his or her shares. Any gain arising from (or, in the case of
distributions in excess of earnings and profits, treated as arising from) the
sale or exchange of shares generally will be a capital gain or loss. This
capital gain or loss normally will be treated as a long-term capital gain or
loss if the stockholder has held his or her shares for more than one year;
otherwise, it will be classified as short-term capital gain or loss. However,
any capital loss arising from the sale or exchange of shares held for six
months or less will be treated as a long-term capital loss to the extent of
the amount of capital gain dividends received with respect to such shares
and, for this purpose, the special rules of Section 246(c)(3) and (4) of
the Code generally apply in determining the holding period of shares.
It is unclear how any such long-term capital loss offsets capital gains
taxable at different rates. All or a portion of any loss realized upon
a taxable disposition of shares of the Company may be disallowed if other
shares of the Company are purchased within 30 days before or after the
disposition.
26
In general, net capital gain (the excess of net long-term capital
gain over net short-term capital loss) of non-corporate taxpayers is
currently subject to a maximum federal income tax rate of 28% (subject to
reduction in many situations) while other income may be taxed at rates as
high as 39.6%. Capital gains derived from the disposition of assets held
for more than 18 months generally are subject to federal income tax at
the rate of 20%. Corporate taxpayers are currently subject to federal
income tax on net capital gain at the maximum 35% rate also applied to
ordinary income. Tax rates imposed by states and local jurisdictions on
capital gain and ordinary income may differ.
The Company may be required to withhold U.S. federal income tax
at the rate of 31% of all taxable dividends and distributions payable to
stockholders who fail to provide the Company with their correct taxpayer
identification number or to make required certifications, or regarding
whom the Company has been notified by the IRS that they are subject to
backup withholding. Backup withholding is not an additional tax, and
any amounts withheld may be credited against a stockholder's U.S. federal
income tax liability.
Federal withholding taxes at a 30% rate (or a lesser treaty rate)
may apply to distributions to stockholders that are nonresident aliens
or foreign partnerships, trusts, or corporations. Foreign investors
should consult their tax advisors with respect to the possible U.S.
federal, state, and local tax consequences and foreign tax consequences
of an investment in the Company.
The Company will send to each of its stockholders, as promptly as
possible after the end of each fiscal year, a notice detailing, on a
per share and per distribution basis, the amounts includible in such
stockholder's taxable income for such year as ordinary income and as
long-term capital gain. In addition, the federal tax status of each
year's distributions generally will be reported to the IRS.
Distributions may also be subject to additional state, local, and
foreign taxes depending on a stockholder's particular situation. The
Company's ordinary income dividends to its corporate shareholders may,
if certain conditions are met, qualify for the dividends received
deduction to the extent that the Company has received qualifying
dividend income during the taxable year; capital gain dividends
distributed by the Company are not eligible for the dividends
received deduction.
If necessary for liquidity purposes, in lieu of distributing its
taxable net capital gains, the Company may retain such net capital
gains and elect to be deemed to have made a distribution of the gains,
or part thereof, to the shareholders under the "designated undistributed
capital gain" rules of section 852(b)(3) of the Code. In such a case,
the Company would have to pay a 35 percent corporate level income tax on
such "designated undistributed capital gain," but it would not have to
distribute the excess of the retained "designated undistributed capital
gain" over the amount of tax thereon in order to maintain its RIC status.
On May 12, 1998, the Company will distribute its cumulative E&P
through December 31, 1997 for a total of approximately $8.0 million.
As of March 31, 1998, the Company believes that it has sufficient current
assets to make such distribution without jeopardizing its ability to pay its
operating expenses as they may become due.
27
Risks
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 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.
Risks Relating to the Year 2000 Issue
The Company believes that the Year 2000 problem is not material to
the Company. Many computer software systems in use today cannot recognize
the Year 2000 and may revert to 1900 or some other date because of the way
in which dates were encoded and calculated. The Company could be adversely
affected if its computer system or those of its service providers do not
properly process and calculate date-related information and data on and
after January 1, 2000. The Company has been actively working on necessary
changes to its computer systems to prepare for the Year 2000 and intends
to obtain reasonable assurances from its service providers that they are
taking comparable steps with respect to their computer systems. However,
the steps the Company is taking and intends to take does not guarantee
complete success or eliminate the possibility that interaction with
outside computer systems may have an adverse impact on the Company.
