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, 1999
[ ] 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 ____
-----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 12, 1999
- --------------------------------------- -----------------------------
Common Stock, $0.01 par value per share 9,240,831 shares
Harris & Harris Group, Inc.
Form 10-Q, June 30, 1999
TABLE OF CONTENTS
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements . . . . . . . . . . 1
Consolidated Statements of Assets and Liabilities. . . . . . . 3
Consolidated Statements of Operations. . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows. . . . . . . . . . . . . 5
Consolidated Statements of Changes in Net Assets . . . . . . . 6
Consolidated Schedule of Investments . . . . . . . . . . . . . 7
Notes to Consolidated Financial Statements . . . . . . . . . . 15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Financial Condition. . . . . . . . . . . . . . . . . . . . . . 22
Results of Operations. . . . . . . . . . . . . . . . . . . . . 24
Liquidity and Capital Resources. . . . . . . . . . . . . . . . 26
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 3. Quantitative and Qualitative Disclosures About
Market Risk. . . . . . . . . . . . . . . . . . . . . . . . . . 32
PART II OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . 34
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . 34
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 34
Item 4. Submission of Matters to a Vote of Security Holders. . 34
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 34
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 35
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . . 35
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Harris & Harris Group, Inc.
Form 10-Q, June 30, 1999
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
The information furnished in the accompanying consolidated financial
statements reflect 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, 1998
contained in the Company's 1998 Annual Report.
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification of the Company as a Regulated Investment
Company ("RIC") under Sub-Chapter M of the Internal Revenue Code (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
("SEC") 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
and its intention to qualify as a RIC, the Company's Board of Directors
declared and paid 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. On February 17, 1999, the Company received
rulings from the Internal Revenue Service (the "IRS") regarding other issues
relevant to the Company's tax status as a RIC. (See "Note 6 of Notes to
Consolidated Financial Statements" contained in "Item 1. Consolidated
Financial Statements" & "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Sub-Chapter M Status.")
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. The Company was unable to
satisfy these requirements for the 1998 tax year owing to the nature of the
Company's ownership interest in one of its investee companies, and therefore
1
it did not elect Sub-Chapter M status for 1998. In addition, because the
Company realized taxable losses in 1998, it was not strategically
advantageous for the Company to elect Sub-Chapter M tax status for 1998.
As of December 31, 1998, the Company had a net operating and capital
loss carryforward of $7.1 million. The Company intends to use the $7.1
million tax loss carryforward to offset the long-term capital gain realized
when the Company sold its interest in NBX Corporation. The Company
anticipates realizing a tax benefit of approximately $2.5 million as a
result of such offset.
The Company changed the nature of its ownership interest in the non-
qualifying investee company (under the RIC regulations) effective January 1,
1999 in order to meet the Sub-Chapter M requirements. However, there can be
no assurance that the Company will qualify for Sub-Chapter M treatment for
1999 or subsequent years. In addition, under certain circumstances, even if
the Company were qualified for Sub-Chapter M treatment in 1999 and elected
Sub-Chapter M treatment for that year, the Company might take action in a
subsequent year to ensure that it would be taxed in that subsequent year as
a C Corporation, rather than a RIC.
2
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
<S> <C> <C>
June 30, 1999 December 31, 1998
(Unaudited) (Audited)
Investments, at value (See
accompanying schedule of
investments and notes). . . . . . $ 26,584,204 $ 24,532,191
Cash and cash equivalents . . . . . 204,854 164,143
Funds in escrow (Note 7). . . . . . 1,327,748 0
Receivable from brokers . . . . . . 808,737 380,707
Interest receivable . . . . . . . . 28,188 666
Note receivable . . . . . . . . . . 32,663 32,663
Prepaid expenses. . . . . . . . . . 66,295 90,649
Other assets. . . . . . . . . . . . 129,192 157,840
------------ ------------
Total assets. . . . . . . . . . . . $ 29,181,881 $ 25,358,859
============ ============
LIABILITIES & NET ASSETS
Accounts payable and accrued
liabilities . . . . . . . . . . . $ 399,803 $ 505,118
Accrued profit sharing (Note 5) . . 2,742,129 1,323,559
Deferred rent . . . . . . . . . . . 37,782 42,409
Deferred income tax
liability (Note 6) . . . . . . . . 1,734,606 931,064
------------ ------------
Total liabilities . . . . . . . . . 4,914,320 2,802,150
------------ ------------
Commitments and contingencies (Note 7)
