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 June 30, 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, June 30, 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. . . . . . . . . . . . . . . . 26
Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 3. Quantitative and Qualitative Disclosures About
Market Risk . . . . . . . . . . . . . . . . . . . . . 30
PART II OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . 31
Item 2. Changes in Securities and Use of Proceeds. . . . . . . 31
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 31
Item 4. Submission of Matters to a Vote of Security Holders. . 31
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 31
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 31
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . 33
Harris & Harris Group, Inc.
Form 10-Q, June 30, 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.
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 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. 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 and paid 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 --
Taxation under Sub-Chapter M.") There can be no assurance that the Company
will qualify for Sub-Chapter M treatment for 1998 or subsequent years.
In addition, under certain circumstances, even if the Company were
qualified for Sub-Chapter M treatment in 1998 or a subsequent year, the
Company might elect to be taxed in that year as a C Corporation.
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>
<CAPTIION>
STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
<S> <C> <C>
June 30, 1998 December 31, 1997
(Unaudited) (Audited)
Investments, at value (See accompanying
schedule of investments and notes) . . . . $ 25,707,972 $ 38,659,230
Cash and cash equivalents. . . . . . . . . 150,677 145,588
Prepaid expenses . . . . . . . . . . . . . 73,580 85,126
Other assets . . . . . . . . . . . . . . . 171,058 383,840
------------ -------------
Total assets . . . . . . . . . . . . . . . $ 26,103,287 $ 39,273,784
============ =============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities . $ 532,937 $ 899,491
Deferred rent. . . . . . . . . . . . . . . 47,035 51,662
Deferred income tax liability (Note 5) . . 0 667,697
Note Payable (Note 6). . . . . . . . . . . 2,500,000 4,000,000
------------ -------------
Total liabilities. . . . . . . . . . . . . 3,079,972 5,618,850
------------ -------------
Commitments and contingencies (Note 6)
Net assets . . . . . . . . . . . . . . . . $ 23,023,315 $ 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; 10,641,400 outstanding
at 6/30/98 and 10,692,971 issued and
outstanding at 12/31/97 . . . . . . . . 106,930 106,930
Additional paid in capital . . . . . . . . 16,178,727 16,178,979
Accumulated net realized income. . . . . . 3,893,147 12,028,191
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $1,856,958 at 6/30/98
and $2,817,898 at 12/31/97 .. . . . . . 2,980,246 5,340,834
Treasury stock, at cost (51,571 shares). . (135,735) 0
------------ ------------
Net assets . . . . . . . . . . . . . . . . $ 23,023,315 $ 33,654,934
------------ ------------
Total net assets and liabilities . . . . . $ 26,103,287 $ 39,273,784
============ ============
Shares outstanding . . . . . . . . . . . . 10,641,400 10,692,971
------------ ------------
Net asset value per outstanding share. . . $ 2.16 $ 3.15
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2<PAGE>
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
(Unaudited)
<S> <C> <C>
Three Months Ended Six Months Ended
6/30/98 6/30/97 6/30/98 6/30/97
Investment income:
Interest from:
Fixed-income securities. . . $ 75,375 $ 78,944 $ 267,666 $ 215,231
Affiliated companies . . . . 27,453 8,889 86,485 18,889
Other income . . . . . . . . . 0 7,500 7,348 8,369
--------- --------- --------- ---------
Total investment income. . . 102,828 95,333 361,499 242,489
Expenses:
Salaries and benefits. . . . . 227,537 345,919 464,148 786,243
Profit sharing expense . . . . (225,045) 0 (423,808) 0
Administration and operations. 109,744 127,449 197,948 225,776
Professional fees. . . . . . . 91,073 54,732 180,099 142,829
Rent . . . . . . . . . . . . . 38,807 33,219 77,615 72,716
Directors' fees and expenses . 41,392 14,878 70,134 50,726
Depreciation . . . . . . . . . 12,500 15,000 25,000 30,000
Custodian fees . . . . . . . . 3,291 3,637 6,198 7,143
Interest expense (Note 6). . . 0 0 73,415 0