Forward-Looking Statements
The information contained herein contains certain forward-looking
statements. These statements include the plans and objectives of
management for future operations and financial objectives, portfolio
growth and availability of funds. These forward-looking statements
are subject to the inherent uncertainties in predicting future results
and conditions. Certain factors that could cause actual results and
conditions to differ materially from those projected in these
forward-looking statements are set forth herein. Other factors
that could cause actual results to differ materially include the
uncertainties of economic, competitive and market conditions, and
future business decisions, all of which are difficult or impossible
to predict accurately and many of which are beyond the control of
the Company. Although the Company believes that the assumptions
underlying the forward-looking statements included herein are
reasonable, any of the assumptions could be inaccurate and therefore,
28
there can be no assurance that the forward-looking statements included
or incorporated by reference herein will prove to be accurate.
Therefore, the inclusion of such information should not be
regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not Applicable
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
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 10K for the
year ended December 31, 1995.
4.1 Specimen Certificate of Common Stock, incorporated by
reference to Exhibit 4 to Company's Registration Statement on
Form N-2 filed October 29, 1992.
10.16* Demand Promissory Note - Line of Credit, Statement of Purpose
for an Extension of Credit Secured by Margin Stock by and
among Harris & Harris Group, Inc. And J.P. Morgan.
11.0* Computation of per share earnings. See Statement of Operations.
27.0* Financial Data Schedule.
(b) The Company did not file any reports on Form 8-K during the first
quarter of 1998.
30
EXHIBIT INDEX
Item Number (of Item 601 of Regulation S-K)
27. Financial Data Schedule
31
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf 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: May 15, 1998
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> $27,854,793
<INVESTMENTS-AT-VALUE> 35,676,498
<RECEIVABLES> 0
<ASSETS-OTHER> 491,160
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 36,167,658
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2,516,255
<TOTAL-LIABILITIES> 2,516,255
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 16,178,979
<SHARES-COMMON-STOCK> 10,692,971
<SHARES-COMMON-PRIOR> 10,692,971
<ACCUMULATED-NII-CURRENT> 11,552,730
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 5,812,764
<NET-ASSETS> 33,651,403
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 203,223
<OTHER-INCOME> 7,348
<EXPENSES-NET> 371,450
<NET-INVESTMENT-INCOME> (526,591)
<REALIZED-GAINS-CURRENT> 78,661
<APPREC-INCREASE-CURRENT> (337,027)
<NET-CHANGE-FROM-OPS> (3,531)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (3,531)
<ACCUMULATED-NII-PRIOR> 12,028,191
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 0
<INTEREST-EXPENSE> 73,415
<GROSS-EXPENSE> 0
<AVERAGE-NET-ASSETS> 0
<PER-SHARE-NAV-BEGIN> 3.15
<PER-SHARE-NII> (.04)
<PER-SHARE-GAIN-APPREC> .04
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 3.15
<EXPENSE-RATIO> 0
<AVG-DEBT-OUTSTANDING> 2,750,000
<AVG-DEBT-PER-SHARE> 0.26
</TABLE>
DEMAND PROMISSORY NOTE -- LINE OF CREDIT
Date: March 26, 1998
U.S. $6,000,000.00
FOR VALUE RECEIVED, Harris & Harris Group, Inc. (the "Borrower")promises
to pay to the order of MORGAN GUARANTY TRUST COMPANY OF NEW YORK (the "Bank"),
ON DEMAND at its office at 60 Wall Street, New York, New York 10260-0060,
U.S.A., for the account of its Lending Office (as hereinafter defined), in
lawful money of the United States of America in same day funds (or in such
funds as may from time to time become customary for the settlement of
international transactions in U.S. dollars), the lesser of (i) U.S.
$6,000,000.00 or (ii) the then-outstanding principal amount of each loan (the
"Loan" or "Loans") made by the Bank from time to time to the Borrower
hereunder. The Borrower shall pay interest on the unpaid principal amount of
each Loan until maturity on the dates and at a rate per annum as hereinafter
set forth. As used herein, "Lending Office" means, (i) with regard to Loans
bearing interest based on the Prime Rate (as hereinafter defined)
(collectively, "Domestic Loans"), the office of the Bank located at 60 Wall
Street, New York, New York or such other office as the Bank may designate, and
(ii) with regard to Loans bearing interest based on the Eurodollar Rate (as
hereinafter defined) (collectively, "Eurodollar Loans"), the Nassau (Bahamas)
office of the Bank or such other office as the Bank may designate.