Net assets. . . . . . . . . . . . . $ 24,267,561 $ 22,556,709
============ ============
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 at 6/30/99
and 12/31/98 . . . . . . . . . . 106,930 106,930
Additional paid in capital. . . . . 16,159,504 16,158,381
Accumulated net realized income
(deficit). . . . . . . . . . . . 2,307,701 (525,177)
Accumulated unrealized appreciation
of investments, net of deferred
tax liability of $1,734,606 at
6/30/99 and $3,410,884 at
12/31/98 . . . . . . . . . . . . 6,398,075 6,996,664
Treasury stock at cost, 371,571
shares at 6/30/99 and 101,739
shares at 12/31/98 . . . . . . . (704,649) (180,089)
------------ ------------
Net assets. . . . . . . . . . . . . $ 24,267,561 $ 22,556,709
------------ ------------
Total net assets and liabilities. . $ 29,181,881 $ 25,358,859
============ ============
Shares outstanding. . . . . . . . . 10,321,400 10,591,232
------------ ------------
Net asset value per outstanding
share. . . . . . . . . . . . . . $ 2.35 $ 2.13
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<S> <C> <C> <C> <C>
Three Months Ended Six Months Ended
6/30/99 6/30/98 6/30/99 6/30/98
Investment income:
Interest from:
Fixed-income securities. . $ 75,999 $ 75,375 $ 121,208 $ 267,666
Affiliated companies . . . 8,689 27,453 9,317 86,485
Other income . . . . . . . . 300 0 300 7,348
---------- --------- ---------- ----------
Total investment income. . 84,988 102,828 130,825 361,499
Expenses:
Salaries and benefits. . . . 185,255 227,537 392,333 464,148
Profit-sharing accrual
(reversal) (Note 5) . . . . 517,229 (225,045) 1,418,570 (423,808)
Administration and
operations. . . . . . . . . 115,154 109,744 187,879 197,948
Professional fees. . . . . . 62,973 91,073 123,990 180,099
Rent . . . . . . . . . . . . 41,378 38,807 82,756 77,615
Directors' fees and
expenses. . . . . . . . . . 26,702 41,392 63,116 70,134
Depreciation . . . . . . . . 12,500 12,500 25,000 25,000
Custodian fees . . . . . . . 1,551 3,291 3,283 6,198
Interest expense (Note 7). . 0 0 0 73,415
--------- --------- --------- ---------
Total expenses . . . . . . 962,742 299,299 2,296,927 670,749
--------- --------- --------- ---------
Operating loss before
income taxes. . . . . . . . (877,754) (196,471) (2,166,102) (309,250)
Income tax (provision)
(Note 6). . . . . . . . . . 0 0 0 (393,243)
--------- --------- ----------- ---------
Net operating loss . . . . . . (877,754) (196,471) (2,166,102) (702,493)
Net realized gain on investments:
Realized gain on
investments . . . . . . . . 380,270 508,516 11,125,818 587,177
--------- --------- ----------- ---------
Total realized gain. . . . 380,270 508,516 11,125,818 587,177
Income tax (provision)
(Note 6). . . . . . . . . . 0 0 (2,479,821) 0
--------- --------- ----------- ---------
Net realized gain on
investments . . . . . . . . 380,270 508,516 8,645,997 587,177
--------- --------- ----------- ---------
Net realized (loss) income . . (497,484) 312,045 6,479,895 (115,316)
Net increase (decrease) in unrealized appreciation on investments:
Increase as a result of
investment sales. . . . . . 485,906 110,625 485,906 110,625
Decrease as a result of
investment sales. . . . . . (55,898) (705,314) (4,840,700) (793,212)
Increase on investments
held. . . . . . . . . . . . 2,996,453 0 3,055,180 3,777,692
Decrease on investments
held. . . . . . . . . . . . (256,838) (2,341,712) (975,254) (6,416,633)
--------- ---------- ---------- ----------
Change in unrealized appreciation
on investments . . . . . . 3,169,623 (2,936,401) (2,274,868) (3,321,528)
Income tax (provision)
benefit (Note 6) . . . . . (29,097) 151,983 1,676,279 960,940
---------- ---------- ----------- ----------
Net increase (decrease)
in unrealized appreciation
on investments . . . . . . 3,140,526 (2,784,418) (598,589) (2,360,588)
---------- ---------- ----------- ----------
Net increase (decrease) in net assets from operations:
Total. . . . . . . . . . . .$ 2,643,042 $(2,472,373) $ 5,881,306 $(2,475,904)
=========== =========== =========== ===========
Per outstanding share. . . .$ 0.26 $ (0.23) $ 0.57 $ (0.23)
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<S> <C> <C>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
Cash flows from operating activities:
Net increase (decrease) in net
assets resulting from operations. $ 5,881,306 $ (2,475,904)
Adjustments to reconcile net
increase (decrease) in net assets
from operations to net cash used
in operating activities:
Net realized and unrealized
(gain) loss on investments. . . (8,850,950) 2,734,351
Deferred income taxes . . . . . . 803,542 (667,697)
Depreciation. . . . . . . . . . . 25,000 25,000
Changes in assets and liabilities:
Funds in escrow (Note 7). . . . . (1,327,748) 0
Receivable from brokers . . . . . (428,030) 0
Interest receivable . . . . . . . (27,522) 101,106
Collection on notes receivable. . 10,000 0
Prepaid expenses. . . . . . . . . 24,354 11,546
Other assets. . . . . . . . . . . 3,650 86,675
Accounts payable and accrued
liabilities. . . . . . . . . . . (105,315) (314,752)
Accrued profit sharing (Note 5) . 1,418,570 0
Deferred rent . . . . . . . . . . (4,627) (4,627)
----------- ----------
Net cash used in operating
activities . . . . . . . . . . (2,577,770) (504,302)
Cash flows from investing activities:
Net (purchase) sale of short-term
investments and marketable
securities. . . . . . . . . . . (3,208,695) 11,060,414
Proceeds from sale of private
placement investment. . . . . . 12,274,631 0
Investment in private placements