-------- -------- -------- ---------
Total expenses . . . . . . . 299,299 594,834 670,749 1,315,433
-------- -------- -------- ---------
Operating loss before
income taxes . . . . . . . (196,471) (499,501) (309,250)(1,072,944)
Income tax (provision)
benefit (Note 5) . . . . . 0 (30,534) (393,243) 168,347
--------- --------- --------- ---------
Net operating loss . . . . . . . (196,471) (530,035) (702,493) (904,597)
Net realized gain on investments:
Realized gain on
sale of investments . . . . 508,516 168,030 587,177 791,138
--------- --------- --------- ---------
Total realized gain. . . . . 508,516 168,030 587,177 791,138
Income tax provision (Note 5). 0 (58,810) 0 (276,898)
--------- --------- --------- ---------
Net realized gain
on investments . . . . . . . 508,516 109,220 587,177 514,240
--------- --------- --------- ---------
Net realized (loss) income . . . 312,045 (420,815) (115,316) (390,357)
Net decrease in unrealized
appreciation on investments:
Increase as a result
of investment sales . . . . . 110,625 0 110,625 0
Decrease as a result
of investment sales . . . . . (705,314) 0 (793,212)(1,764,909)
Increase on investments held. . 0 1,430,872 3,777,692 2,845,226
Decrease on
investments held. . . . . . (2,341,712)(5,420,882) (6,416,633)(7,674,552)
--------- --------- --------- ---------
Change in unrealized
appreciation on
investments . . . . . . . . (2,936,401)(3,990,010) (3,321,528)(6,594,235)
Income tax benefit (Note 5). 151,983 1,384,519 960,940 2,295,998
--------- --------- --------- ---------
Net decrease in unrealized
appreciation on
investments . . . . . . . . (2,784,418)(2,605,491) (2,360,588)(4,298,237)
--------- --------- --------- ---------
Net decrease in net assets from operations:
Total . . . . . . . . . . . $(2,472,373)$(3,026,306)$(2,475,904)$(4,688,594)
========== =========== ========== ==========
Per outstanding share . . . $ (0.23)$ (0.29)$ (0.23)$ (0.45)
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
(Unaudited)
<S> <C> <C>
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
Cash flows used in operating activities:
Net decrease in net assets
resulting from operations . . . . . $ (2,475,904) $ (4,688,594)
Adjustments to reconcile net decrease in
net assets from operations to net cash used in
operating activities:
Net realized and unrealized loss on
investments . . . . . . . . . . . 2,734,351 5,803,097
Deferred income taxes . . . . . . . (667,697) (2,187,447)
Depreciation. . . . . . . . . . . . 25,000 30,000
Changes in assets and liabilities:
Prepaid expenses. . . . . . . . . . 11,546 41,952
Interest receivable . . . . . . . . 101,106 82,652
Other assets. . . . . . . . . . . . 86,675 104,581
Accounts payable
and accrued liabilities . . . . . (314,752) 26,132
Deferred rent . . . . . . . . . . . (4,627) (4,626)
Purchase of fixed assets. . . . . . 0 (18,427)
----------- ----------
Net cash used in
operating activities . . . . . . . (504,302) (810,680)
Cash provided by investing activities:
Net sale of short-term investments
and marketable securities . . . . . 11,060,414 3,437,835
Investment in private
placements and loans . . . . . . . (895,308) (2,650,565)
----------- -----------
Net cash provided by
investing activities . . . . . . . . 10,165,106 787,270
Cash flows used in financing activities:
Payment of dividend . . . . . . . . (8,019,728) 0
Payment of note payable (Note 6) . . (1,500,000) 0
Purchase of Treasury stock (Note 6) (165,714) 0
Proceeds from sale of stock. . . . . 29,727 0
---------- ----------
Net cash used in
financing activities . . . . . . . (9,655,715) 0
Net increase (decrease) 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 . . . . . . . . . . . 150,677 132,030
------------ -------------
Net increase (decrease) in cash and cash
equivalents . . . . . . . . . . . . . $ 5,089 $ (23,410)
============ =============
Supplemental disclosures of
cash flow information:
Income taxes paid . . . . . . . . . . $ 300 $ 5,959
Interest paid . . . . . . . . . . . . $ 73,415 $ 0
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
<S> <C> <C>
Three Months Ended Six Months Ended
6/30/98 6/30/97 6/30/98 6/30/97
Changes in net assets from operations:
Net operating loss. . . . . $ (196,471) $ (530,035) $ (702,493) $(904,597)
Net realized gain
on investments. . . . . . 508,516 109,220 587,177 514,240
Net decrease in unrealized
appreciation on investments
as a result of sales. . . (594,689) 0 (682,587)(1,147,190)
Net decrease in unrealized