Interest based on the Prime Rate shall be computed on the basis of a year
of 365 days (or 366 days in a leap year) and paid for actual days elapsed
(including the first day but excluding the last day). Interest based on the
Eurodollar Rate shall be computed on the basis of a year of 360 days and paid
for the actual number of days elapsed (including the first day but excluding
the last day).
Each Eurodollar Loan shall bear interest at a rate per annum (the
"Eurodollar Rate") equal to the Adjusted Eurodollar Rate (as hereinafter
defined) plus 1.500% (the Eurodollar Margin"), payable on the last day of the
Interest Period applicable thereto and, if such Interest Period is longer than
three months, at intervals of three months after the first day thereof. The
"Adjusted Eurodollar Rate" applicable to any Interest Period (as hereinafter
defined) means a rate per annum equal to the quotient obtained (rounded
upwards, if necessary, to the next higher 1/100 of 1%) by dividing (i) the
applicable London Interbank Offered Rate by (ii) 1.00 minus the Eurodollar
Reserve Percentage. The "London Interbank Offered Rate" applicable to any
Interest Period means the rate per annum at which deposits in U.S. dollars are
offered to the Bank in the London interbank market at approximately 11:00 a.m.
(London time) two business days prior to the first day of such Interest Period
in an amount approximately equal to the principal amount of the Loan to which
such Interest Period applies and for the period of time comparable to such
Interest Period. The "Eurodollar Reserve Percentage" means for any day that
percentage (expressed as a decimal) which is in effect on such day, as
prescribed by the Board of Governors of the Federal Reserve System (or any
successor) for determining the maximum reserve requirement for a member bank
of the Federal Reserve System in New York City with deposits exceeding five
billion dollars in respect of "Eurocurrency liabilities" (or in respect of any
other category of liabilities which includes deposits by reference to which
the interest rate on the Loans is determined or any category of extensions of
credit or other assets which includes loans by a non-United States office of
the Bank to United States residents). The Adjusted Eurodollar Rate shall be
adjusted automatically on and as of the effective date of any change in the
Eurodollar Reserve Percentage. As used herein, the term "Interest Period"
means the period beginning on the date of each Eurodollar Loan and ending on
the numerically corresponding day in the calendar month One or Three months
after such date; provided, that if an Interest Period would otherwise end on a
day which is not a business day it shall be extended to the next succeeding
business day unless such business day falls in the next calendar month, in
which case the Interest Period shall end on the next preceding business day;
provided, further, that if the Bank shall not have received written notice to
the contrary from the Borrower at least five business days prior to the end of
an Interest Period the Borrower shall be deemed to have requested to select an
Interest Period with a duration equal to that then ending. As used herein,
the term "business day" means any day on which dealings in U.S. dollar
deposits are carried on in the London interbank market and on which commercial
banks are open for domestic and foreign exchange business in London and New
York City. Notice by the Bank to the Borrower of the rate of interest so
determined shall be binding and conclusive upon the Borrower in the absence of
manifest error.
Each Domestic Loan shall bear interest payable on the last day of each
month at a rate per annum for each day equal to the rate of interest publicly
announced by the Bank in New York City from time to time as its Prime Rate
(the "Prime Rate") for such day, plus 0.000%.
The Borrower shall pay interest on the unpaid principal amount of each
Loan after the maturity thereof and, to the extent permitted by law, on
accrued and unpaid interest until paid at a rate per annum equal to the sum of
2% plus the Prime Rate.