and loans . . . . . . . . . . . (2,277,001) (895,308)
----------- -----------
Net cash provided by investing
activities. . . . . . . . . . . 6,788,935 10,165,106
Cash flows from financing activities:
Payment of dividend . . . . . . . (3,647,017) (8,019,728)
Payment of note payable (Note 7). 0 (1,500,000)
Proceeds from sale of treasury
stock (Note 4). . . . . . . . . 17,283 29,727
Purchase of treasury stock
(Note 4). . . . . . . . . . . . (540,720) (165,714)
---------- -----------
Net cash used in financing
activities. . . . . . . . . . . (4,170,454) (9,655,715)
Net increase in cash and cash equivalents:
Cash and cash equivalents at
beginning of the period . . . . 164,143 145,588
Cash and cash equivalents at
end of the period . . . . . . . 204,854 150,677
----------- -----------
Net increase in cash and cash
equivalents . . . . . . . . . . $ 40,711 $ 5,089
=========== ===========
Supplemental disclosures of cash flow information:
Income taxes paid . . . . . . . . $ 797 $ 300
Interest paid . . . . . . . . . . $ 0 $ 73,415
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
<S> <C> <C> <C> <C>
Three Months Ended Six Months Ended
6/30/99 6/30/98 6/30/99 6/30/98
Changes in net assets from operations:
Net operating loss. . . . .$ (877,754) $ (196,471) $(2,166,102) $ (702,493)
Net realized gain on
investments. . . . . . . . 380,270 508,516 8,645,997 587,177
Net increase (decrease) in
unrealized appreciation
on investments as a
result of sales. . . . . . 430,008 (594,689) (1,874,973) (682,587)
Net increase (decrease) in
unrealized appreciation
on investments held. . . . 2,710,518 (2,189,729) 1,276,384 (1,678,001)
---------- ---------- ----------- -----------
Net increase (decrease)
in net assets resulting
from operations. . . . . . 2,643,042 (2,472,373) 5,881,306 (2,475,904)
Changes in net assets from capital
stock transactions:
Payment of dividends. . . . 0 (8,019,728) (3,647,017) (8,019,728)
Proceeds from sale of
treasury stock (Note 4). . 1,105 29,727 17,283 29,727
Purchase of treasury stock
(Note 4) . . . . . . . . . (63,376) (165,714) (540,720) (165,714)
_________ __________ __________ ___________
Net decrease in net assets
resulting from capital
stock transactions . . . . (62,271) (8,155,715) (4,170,454) (8,155,715)
--------- ---------- ---------- -----------
Net increase (decrease) in
net assets . . . . . . . . . 2,580,771 (10,628,088) 1,710,852 (10,631,619)
Net assets:
Beginning of the period . 21,686,790 33,651,403 22,556,709 33,654,934
___________ ___________ ___________ ___________
End of the period . . . . $24,267,561 $23,023,315 $24,267,561 $23,023,315
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
6
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS JUNE 30, 1999
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Unaffiliated
Companies (10)(11)(12) -- 38.8% of total investments
Publicly Traded Portfolio (Common
stock unless noted otherwise) -- 15.0% of total
investments
ATG, Inc. (1)(4) --
Radioactive and hazardous
waste management services. . . . . . (C) 20,000 $ 132,500
3Com Corporation (1)(4) --
Computer network technology
related. . . . . . . . . . . . . . . (C) 30,000 800,625
Energy Research Corporation (1)(4) --
Fuel cell energy . . . . . . . . . . (C) 10,000 142,500
Nanophase Technologies Corporation (1)(6) --
Manufactures and markets inorganic
crystals of nanometric dimensions
-- 4.59% of fully diluted equity . . (C) 672,916 1,211,249
Somnus Medical Technology, Inc. (1) --
Biotechnology and healthcare
related. . . . . . . . . . . . . . . (C) 200,000 650,000
Sterling Commerce (1)(4) --
Software technology for business-
to-business e-commerce . . . . . . . (C) 10,000 367,500
Synetic, Inc. (1)(4) --
Developing internet-based
healthcare network services. . . . . (C) 10,000 687,500
----------
Total Publicly Traded Portfolio (cost: $3,892,827) . . . . . . .$3,991,874
</TABLE>
The accompanying notes are an integral part of this
consolidated schedule.
7
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS JUNE 30, 1999
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio (Illiquid)
(10)(11)(12) -- 23.8% of total investments
Alliance Pharmaceutical Corp.(1)(2)(4) --
Research and development of
pharmaceutical products -- $1,200,000
subordinated 6% notes due 5/20/02
convertible into 600,000 common
shares @ $2.00 per share. . . . . . . . (C) $1,200,000
Warrants @ $2.45 expiring 5/20/04 . . . (C) 200,000 $ 1,526,000
Exponential Business Development Company (1)(2)(5) --
Venture capital partnership focused
on early stage companies
Limited partnership interest . . . . . . (A) -- 25,000
Kriton Medical, Inc. (1)(2)(4) --
Research and development of medical
devices -- 2.03% of fully diluted equity
Series B Convertible Preferred Stock . . (A) 476,191 1,000,001
MedLogic Global Corporation (1)(2)(5) --
Medical cyanoacrylate adhesive -- 0.37%
of fully diluted equity
Series B Convertible Preferred Stock. . . (B) 54,287
Common Stock. . . . . . . . . . . . . . . (B) 25,798 565,977
SciQuest.com, Inc. (1)(2)(8) -- Internet
e-commerce source for scientific
products -- 2.39% of fully diluted equity
Series C Convertible Preferred Stock. . . (B) 277,163
Common Stock. . . . . . . . . . . . . . . (B) 26,822 3,200,962
___________
Total Private Placement Portfolio (cost: $4,110,776) . . . . . . $ 6,317,940
-----------
Total Investments in Unaffiliated Companies (cost: $8,003,603) . $10,309,814
-----------
</TABLE>
The accompanying notes are an integral part of this
consolidated schedule.