appreciation on
investments held . . . . (2,189,729) (2,605,491) (1,678,001)(3,151,047)
----------- ----------- ----------- ---------
Net decrease in net assets
resulting from operations .(2,472,373) (3,026,306) (2,475,904)(4,688,594)
Changes in net assets from capital
stock transactions:
Payment of dividends. . . . .(8,019,728) 0 (8,019,728) 0
Proceeds from sale of stock . 29,727 0 29,727 0
Purchase of Treasury stock. . (165,714) 0 (165,714) 0
---------- --------- ---------- -------
Net decrease in net assets
resulting from capital
stock transactions . . . . (8,155,715) 0 (8,155,715) 0
---------- --------- --------- -------
Net decrease in net assets . .(10,628,088) (3,026,306)(10,631,619)(4,688,594)
Net assets:
Beginning of the period . . 33,651,403 34,270,315 33,654,934 35,932,603
---------- ---------- ---------- ----------
End of the period . . . . .$ 23,023,315 $31,244,009 $23,023,315 $31,244,009
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS JUNE 30, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated Companies
(12)(13)(14) -- 13.1% of total investments
Publicly Traded Portfolio
(Common stock unless noted otherwise) -- 11.0% of total investments
Oil and Gas Related
CORDEX Petroleums Inc. (1)
Argentine and Chilean oil and gas exploration -- 2.01%
of fully diluted equity
Class A Common Stock. . . . . . . . . .(C) 4,052,080 $ 93,863
Biotechnology and Healthcare Related
Somnus Medical Technology, Inc. (1)(4). .(C) 35,000 286,580
Energy Research Corporation (1) --
Fuel cell energy . . . . . . . . . . . .(C) 55,000 1,086,250
Princeton Video Image, Inc. (1)(2)(7) --
Real time sports and entertainment
advertising -- 1.4% of fully diluted
equity . . . . . . . . . . . . . . . . . (C) 150,200 576,302
Voice Control Systems, Inc. (1)(2) --
Supplier of speech recognition and
related speech input technology -- 2.2% of
fully diluted equity . . . .. . . . . . .(C) 268,343 795,805
-----------
Total Publicly Traded Portfolio
(cost: $3,664,180) . . . . . . . . . . . . . . . . . . . . . $ 2,838,800
Private Placement Portfolio (Illiquid) -- 2.1% of total investments
Exponential Business Development Company (1)(2)(5) --
Venture capital partnership focused
on early stage companies -- 0.87% of
fully diluted equity
Limited partnership interest . . . . . . .(A) -- $ 25,000
MedLogic Global Corporation (1)(2) -- Medical
cyanoacrylate adhesive --
0.42% of fully diluted equity
Series B Convertible Preferred Stock . . .(B) 60,319
Common Stock . . . . . . . . . . . . . . .(B) 25,798 511,692
-----------
Total Private Placement
Portfolio (cost: $1,058,775) . . . . . . . . $ 536,692
-----------
Total Investments in
Unaffiliated Companies (cost: $4,722,955) . . . . . . . . $ 3,375,492
</TABLE>
The accompanying notes are an integral part of this schedule.
6
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS JUNE 30, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled
Affiliates (12)(14) -- 51.1% of total investments
Publicly Traded Portfolio -- 11.4% of total investments
Nanophase Technologies Corporation (1)(6)(8) --
Manufactures and markets inorganic crystals of
nanometric dimensions --
5.10% of fully diluted equity
Common Stock . . . . . . . . . . . . .(C) 730,916 $ 2,923,664
-----------
Total Publicly Traded
Portfolio (cost: $1,626,204) . . . . . . . . . . . . . . . . $ 2,923,664
-----------
Private Placement Portfolio (Illiquid)
-- 39.7% of total investments
Genomica Corporation (1)(2)(5)(6)(9) -- Develops software
that enables the study of complex genetic diseases --
10.8% of fully diluted equity
Common Stock . . . . . . . . . . . . .(A) 199,800
Series A Voting
Convertible Preferred Stock. . . . . .(A) 1,660,200 $ 1,000,304
InSite Marketing Technology, Inc. (1)(2)(4) -- Integrates
marketing science and sales strategy into e-commerce
-- 7.21% of fully diluted equity
Common Stock . . . . . . . . . . . . .(A) 1,351,351 500,000
NBX Corporation (1)(2)(6)(10) -- Exploits
innovative distributed computing technology
for use in small business telephone systems
-- 14.6% 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
Questech Corporation (1)(2)(6)
-- Manufactures and markets proprietary
decorative tiles and signs -- 12.6% 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: $6,420,308). . . . . $ 10,219,559
------------
Total Investments in
Non-Controlled Affiliates (cost: $8,046,512) . . . . . . . . $ 13,143,223
</TABLE>
The accompanying notes are an integral part of this schedule.