If after the date of this Note any applicable rule, executive order,
decree, regulation or interpretation is amended, modified, enacted or
promulgated by any government or governmental authority so as to (i) change
the basis of taxation of payments to the Bank or the Lending Office of the
Bank extending a Eurodollar Loan (the "Eurodollar Lending Office") in respect
to the principal of and interest on any Eurodollar Loan (except for changes in
the rate of taxation on the overall net income of the Bank by the United
States of America or the Eurodollar Lending Office of the Bank by the
jurisdiction in which such Lending Office is located), or (ii) impose, modify
or deem applicable any reserve, special deposit or similar requirement against
any of the assets of, deposits with or for the account of, or credit extended
by the Bank's Eurodollar Lending Office, or (iii) impose on the Bank (or its
Eurodollar Lending Office) or the London interbank market any other conditions
affecting any Loan, the Loans or this Note, and the result of any of the
foregoing is to increase the cost to the Bank (or its Eurodollar Lending
Office) of agreeing to make or making, funding or maintaining any Loan
evidenced by this Note or would have the effect of reducing the rate of return
on the capital of the Bank or any entity controlling the Bank (its "Parent")
as a consequence of agreeing to make any Loan, or to reduce the amount of any
sum receivable by the Bank (or its Eurodollar Lending Office) on this Note,
then the Borrower shall pay to the Bank or its Parent upon demand such amount
as will compensate the Bank or its Parent for such additional cost or
reduction in return. A certificate of the Bank setting forth the basis for
the determination of any amount necessary to compensate the Bank or its Parent
as aforesaid shall be conclusive as to the determination of such amount in the
absence of manifest error.
If, after the date of this Notice, the introduction of, or any change in,
any applicable law, rule or regulation or in the interpretation or
administration thereof by any governmental authority charged with the
interpretation or administration thereof or compliance by the Bank (or its
Eurodollar Lending Office) with any request or directive (whether or not
having the force of law) of any such authority shall make it unlawful or
impossible for the Bank (or its Eurodollar Lending Office) to make, maintain
or fund its Eurodollar Loans, the Bank forthwith shall so notify the Borrower.
Upon receipt of such notice, the Borrower shall prepay in full the then
outstanding principal amount of each Eurodollar Loan, together with accrued
interest thereon, either (a) on the last day of the Interest Period applicable
thereto if the Bank may lawfully continue to maintain and fund such Loan to
such day or (b) immediately if the Bank may not lawfully continue to fund and
maintain such Loan to such day.
Eurodollar Loans may not be repaid at the Borrower's option on a date
other than the last day of an Interest Period. If, however, the Borrower
makes any payment of principal of any Eurodollar Loan or any day other than
the last day of the Interest Period applicable thereto, the Borrower shall
reimburse the Bank on demand for any loss or expense incurred by it as a
result of the timing of such payment, including (without limitation) any loss
incurred in obtaining, liquidating or employing deposits from third parties,
provided that the Bank shall have delivered to the Borrower a certificate as
to the amount of such loss, which certificate shall be conclusive in the
absence of manifest error.
Domestic Loans may be prepaid at any time without penalty or premium.
The Borrower hereby waives diligence, presentment, demand, protest and
notice of any kind whatsoever. The non-exercise by the Bank of its rights
hereunder in any particular instance shall not constitute a waiver of any
right in any subsequent instance.
The holder of this Note shall, and is hereby authorized by the Borrower
to, endorse on the schedule forming a part hereof appropriate notations
evidencing the date and the amount of each Loan made by the Bank, the date and
amount of each payment of principal, whether such Loan is a Domestic or
Eurodollar Loan and, in the case of Eurodollar Loans, the Eurodollar Rate
applicable thereto.
If this Note is not paid in full when due the Borrower agrees to pay all
costs and expenses of collection including reasonable attorney's fees. The
Borrower shall reimburse the Bank on demand for any transfer taxes,
documentary taxes, assessments or charges that are imposed at any time on or
in connection with this Note, any renewal hereof, the debt evidenced hereby or
any advance made hereunder and shall indemnify the Bank against liability for
any such tax (including any interest and penalties).
To secure payment of this Note, the Borrower hereby transfers, pledges,
gives a security interest in and delivers to the Bank all present and future
contents of the Borrower's
USA Treasurers held in Morgan Custody Account C88659
, all proceeds and products thereof, accessions thereto and substitutions
therefor (the "Collateral").