8
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS JUNE 30, 1999
(Unaudited)
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio in Non-Controlled Affiliates (10)(12) (Illiquid)
-- 43.6% of total investments
Genomica Corporation (1)(2)(5)(6)(7)
-- Develops software that
enables the study of complex
genetic diseases -- 5.01% of
fully diluted equity
Common Stock . . . . . . . . . . . (B) 199,800
Series A Voting Convertible
Preferred Stock. . . . . . . . . (B) 1,660,200 $ 1,209,730
InSite Marketing Technology, Inc. (1)(2)(5)(6) --
Integrates marketing science and
sales strategy into e-commerce
-- 6.92% of fully diluted equity
Common Stock . . . . . . . . . . . (A) 1,351,351 500,000
NeuroMetrix, Inc. (1)(2)(6) --
Medical devices for monitoring
neuromuscular disorders -- 16.35%
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 . . . . . . . . . . . . . (B) 229,620 5,958,225
PHZ Capital Partners Limited Partnership (2)(9)
-- Organizes and manages investment
partnerships -- 20.0% of fully diluted equity
Limited partnership interest. . . (D) -- 1,673,586
Questech Corporation (1)(2)(6) --
Manufactures and markets proprietary
decorative tiles and signs -- 12.35% 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
in Non-Controlled Affiliates (cost: $5,778,406). . . . . . . .$11,604,876
-----------
U.S. Government Obligations -- 17.6% of total investments
U.S. Treasury Bill dated 2/25/99 due date
8/26/99 -- 4.6% yield. . . . . . (K) $ 300,000 $ 297,882
U.S. Treasury Bill dated 3/4/99 due date
9/2/99 -- 4.5% yield . . . . . . (K) $ 550,000 545,716
U.S. Treasury Bill dated 3/11/99 due date
9/9/99 -- 4.5% yield . . . . . . (K) $2,600,000 2,577,790
U.S. Treasury Bill dated 3/25/99 due date
9/23/99 -- 4.7% yield. . . . . . (K) $ 272,000 269,071
U.S. Treasury Bill dated 12/10/98 due date
12/9/99 -- 4.8% yield. . . . . . (K) $1,000,000 979,055
----------
Total U.S. Government Obligations (cost: $4,669,514) . . . . . .$ 4,669,514
----------
Total Investments -- 100% (cost: $18,451,523). . . . . . . . . .$26,584,204
===========
</TABLE>
The accompanying notes are an integral part of this
consolidated schedule.
9
CONSOLIDATED SCHEDULE OF INVESTMENTS JUNE 30, 1999
(Unaudited)
Notes to Consolidated 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 1999. Accordingly, the amounts shown
on the schedule represent the gross additions in 1999.
(5) No changes in valuation occurred in these investments during the six
months ended June 30, 1999.
(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) Genomica Corporation was cofounded by the Company, Cold Spring Harbor
Laboratory ("CSHL"), a not-for-profit institution, and Falcon
Technology Partners, LP. Mr. G. Morgan Browne serves on the
Board of Directors of the Company and is Administrative Director of
CSHL. In late 1998, Mr. Charles E. Harris, Chairman and CEO of
Harris & Harris Group became a trustee of CSHL.
(8) In September 1998, SciQuest.com, Inc. acquired BioSupplyNet, Inc.
(9) Harris Partners I L.P. owns a 20 percent limited partnership interest
in PHZ Capital Partners L.P. The partners of Harris Partners I L.P.
are Harris & Harris Enterprises, Inc. (sole general partner) and
Harris & Harris Group, Inc. (sole limited partner). Harris & Harris
Enterprises, Inc. is a 100 percent owned subsidiary of Harris & Harris
Group, Inc.
(10) Investments in unaffiliated companies consist of investments in which
Harris & Harris Group, Inc. (the "Company") owns less than five percent
of the investee company. Investments in non-controlled affiliated
companies consist of investments where the Company owns more than five
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.
(11) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $8,003,603. The gross unrealized
appreciation based on the tax cost for these securities is $2,903,593.
The gross unrealized depreciation based on the tax cost for these
securities is $597,382.
(12) 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
consolidated schedule.
10
FOOTNOTE TO CONSOLIDATED 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 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:
11
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
12
values of similar securities issued by companies in similar businesses, the
proportion of the company's securities owned by the Company and the nature
of any rights to require the company to register restricted securities under
applicable securities laws.
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.
13
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.
14
NOTES TO CONSOLIDATED 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"). A BDC is a
specialized type of investment company under the 1940 Act. The Company
operates as an internally managed investment company whereby its officers
and employees, under the general supervision of its Board of Directors,
conduct its operations.
Harris & Harris Enterprises, Inc. is a 100 percent owned subsidiary of
the Company. Harris Partners I L.P. is a limited partnership. The partners
of Harris Partners I L.P. are Harris & Harris Enterprises, Inc. (sole
general partner) and Harris & Harris Group, Inc. (sole limited partner).
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.
On September 25, 1997, the Company's Board of Directors approved a proposal
to seek qualification as a Regulated Investment Company ("RIC") under Sub-
Chapter M of the Internal Revenue 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 "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Sub-Chapter M Tax Status.")
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, and elected Sub-Chapter M treatment for
that year, the Company might take action in a subsequent year to ensure
that it would be taxed in that subsequent year as a C Corporation, rather
than a RIC.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed in
the preparation of the consolidated financial statements:
Principles of Consolidation. The consolidated financial statements have
been prepared in accordance with Generally Accepted Accounting Principles for
investment companies and include the accounts of the Company and its wholly
owned subsidiary. All significant intercompany accounts and transactions
have been eliminated in consolidation.
15
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 or specific identification basis for financial
reporting and tax reporting.
Income Taxes. The June 30, 1999 consolidated financial statements
include a provision for deferred taxes on the net unrealized gains as of
December 31, 1998. (See Note 6. Income Taxes.)
Reclassifications. Certain reclassifications have been made to the
June 30, 1998 financial statements to conform to the June 30, 1999
presentation.
Estimates by Management. The preparation of the consolidated 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, 1999 and December 31, 1998, and the
reported amounts of revenues and expenses for the three and six months ended
June 30, 1999 and 1998. 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 BDC 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.
As a substitution for the 1988 Stock Option Plan, the Company adopted an
employee profit-sharing plan. (See Note 5. Employee Benefits.)
16
NOTE 4. CAPITAL TRANSACTIONS
In 1998, the Board of Directors approved that effective January 1, 1998,
50 percent of all Directors' fees be used to purchase Company common stock
from the Company. However, effective on March 1, 1999, the directors may
purchase the Company's common stock in the open market, rather than directly
from the Company. During 1998 and 1999, the directors bought a total of
30,307 shares.
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, 1999, the Company had purchased a total of 401,878
shares for a total of $795,529 or an average of $1.98 per share. However,
the treasury shares purchased were decreased by the directors' purchases of
a total of 30,307 shares of Company stock.