7
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS JUNE 30, 1998
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in
Controlled Affiliates (12)(14) (Illiquid)
-- 15.1% 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 --
47.6% fully diluted equity
Series A Convertible Preferred Stock. .(A) 775,000 $ 775,000
Warrants at $1.00 expiring 6/30/07. . .(A) 235,000
Revolving Credit Facility (Note 6). . .(A) $ 235,000 235,000
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 -- 27.6% of fully diluted equity
Series A Convertible Preferred Stock. .(B) 175,000
Series B Convertible Preferred Stock. .(B) 125,000
Series C-2 Convertible Preferred Stock.(A) 229,620 2,648,100
-----------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $2,778,100) . . . . . . . . . . $ 3,868,100
U.S. Government Obligations -- 20.7% of total investments
U.S. Treasury Bill dated 02/05/98
due date 08/06/98 -- 4.7% yield. . . (K) $ 250,000 $ 248,791
U.S. Treasury Bill dated 03/05/98
due date 09/03/98 -- 4.8% yield . . .(K) $ 395,000 391,571
U.S. Treasury Bill dated 04/02/98
due date 10/01/98 -- 5.0% yield . . .(K) $ 2,250,000 2,221,470
U.S. Treasury Bill dated 04/30/98
due date 10/29/98 -- 4.9% yield . . .(K) $ 2,500,000 2,459,325
Total Investments in ------------
U.S. Government Obligations (cost: $5,323,201) . . . . . . . . $ 5,321,157
------------
Total Investments -- 100% (cost: $20,870,768) . . . . . . . . . $25,707,972
============
</TABLE>
The accompanying notes are an integral part of this schedule.
8
SCHEDULE OF INVESTMENTS JUNE 30, 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
six months ended June 30, 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
June 30, 1998, the market price per share of Princeton Video
Image, Inc. ("PVII") was $4.625. As of August 3, 1998, the market
price was $4.875 and the Company valued its holding at $617,815.
The Company is subject to a lock-up agreement on the stock,
which expires December 16, 1998.
(8) As of June 30, 1998, the market price per share of Nanophase
Technologies Corporation ("NANX") was $5.00. As of August 3, 1998,
the market price per share was $3.50, and the Company valued its
holding at $2,046,565.
(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 $4,830,632. The gross unrealized
appreciation based on tax cost for these securities is $170,469.
The gross unrealized depreciation based on the tax cost for these
securities is $1,625,608.
(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
11
companies in similar businesses, the proportion of the company's
securities owned by the Company and the nature of any rights to
require the company to register restricted securities under
applicable securities laws.
INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT
Such investments are carried at fair value using the following
basic methods of valuation:
E. Cost: The cost method is based on the original cost to the
Company. Such method is generally used in the early stages of
commercializing or developing intellectual property or patents or
research and development in technology or product development until
significant positive or adverse events occur subsequent to the
date of the original investment that dictate a change to another
valuation method.
F. Private Market: The private market method uses actual third-party
investments in intellectual property or patents or research and
development in technology or product development as a basis for valuation,
using actual executed historical transactions by responsible third
parties. The private market method may also use, where applicable,
unconditional firm offers by responsible third parties as a basis
for valuation.
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 -- Taxation under Sub-Chapter M.") There can
be no assurance that the Company will qualify as a RIC or that if it
does qualify, it will continue to qualify. In addition, even if the
Company were to qualify as a RIC, under certain circumstances, it might
elect in a given year to be taxed as a C Corporation.
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.
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 June 30, 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 and June 30, 1997 financial statements to
conform to the June 30, 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 June 30, 1998 and
December 31,1997, and the reported amounts of revenues and expenses
for the three months and six months ended June 30, 1998 and June 30, 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 of non-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.