Upon the nonpayment of any amount when due hereunder, the holder shall
have the rights and remedies provided in the Uniform Commercial Code in force
in New York at the date of execution of this Note and in addition to, in
substitution for, in modification of, or in conjunction with those rights and
remedies, the holder or its agents may, in its discretion, sell, assign and
deliver all or any part of the Collateral at any broker's board or at public
or private sale without notice or advertisement, and bid and become purchasers
at any public sale or at any broker's board, and, if notice to the Borrower is
required by law, give written notice to the Borrower five days prior to the
date of public sale of the Collateral or prior to the date after which private
sale of the Collateral will be made by mailing such notice to the address
designated by the Borrower with the Borrower's signature below. The Borrower
agrees that the proceeds of the disposition of the collateral may be applied
by the holder to the satisfaction of the liabilities of the Borrower to the
holder in any order of preference which the holder, in its sole discretion,
chooses, and that the excess, if any, shall be returned to the Borrower, which
shall continue liable to the holder for any deficiency remaining with interest
thereon. The waiver or remedying of any default shall not operate as a waiver
of the default remedies or any other prior or subsequent default.
The undersigned, if more than one, shall be jointly and severally liable
hereunder and the term "Borrower" shall mean the undersigned or any one or
more of them and their heirs, executors, administrators, successors and
assigns.
THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAW
OF THE STATE OF NEW YORK. THE BORROWER HEREBY SUBMITS TO THE NONEXCLUSIVE
JURISDICTION OF THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF
NEW YORK AND OF ANY NEW YORK STATE COURT SITTING IN NEW YORK CITY FOR PURPOSES
OF ALL LEGAL PROCEEDINGS ARISING OUT OF OR RELATING TO THIS NOTE OR ANY
AGREEMENT RECEIVED BY THE BANK IN CONNECTION HEREWITH. THE BORROWER
IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION
WHICH THE BORROWER MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY
SUCH PROCEEDING BROUGHT IN SUCH A COURT AND ANY CLAIM THAT ANY SUCH PROCEEDING
BROUGHT IN SUCH A COURT HAS BEEN IN AN INCONVENIENT FORUM. THE BORROWER
HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL
PROCEEDING ARISING OUT OF OR RELATING TO THIS NOTE OR ANY AGREEMENT RECEIVED
BY THE BANK IN CONNECTION HEREWITH.
By executing and delivering this Note to the Bank, the Borrower is deemed to
have agreed to be bound by the Terms and Conditions of Advised Line of Credit
and any changes or revisions made thereto pursuant to paragraph 7 thereof.
SIGNATURE:
/s/Mel P. Melsheimer
- ---------------------
Mel P. Melsheimer
President & COO
Harris & Harris Group, Inc.
Address: One Rockefeller Plaza
Suite 1430
New York, NY 10020
<PAGE>
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Statement of Purpose for an Extension of Credit Secured by Margin Stock
Morgan Guaranty Trust Company of New York
____________________________________________
Name of Bank
(Federal Reserve Form U-1)
This form is required by law (15 U.S.C. Sections 78g and 78w; 12 CFR 221)
Instructions
1. This form must be completed when a bank extends credit in excess of
$100,000 secured directly or indirectly, in whole or in part, by any
margin stock.
2. The term "margin stock" is defined in Regulation U (12 CFR 221) and
includes, principally: (1) stocks that are registered on a national
securities exchange or that are on the Federal Reserve Board's List of
Marginable OTC Stocks; (2) debt securities (bonds) that are convertible
into margin stocks; (3) any over-the-counter security designated as
qualified for trading in the National Market System under a designation
plan approved by the Securities and Exchange Commission (NMS security);
and (4) shares of mutual funds, unless 95 per cent of the assets of the
fund are continuously invested in U.S. government, agency, state, or
municipal obligations.
3. Please print or type (if space is inadequate, attach separate sheet).
Part 1 To be completed by borrower(s).
1. What is the amount of the credit being extended? $6,000,000 = Six
Million Dollars
2. Will any part of this credit be used to purchase or carry margin stock?
Yes ____ No _X_
If the answer is "no", describe the specific purpose of the credit. WORKING
CAPITAL
I (we) have read this form and certify that to the best of my (our) knowledge
and belief the information given in true, accurate, and complete, and that
the margin stock and any other securities collateralizing this credit are
authentic, genuine, unaltered, and not stolen, forged, or counterfeit.
Signed:
/s/Mel P. Melsheimer
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Mel P. Melsheimer 3/26/98
Harris & Harris Group, Inc.
This form should not be signed in blank.
A borrower who falsely certifies the purpose of a credit on this
form or otherwise willfully or intentionally evades the provisions
of Regulation U will also violate Federal Reserve Regulation X
"Borrower of Securities Credit."