On July 14, 1999, the Company announced an offer to purchase up to
1,100,000 shares of its common stock, par value $.01 per share for cash at
a price equal to $1.63 per share. The Company will not purchase any shares
of Common Stock unless a minimum of 700,000 shares are duly tendered.
NOTE 5. 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's 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, 1998, the Company implemented 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.
17
As soon as practicable following the year-end audit, the Board of
Directors will determine whether, and if so how much, Qualifying Income
exists for a plan year, and 90 percent of the Qualifying Income will be
paid out to Plan participants pursuant to the distribution percentages set
forth in the Plan. The remaining 10 percent will be paid out after the
Company has filed its federal tax return for that year in which Qualifying
Income exists. The distribution amounts for each officer and employee is
as follows: Charles E. Harris, 13.790%; Mel P. Melsheimer, 4.233%; Rachel
M. Pernia, 1.524%; and Jacqueline M. Matthews, 0.453%. If a participant
leaves the Company for other than cause, the amount earned will be accrued
and paid to such participant.
Notwithstanding any provisions of the Plan, in no event may the aggregate
amount of all awards payable for any Plan year during which the Company
remains a BDC within the meaning of the 1940 Act, be greater than 20 percent
of the Company's "net income after taxes" within the meaning of Section 57(n)
(1)(B) of the 1940 Act. In the event the awards exceed such amount, the
awards will be reduced pro rata.
The Plan may be modified, amended or terminated by the Company's Board of
Directors at any time; provided however, no such modification, amendment or
termination may adversely affect any participant that has not consented to such
modification, amendment or termination.
The Company calculates the Plan accrual at each quarter end based on the
realized and unrealized gains at that date, net of operating expenses for the
year. Any adjustments to the Plan accrual are then reflected in the
Consolidated Statements of Operations for the quarter. The Plan accrual is
not paid out until the gains are realized. The Plan profit-sharing
resulting from the realized gains during 1999 net of operating expenses for
the year, will be paid out as soon as practicable following year end.
During the second quarter of 1999, the Company accrued profit-sharing
expense of $517,229, bringing the cumulative accrual under the Plan to
$2,742,129 at June 30, 1999.
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 10 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,
1999, the Company had a reserve of $283,305 for the plan.
18
NOTE 6. INCOME TAXES
As of December 31, 1998, the Company had not elected tax treatment
available to a RIC under Sub-Chapter M of the Code. Accordingly, for
federal and state income tax purposes, the Company was taxed at statutory
corporate rates on its income, which enabled the Company to offset any prior
years' losses against 1998 income. Following that offset, the Company had a
$7.1 million loss carryforward. The Company intends to use the $7.1 million
loss carryforward (which it anticipates will result in a tax credit of
approximately $2.5 million) to offset the long-term capital gain realized
when the Company sold its interest in NBX Corporation.
For the three and six months ended June 30, 1999 and 1998, the Company's
income tax provision (benefit) was allocated as follows:
<TABLE>
<S> <C> <C> <C> <C>
Three Months Ended Six Months Ended
6/30/99 6/30/98 6/30/99 6/30/98
Investment operations. . . . $ 0 $ 0 $ 0 $ 393,243
Realized (loss) gain
on investments . . . . . . 0 0 2,479,821 0
Net increase (decrease) in
unrealized appreciation
on investments . . . . . . 29,097 (151,983) (1,676,279) (960,940)
---------- --------- ----------- ---------
Total income tax provision
(benefit). . . . . . . . . $ 29,097 $(151,983) $ 803,542 $(567,697)
========== ========= =========== =========
The above tax provision (benefit) consists of the following:
Current -- Federal $ 0 $ 0 $ 0 $ 100,000
Deferred -- Federal 29,097 (151,983) 803,542 (667,697)
---------- --------- ----------- ---------
Total income tax provision
(benefit) $ 29,097 $(151,983) $ 803,542 $(567,697)
========== ========= =========== =========
</TABLE>
The Company's net deferred tax liability at June 30, 1999 and
December 31, 1998 consists of the following:
<TABLE>
<S> <C> <C>
June 30, 1999 December 31, 1998
Tax on unrealized appreciation
on investments $1,734,606 $ 3,410,885
Net operating loss and capital
loss carryforward 0 (2,479,821)
---------- -----------
Net deferred income tax liability $1,734,606 $ 931,064
========== ===========
</TABLE>
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification 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. To initially qualify
as a RIC, among other requirements, the Company had to pay a dividend to
shareholders equal to the Company's cumulative realized earnings and profits
("E&P"). On April 9, 1998, the Company declared a one-time cash dividend of
19
$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.
The Company incurred net ordinary and capital losses during the C
Corporation taxable years, of which $7.1 million will be eligible to be
carried forward to the Company's 1999 taxable year. Ordinarily, a
corporation that elects to qualify as a RIC may not use its ordinary loss
carryforwards from C Corporation taxable years to offset RIC investment
company taxable income, although a RIC in certain cases may use ordinary
and capital loss carryforwards to reduce net capital gains. In addition,
a corporation that elects to qualify as a RIC and that makes an
appropriate election 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 intends to use its $7.1 million loss
carryforward to offset the long term capital gain realized when the Company
sold its interest in NBX Corporation. The Company anticipates realizing a
tax benefit of approximately $2.5 million as a result of such offset.
The IRS recently announced an intention to issue formal guidance in 1999
concerning conversions of C Corporations to RIC's. Such guidance may include
resolution of certain issues relevant to the conversion of the Company from a C
Corporation to a RIC.
There can be no assurance that the Company will qualify as a RIC or that, if
it does qualify, it will elect RIC status.
NOTE 7. COMMITMENTS AND CONTINGENCIES
During 1993, the Company signed a 10-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
June 30, 1999 and 1998, was $41,378 and $38,807 respectively and $82,756
and $77,615 for the six months ended June 30, 1999 and 1998, respectively.