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:
15
<TABLE>
<S> <C> <C>
Three Months Ended Six Months Ended
June 30, 1997 June 30, 1997
Net Realized (Loss) Income:
As Reported $ (420,815) $ (390,357)
Pro Forma $ (526,580) $ (601,888)
Net Asset Value per share:
As Reported $ 2.99 $ 2.99
Pro Forma $ 2.98 $ 2.97
</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>
June 30, 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.
A summary of the status of the Company's 1988 Plan at June 30, 1997
and changes during the six months then ended is presented in the table and
narrative below. The Company's 1988 Plan was cancelled as of December 31,
1997, canceling all outstanding stock options and eliminating all potential
stock option grants.
<TABLE>
June 30, 1997
----------------------------------
<S> <C> <C>
Shares Weighted
Average
-------- --------------
Exercise Price
--------------
Outstanding at beginning of period 1,080,000 $4.58
Granted 320,000 $3.94
Exercised - - - -
Forfeited 270,000 $5.34
Expired - - - -
Canceled - - - -
---------- ---------
Outstanding at end of period 1,130,000 $4.22
========== =========
Exercisable at end of period 357,000 $3.19
========== =========
Weighted average fair
value of options granted $2.50
=========
</TABLE>
16
As of January 1, 1998, the Company began implementing the Harris
& Harris Group, Inc. Employee Profit Sharing Plan (the "Plan") that
provides for profit sharing equal to 20 percent of the net realized
income of the Company as reflected on the statement of operations of
the Company for such year, less the nonqualifying gain, if any. Under
the Plan, net realized income of the Company includes investment income,
realized gains and losses, and operating expenses (including taxes paid
or payable by the Company), but it will be calculated without regard to
dividends paid or distributions made to shareholders, payments under the
Plan, unrealized gains and losses, and loss carry-overs from other
years ("Qualifying Income"). The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 will be considered
nonqualifying gain, which will reduce "Qualifying Income." As of June 30,
1998, the Company does not have an accrual for the Plan and in the six
months ended June 30, 1998 reversed a bonus accrual of $423,808
established as of December 31, 1997; $198,763 in the three months
ended March 31, 1998 and $225,045 in the three months ended June 30, 1998.
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 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 June 30, 1998, the Company had a reserve of $255,430 for the
plan.
17
NOTE 5. INCOME TAXES
For the three months ended June 30, 1998 and 1997, the Company's
income tax benefit was allocated as follows:
<TABLE>
<S> <C> <C> <C> <C>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
6/30/98 6/30/97 6/30/98 6/30/97
Investment operations . . . . .$ 0 $ 30,534 $ 393,243 $ (168,347)
Realized gain
on investments. . . . . . . . 0 58,810 0 276,898
Net decrease in
unrealized appreciation
on investments . . . . . . . (151,983) (1,384,519) (960,940) (2,295,998)
---------- ------------ ----------------------
Total income tax
benefit . . . . . . . . . . .$(151,983) $(1,295,175) $(567,697)$(2,187,447)
========== ============ ======================
The above tax benefit consists of the following:
Current -- Federal. . . . . . .$ 0 $ (16,197) $ 100,000 $ 0
Deferred -- Federal . . . . . . (151,983) (1,278,978) (667,697) (2,187,447)
----------------------- -----------------------
Total income tax benefit. . . .$(151,983)$(1,295,175) $(567,697)$(2,187,447)
======================= =======================
</TABLE>
The Company's net deferred tax liability at June 30, 1998 and
December 31, 1997 consists of the following:
<TABLE>
<S> <C> <C>
June 30, 1998 December 31, 1997
Unrealized appreciation on investments $ 1,856,958 $ 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 $ 0 $ 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 or will elect to qualify.
To initially qualify as a RIC, among other requirements, the Company had
to 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). The cash dividend was paid
on May 12, 1998. 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 Operations -- Taxation under Sub-Chapter M.")
18
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 June 30, 1998 NAV includes the
ordinary and capital loss carryforwards which 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 as of June 30,
1998 would have been approximately $0 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 was
$38,807 and $33,219 and for the three months ended June 30, 1998 and
1997, respectively and $77,615 and $72,716 for the six months ended
June 30, 1998 and 1997, 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 be applied to the MIT Pledge
at their market value at the time the shares become publicly traded
or otherwise monetized in a commercial
19
transaction and are free from restriction as to sale by MIT.
At June 30, 1998, the Company would have to fund additional cash
and/or property that would have to be valued at a total of approximately
$760,000 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 $235,000
had been used through June 30, 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 percent
(7.3125 percent). In March 1998, the Company paid down $2,500,000;
in April 1998, the Company paid the remaining balance. On June 30, 1998,
the Company borrowed $2,500,000 against the line of credit at an interest
rate of 8.5 percent through July 2, 1998. From July 2, 1998 forward the
interest rate was LIBOR plus 1.5 percent (7.21875 percent).
On April 15, 1998, the Company announced that the Board of Directors
had approved the purchase of up to 700,000 shares of Company stock
in the open market. As of June 30, 1998, the Company had purchased
a total of 61,400 shares for a total of $165,714 or an average of $2.70
per share.
20
<PAGE>
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 (provision) benefit. The second element is "Net realized
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. These two elements
are combined in the Company's financial statements and reported as
"Net realized (loss) income." The third element, "Net decrease in
unrealized appreciation on investments," is the net change in the
fair value of the Company's investment portfolio, net of increase
(decrease) in deferred income taxes that would become payable if
the unrealized appreciation were realized through the sale or other
disposition of the investment portfolio.
"Net realized gain on investments" and "Net 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,
$26,103,287 and $23,023,315 at June 30, 1998, compared to $39,273,784
and $33,654,934 at December 31, 1997. The decrease is mainly due to
the payment of a one-time cash dividend of approximately $8 million
to meet one of the Company's requirements for qualifications for
Sub-Chapter M tax treatment in 1998; and a decrease of approximately
$3.9 million in the valuation of one of the Company's investee companies,
Nanophase Technologies Corporation. Net asset value per share was $2.16
at June 30, 1998 and $3.15 at December 31, 1997.
The Company's outstanding shares were 10,641,400 as of June 30, 1998
and 10,692,971 as of December 31, 1997. The Company's outstanding shares
were reduced as a result of its buyback program of 61,400 shares for a
total of $165,714. However the treasury shares were then decreased by
purchases of Company stock by directors with 50 percent of their director
compensation.
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
June 30, 1998, approximately 56.0 percent of the Company's $26.1 million
in total assets consisted of investments at fair value in private
businesses, of which net unrealized appreciation was approximately $4.4
million before taxes. At December 31, 1997, approximately 34.0 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
21
was approximately $2.5 million before taxes, if applicable.
A summary of the Company's investment portfolio is as follows:
<TABLE>
<S> <C> <C>
June 30, 1998 December 31, 1997
Investments, at cost $20,870,768 $30,500,498
Unrealized appreciation* 4,837,204 8,158,732
----------- -----------
Investments, at fair value $25,707,972 $38,659,230
=========== ===========
</TABLE>
*The accumulated unrealized appreciation on investments net of deferred
taxes is $2,980,246 at June 30, 1998, versus $5,340,834 at
December 31, 1997. (See Note 5 of Notes to Financial Statements.)
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 and other increases in cost in its private placement
portfolio during the six months ended June 30, 1998:
<TABLE>
<S> <C>
New Investments Amount
InSite Marketing Technology, Inc. $ 500,000
Follow-on Investments:
MultiTarget, Inc. $ 51,802
Exercise of Warrants:
Voice Control Systems, Inc. $ 82,953
Loans:
BioSupplyNet, Inc. $ 185,000
NBX Corporation 10,000
----------
Sub-total $ 195,000
22
Interest on Loans*
NeuroMetrix, Inc. $ 48,100
Voice Control Systems, Inc. 17,453
----------
Sub-total $ 65,553
----------
Total $ 895,308
==========
</TABLE>
*The Company received additional shares in NeuroMetrix, Inc. and Voice
Control Systems, Inc. in exchange for the accrued interest on its loans.
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
$267,666 and $215,231 for the six months ended June 30, 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.
The Company had interest income from affiliated companies of $86,485
and $18,889 for the six months ended June 30, 1998 and 1997, respectively.
The increase is due to the receipt of interest income on loans outstanding
to investee companies.