Future minimum lease payments in each of the following years are: 2000 --
$178,561; 2001 -- $178,561; 2002 -- $178,561; 2003 -- $101,946.
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.
20
The Company has a total of $1,475,276 of funds in escrow as a result of
the acquisition of NBX Corporation by 3Com Corporation. The funds are in a
one-year, interest-bearing escrow account for the benefit of the Company,
subject to any 3Com Corporation warranty claims associated with its
acquisition of NBX Corporation. The Company set up a reserve of 10 percent
for any potential claims, therefore the funds in escrow reflect $1,327,748
net of the reserve of $147,528. At this time, the Company does not
anticipate any claims against the escrowed funds and expects to receive
these proceeds by March 8, 2000.
NOTE 8. SUBSEQUENT EVENTS
On July 14, 1999, the Board of Directors of the Company announced that
the Company had commenced an offer to purchase up to 1,100,000 shares of
its Common Stock, par value $.01 per share (the "Common Stock"), for cash
at a price equal to $1.63 per share. The Company will not purchase any
shares of Common Stock unless a minimum of 700,000 shares are duly tendered.
The offer will expire at 12:00 Midnight, Eastern Daylight time, on August 11,
1999 unless extended. The Board of Directors does not currently intend to
extend the Offer.
The Company's Board of Directors believes that the Company's financial
condition and outlook and current market conditions, including recent trading
prices of the shares of its Common Stock, make this an attractive time to
repurchase a portion of its outstanding shares of Common Stock. The Company's
Board of Directors believes that the Offer constitutes a prudent use of the
Company's financial resources, given the Company's business profile, assets
and prospects.
The Offer is being made to all stockholders of the Company. The Company
will not purchase any shares of Common Stock unless a minimum of 700,000
shares of Common Stock are duly tendered prior to the Expiration Date. If
more than 1,100,000 shares are duly tendered prior to the expiration of the
Offer, the Company intends to, assuming no changes in factors originally
considered by the Board of Directors when it determined to make the Offer
and the other conditions set forth in the Offer to Purchase, purchase shares
on a pro-rata basis. The Board of Directors may determine not to purchase
shares pursuant to the Offer for reasons set forth in the tender offer
documents.
On August 12, 1999, the Company received notification from its transfer
agent, the Bank of New York, that a total of 1,080,569 shares were tendered for
a total of $1,761,327.
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 increase
(decrease) in net assets from operations," which is the sum of three
elements. The first element is "Net operating loss," which is the
difference between the Company's income from interest, dividends, and fees
and its operating expenses, net of applicable income tax benefit. The
second element is "Net realized gain (loss) on investments," which
21
is the difference between the proceeds received from dispositions of
portfolio securities and their stated cost, net of applicable income tax
provisions (benefits). These two elements are combined in the Company's
financial statements and reported as "Net realized income (loss)." The
third element, "Net (decrease) increase in unrealized appreciation on
investments," is the net change in the fair value of the Company's
investment portfolio, net of decrease in deferred income taxes that would
become payable if the unrealized appreciation were realized through the
sale or other disposition of the investment portfolio.
"Net realized gain (loss) on investments" and "Net (decrease) increase
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,
$29,181,881 and $24,267,561 at June 30, 1999, compared with $25,358,859 and
$22,556,709 at December 31, 1998.
Net asset value per share ("NAV") was $2.35 at June 30, 1999 versus
$2.13 at December 31, 1998.
Among the significant changes which affected total assets, net assets
and NAV in the first six months of 1999 were: 1) the acquisition of NBX
Corporation by 3Com Corporation, which increased Harris & Harris Group's
net assets by approximately $5,868,568; 2) an increase in the value of the
Company's holdings in SciQuest.com, Inc., which increased net assets by
approximately $2,350,962; 3) the payment of a cash dividend of $0.35 per
share, which reduced net assets by approximately $3,647,017; 4) the
addition to a deferred income tax liability, which reduced net assets by
$803,542 and 5) the operating loss which reduced net assets by approximately
$2,166,102. (See "Consolidated Statements of Operations" contained in
"Item 1. Consolidated Financial Statements.")
The Company's shares outstanding as of June 30, 1999 were 10,321,400
versus 10,591,232 at December 31, 1998. The Company's outstanding shares
were reduced as a result of its purchase in the open market of a total of
401,878 shares as of June 30, 1999. The Company purchased 243,523 in the
first quarter of 1999 and 32,125 in the second quarter of 1999. However,
the treasury shares were then decreased by purchases of Company stock by
directors. (See "Note 4 of Notes to Consolidated Financial Statements.")
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, 1999,
$17,922,816 or 61 percent of the Company's total assets consisted of
investments at fair value in private businesses, of which net unrealized
appreciation was $8,033,634 before taxes. At December 31, 1998, $19,562,386
or 77 percent of the Company's total assets consisted of investments at fair
22
value in private businesses, of which net unrealized appreciation was
$10,250,204 before taxes. The decrease in the percentage of private
investments from 77 percent at December 31, 1998 to 61 percent at June 30,
1999 is primarily owing to the acquisition of NBX Corporation by 3Com
Corporation.
A summary of the Company's investment portfolio is as follows:
<TABLE>
<S> <C> <C>
June 30, 1999 December 31, 1998
Investments, at cost $18,451,523 $14,124,642
Unrealized appreciation 8,132,681 10,407,549
----------- -----------
Investments, at fair value $26,584,204 $24,532,191
=========== ===========
</TABLE>
The accumulated unrealized appreciation on investments net of deferred taxes
is $6,398,075 at June 30, 1999, versus $6,996,664 at December 31, 1998.