Operating expenses were $670,749 and $1,315,433 for six months ended
June 30, 1998 and 1997, respectively. The decrease is primarily due to:
the reversal of $423,808 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 the Chairman's salary, and a decrease
in overall expenses as a result of the Company's effort to cut expenses.
The decreases were offset by the
23
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 $309,250 and $1,072,944 for
the six months ended June 30, 1998 and 1997, respectively.
The Company had interest income from fixed-income securities of
$75,375 and $78,944 for the three months ended June 30, 1998 and 1997,
respectively. The slight decrease is a result of the Company having
less available funds as a result of operating expenses and additional
investments.
The Company had interest income from affiliated companies of
$27,453 and $8,889 for the three months ended June 30, 1998 and 1997,
respectively. The increase is due to the receipt of interest income
on loans outstanding to investee companies.
Operating expenses were $299,299 and $594,834 for three months
ended June 30, 1998 and 1997, respectively. The decrease is primarily
due to: the reversal of $225,045 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 the Chairman's salary, and
a decrease in administration and operation expenses as a result of the
Company's effort to cut expenses. The decreases were offset by: an
increase in professional fees, particularly legal fees as a result of
the Company's change of tax structure; an increase in directors' fee
as a result of additional Board meetings held during the three months
ended June 30, 1998.
Net operating losses before taxes were $196,471 and $499,501
for the three months ended June 30, 1998 and 1997, respectively.
For a discussion of the tax benefit and provision for the three
months and six months ended June 30, 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 on Portfolio Securities:
During the six months ended June 30, 1998, the Company sold various
investments, realizing a net pre-tax gain of $587,177 of which a net
of $682,587 has been recognized in prior periods, therefore, it decreased
unrealized appreciation on investments.
24
During the six months ended June 30, 1997, the Company sold
various public securities realizing a net pre-tax gain of $791,138,
of which $1,764,909 had been recognized in prior years, therefore,
it decreased unrealized appreciation on investments.
During the three months ended June 30, 1998, the Company sold
various public securities realizing a net pre-tax gain of $508,516
of which a net gain of $594,689 had been recognized in prior periods,
therefore, it decreased unrealized appreciation on investments. During
the three months ended June 30, 1997, the Company sold various public
securities realizing a net pre-tax gain of $168,030, of which none
had been recognized in prior periods.
Unrealized Appreciation and Depreciation on Portfolio Securities:
The Board of Directors values the portfolio securities on a
quarterly basis pursuant to the Company's Asset Valuation Policy
Guidelines in accordance with the 1940 Act. (See Footnote to
Schedule of Investments.)
Net unrealized appreciation on investments before taxes
decreased during the six months ended June 30, 1998, $3,321,528
from $8,158,732 to $4,837,204, primarily as a result of decreased
valuations in Nanophase Technologies Corporation, Princeton Video
Image, Inc. and MedLogic Global Corporation. These decreases were
offset primarily by increased valuations in NeuroMetrix, Inc. and
Voice Control Systems, Inc.
Net unrealized appreciation on investments before taxes
decreased, during the six months ended June 30, 1997, $6,594,235
from $6,667,589 to $73,354 owing primarily to decreased valuations
in Gel Sciences, Inc. (subsequently acquired by MedLogic Global
Corporation), Harber Brothers Productions, Inc., nFX Corporation,
Princeton Video Image, Inc. and PureSpeech, Inc. (subsequently
acquired by Voice Control Systems, Inc.), offset by the increased
valuation in NBX Corporation and Nanophase Technologies Corporation.
Net unrealized appreciation on investments before taxes decreased
during the three months ended June 30, 1998, $2,936,401 from $7,773,605
to $4,837,204 owing primarily to decreases in Voice Control Systems, Inc.,
MedLogic Global Corporation, Princeton Video Image, Inc.,
and Energy Research Corporation.
Net unrealized appreciation on investments before taxes decreased,
during the three months ended June 30, 1997, $3,990,010 from $4,063,364
to $73,354 owing primarily to decreased valuations in Gel Sciences, Inc.
(subsequently acquired by MedLogic Global Corporation), nFX Corporation
and Princeton Video Image, Inc., offset by an increased valuation in
Nanophase Technologies Corporation.
The Company's investee companies may have an overall increase in
valuation over the six months period ended June 30, 1998, but a decrease
in the three month period ended June 30, 1998 compared to the three
month period ended March 31, 1998.