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 six months ended
June 30, 1999:
<TABLE>
<S> <C>
New Investments: Amount
Alliance Pharmaceutical Corp. $1,202,000
Kriton Medical, Inc. 1,000,001
----------
Sub-Total $2,202,001
Exercise of Warrants:
SciQuest.com, Inc. 75,000
----------
Total $2,277,001
==========
</TABLE>
23
Results of Operations
Investment Income and Expenses:
The Company realized a net operating loss of $2,166,102 and $702,493 for
the six months ended June 30, 1999 and 1998, respectively. 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 $121,208
and $267,666 for the six months ended June 30, 1999 and 1998, respectively.
The decrease of $146,458 or 54.7 percent is the result of a decline in the
balance of the Company's fixed income portfolio during the six months ended
June 30, 1999 versus the six months ended June 30, 1998. The Company had
borrowed funds against the JP Morgan line of credit during the six months
ended June 30, 1998, which were not outstanding during the six months ended
June 30, 1999. Accordingly, the Company had interest expense of $73,415
during the six months ended June 30, 1998 and did not have any interest
expense for the six months ended June 30, 1999.
The Company had interest income from affiliated companies of $9,317 and
$86,485 for the six months ended June 30, 1999 and 1998, respectively. The
decrease of $77,168 or 89.2 percent is owing to the repayment of the majority
of the outstanding loans by the investee companies during the fourth quarter
of 1998.
The Company had other income of $300 and $7,348 for the six months
ended June 30, 1999 and 1998, respectively. The other income in 1998
represents rental income. The Company did not have any rental income in
1999.
Operating expenses were $2,296,927 and $670,749 for the six months
ended June 30, 1999 and 1998, respectively. The increase of $1,626,178 or
242.4 percent is primarily owing to the increase in the accrual for the
Company's profit-sharing plan of $1,418,570 as a result of the realized gain
on the sale of NBX Corporation and the increase in the unrealized
appreciation on investments. Also, the first six months of 1998 included a
profit-sharing reversal of $423,808, which reduced the total expenses for
that period by such amount. 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).
The profit sharing accruals resulting from the realized gains during 1999,
net of operating expenses for the year, will be paid out as soon as practicable
following the 1999 year-end audit.
24
The Company had interest income from fixed-income securities of $75,999
and $75,375 for the three months ended June 30, 1999 and 1998, respectively.
The slight increase of $624 is a result of the Company having slightly more
funds available in the second quarter of 1999 as a result of the funds
received from the sale of NBX Corporation.
The Company had interest income from affiliated companies of $8,689 and
$27,453 for the three months ended June 30, 1999 and 1998, respectively. The
decrease of $18,764 or 68.3 percent is owing to a lower amount of loans
outstanding to investee companies.
Operating expenses were $962,742 and $299,299 for three months ended
June 30, 1999 and 1998, respectively. The increase of $663,443 or 221.6
percent is primarily owing to an increase in the accrual of the Company's
profit-sharing plan as a result of an increase in the unrealized
appreciation on investments offset by a decrease in salaries as a result of
reduced staff and a decrease in professional fees as a result of the
Company's effort to cut expenses. Also the three months ended June 30, 1998
included a profit sharing reversal of $225,045, which reduced the total
expenses for that period by such amount.
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 six months ended June 30, 1999 and 1998, the Company realized
gains of $11,125,818 and $587,177, respectively. During the six months
ended June 30, 1999, the Company realized a gain of approximately
$10,584,630 on the acquisition of NBX Corporation by 3Com Corporation; a
gain of approximately $160,918 on its sale of Princeton Video Image, Inc.
stock; and received a cash distribution from PHZ Capital Partners L.P. of
approximately $586,311. The Company also incurred losses of approximately
$206,041 on the sale of various publicly traded investments.
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, unrealized
appreciation on investments decreased.
During the three months ended June 30, 1999 and 1998, the Company
realized gains of $380,270 and $508,516, respectively. During the three
months ended June 30, 1999, the Company sold various publicly traded
securities realizing a net loss of $206,041 and received a cash distribution
from PHZ Capital Partners L.P. of $586,311.
During the three months ended June 30, 1998, the Company sold various
publicly traded 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,
unrealized appreciation on investments decreased.
25
Unrealized Appreciation and Depreciation of Portfolio Securities:
The Board of Directors values the portfolio securities on a quarterly
basis pursuant to the Company's Asset Valuation guidelines in accordance
with the 1940 Act. (See "Footnote to Consolidated Schedule of Investments"
contained in "Item 1. Consolidated Financial Statements.")
Net unrealized appreciation on investments before taxes decreased by
$2,274,868 or 21.8 percent during the six months ended June 30, 1999, from
$10,407,549 to $8,132,681, primarily as a result of the reclassification of
the NBX Corporation from unrealized to realized gain of approximately
$4,716,062, offset by the increase in value of SciQuest.com, Inc. of
approximately $2,350,962.
Net unrealized appreciation on investments before taxes decreased by
$3,321,528 or 40.7 percent during the six months ended June 30, 1998, from
$8,158,732 to $4,837,204, primarily as a result of decreased valuations in
Nanophase Technologies Corporation of approximately $3,930,996, Princeton
Video Image, Inc. of approximately $488,593 and MedLogic Global Corporation
of approximately $431,604. These decreases were offset primarily by increased
valuations in NeuroMetrix, Inc. of approximately $1,090,000 and Voice Control
Systems, Inc. of approximately $695,397.
Net unrealized appreciation on investments before taxes increased by
$3,169,623 or 63.8 percent during the three months ended June 30, 1999, from
$4,963,058 to $8,132,681, primarily as a result of the increase in the value
of SciQuest.com, Inc. of approximately $2,350,962 and Alliance
Pharmaceutical, Corp. of approximately $324,000.
Net unrealized appreciation on investments before taxes decreased by
$2,936,401 or 37.8 percent during the three months ended June 30, 1998, from
$7,773,605 to $4,837,204 owing primarily to decreases in Voice Control Systems,
Inc., of approximately $935,018, MedLogic Global Corporation of approximately
$380,008, Princeton Video Image, Inc. of approximately $390,234 and Energy
Research Corporation of approximately $380,000.