25
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable
securities (the primary measure of liquidity) at June 30, 1998 of
$8,734,298 (net of $2,500,000 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
$2,923,664 and Princeton Video Image, Inc. of $576,302. Princeton
Video Image, Inc. is subject to a lock-up agreement and both holdings
are valued at June 30, 1998 at discounts from market value: a 20
percent discount in the case of Nanophase Technologies Corporation
and a 17.04 percent discount in the case of Princeton Video Image, Inc.
As of June 30, 1998, the Company had a $6,000,000 line of credit in
place with J.P. Morgan, of which the Company had borrowed $2,500,000.
Management believes that its cash, receivables and marketable securities
provide the Company with sufficient liquidity for its operations over
the next 12 months.
On May 12, 1998, the Company paid 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.
Taxation Under Sub-Chapter M
The Company presently intends to elect to be treated as a RIC for
federal income tax purposes for 1998 and intends to continue to maintain
that status. (See Item 1. Financial Statements Note 1.) As a
qualifying RIC, if the Company distributes to stockholders annually
in a timely manner at least 90 percent 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 percent 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 percent
of its capital gain net income for each one-year period ending on
December 31, and distributes 98 percent of its net ordinary income
for each calendar year (as well as any income not distributed in
prior years), it will not be subject to the 4 percent 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
percent 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 percent Income Test"); and (c)
adequately diversify its holdings pursuant to detailed rules set
forth in section 851 of the Code.
26
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 percent 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 of its 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 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
27
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.
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 20 percent
(subject to reduction in many situations) while other income may be
taxed at rates as high as 39.6 percent. Corporate taxpayers are
currently subject to federal income tax on net capital gain at the
maximum 35 percent 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 percent 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
28
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 percent 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.
29
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. In addition, the
Company may not qualify or seek to qualify for RIC status.
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 its computer systems. However, the
steps the Company is taking and intends to take do 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, 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
30
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
In accordance with recent amendments to the shareholder
proposal rules set forth in Rules 14a-4 and 14a-8 under the
Securities and Exchange Act of 1934, as amended, written notice
of shareholder proposals submitted outside the processes of Rule
14a-8 for consideration at the 1999 Annual Meeting of Shareholders
must be received by the Company on or before May 11, 1999, in order
to be considered timely for purposes of Rule 14a-4. The persons
designated in the Company's proxy statement shall be granted
discretionary authority with respect to any shareholder proposal
of which the Company does not receive timely notice.
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.
11.0* Computation of per share earnings. See Statement of
Operations.
27.0* Financial Data Schedule.
(b) The Company filed a report on Form 8-K on June 15, 1998
concerning the Company's Employee Profit Sharing Plan.
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: August 14, 1998
32
EXHIBIT INDEX
Item Number (of Item 601 of Regulation S-K)
27. Financial Data Schedule
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1998
<INVESTMENTS-AT-COST> $20,870,768
<INVESTMENTS-AT-VALUE> 25,707,972
<RECEIVABLES> 0
<ASSETS-OTHER> 395,315
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 26,103,287
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 3,079,972
<TOTAL-LIABILITIES> 3,079,972
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 16,178,727
<SHARES-COMMON-STOCK> 10,641,400
<SHARES-COMMON-PRIOR> 10,692,971
<ACCUMULATED-NII-CURRENT> 3,893,147
<OVERDISTRIBUTION-NII> 0
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<ACCUM-APPREC-OR-DEPREC> 2,980,246
<NET-ASSETS> 23,023,315
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 354,151
<OTHER-INCOME> 7,348
<EXPENSES-NET> 670,749
<NET-INVESTMENT-INCOME> (702,493)
<REALIZED-GAINS-CURRENT> 587,177
<APPREC-INCREASE-CURRENT> (2,360,588)
<NET-CHANGE-FROM-OPS> (2,475,904)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
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<NET-CHANGE-IN-ASSETS> (2,475,904)
<ACCUMULATED-NII-PRIOR> 11,552,730
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<INTEREST-EXPENSE> 73,415
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<PER-SHARE-NAV-BEGIN> 3.15
<PER-SHARE-NII> (.01)
<PER-SHARE-GAIN-APPREC> (.22)
<PER-SHARE-DIVIDEND> (.75)
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</TABLE>