Liquidity and Capital Resources
The Company reported total cash, receivables and marketable securities
(the primary measure of liquidity) at June 30, 1999 of $11,063,578 versus
$5,547,984 at December 31, 1998.
The increase in cash, receivables and marketable securities from
December 31, 1998 to June 30, 1999 is primarily owing to the receipt of
total proceeds of $12,422,159 in cash and funds in escrow ($1,475,276,
against which the Company recorded a 10 percent reserve); offset by the 1)
payment of a dividend of $0.35 per share for a total of $3,647,017; 2) the
investment of $1,000,001 in Kriton Medical, Inc. and $1,202,000 in Alliance
Pharmaceutical Corp.; and 3) the purchase of treasury shares for a total of
$540,720.
26
From December 31, 1998 to June 30, 1999, the amounts receivable from
brokers increased by $428,030 or 112.4 percent, owing to a purchase of stock
in the open market that occurred in June which will settle in July 1999.
Funds in escrow increased by $1,327,748 or 100 percent, owing to the
escrowed funds net of reserve received by the Company on the sale of NBX
Corporation. The Company's liabilities of accrued profit-sharing and
deferred income tax liability increased significantly from December 31, 1998
to June 30, 1999. Accrued profit-sharing increased by $1,418,570 or 107.2
percent to $2,742,129 as a result of the gain on the sale of NBX Corporation
and the increase in the unrealized appreciation on investments. The accrued
profit-sharing attributable to 1999 net realized income will be paid
out as soon as practicable following the year-end audit. There was no
profit-sharing paid out during the six months ended June 30, 1999.
The deferred income tax liability increased by $803,542 or 86.3 percent
to $1,734,606. The increase in the deferred tax liability reflects the
utilization of all of the Company's net operating and capital loss
carryforward to offset the long-term capital gain realized when the Company
sold its interest in NBX Corporation.
As of June 30, 1999, the Company had a $6,000,000 line of credit in place
with J.P. Morgan, of which the Company had no outstanding balance. Management
believes that its cash, receivables and marketable securities provide the
Company with sufficient liquidity for its operations over the next 12 months.
On July 14, 1999, the Company announced an offer to purchase up to
1,100,000 shares of its common stock, par value $.01 per share for cash at a
price equal to $1.63 per share ("Purchase Price"). The Company will not
purchase any shares of Common Stock unless a minimum of 700,000 shares are
duly tendered. The offer will expire at 12:00 Midnight, Eastern Daylight
time, on August 11, 1999 unless extended. The Board of Directors does not
currently intend to extend the Offer.
The Company's Board of Directors believes that the Company's financial
condition and outlook and current market conditions, including recent trading
prices of the shares of its Common Stock, make this an attractive time to
repurchase a portion of its outstanding shares of Common Stock. The Company's
Board of Directors believes that the Offer constitutes a prudent use of the
Company's financial resources, given the Company's business profile, assets
and prospects.
The total cost to the Company of purchasing the full 1,100,000 shares of
Common Stock at the Purchase Price pursuant to the Offer would be
approximately $1,793,000. The Company anticipates that the Purchase Price
for any shares of Common Stock acquired pursuant to the Offer will be
derived first from cash on hand and then from the proceeds from the sale of
certain portfolio securities held by the Company. The selection of which
portfolio securities to sell will be made by the Company taking into account
investment merit, relative liquidity and applicable investment restrictions
and legal requirements. The Company believes that it has sufficient
liquidity to purchase the Common Stock tendered pursuant to the Offer
without utilizing borrowing.
27
On August 12, 1999, the Company received notification from its transfer
agent, the Bank of New York, that a total of 1,080,569 shares were tendered for
a total of $1,761,327.
Sub-Chapter M Status
On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification of the Company as a RIC under Sub-Chapter M
of the Code. In order to qualify as a RIC, the Company must, in general (1)
annually derive at least 90 percent of its gross income from dividends,
interest and gains from the sale of securities; (2) quarterly meet certain
investment diversification requirements; and (3) annually distribute at
least 90 percent of its investment company taxable income as a dividend.
In addition to the requirement that the Company must annually distribute at
least 90 percent of its investment company taxable income, the Company may
either distribute or retain its taxable net capital gains from investments,
but any net capital gains not distributed could be subject to corporate
level tax. (Any undistributed investment company taxable income would also
be taxed.) Further, the Company could be subject to a four percent excise
tax if it fails to distribute at least 98 percent of its annual ordinary
income and net capital gain income.
Because of the specialized nature of its investment portfolio, the
Company could satisfy the diversification requirements under Sub-Chapter M
of the Code only if it received a certification from the SEC that it is
"principally engaged in the furnishing of capital to other corporations
which are principally engaged in the development or exploitation of
inventions, technological improvements, new processes, or products not
previously generally available."
On April 8, 1998, the Company announced that it had received such a
certification from the SEC for 1997. Pursuant to the Company's receipt of
the 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. On
February 17, 1999, the Company received rulings from the IRS regarding
other issues relevant to the Company's tax status as a RIC. (See "Note 6
of Notes to Consolidated Financial Statements" contained in "Item 1.
Consolidated Financial Statements.") Although the SEC certification for
1997 was issued, there can be no assurance that the Company will
receive such certification for 1998 or subsequent years (to the extent it
needs additional certification as a result of changes in its portfolio) or
that it will qualify as a RIC in 1999 or that if it does qualify in 1999,
it will continue to qualify in subsequent years.
28
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. The Company was unable to satisfy
these requirements for the 1998 tax year owing to the nature of the Company's
ownership interest in one of its investee companies. In addition, because
it realized taxable losses in 1998, it was not strategically advantageous
for the Company to elect Sub-Chapter M tax status for 1998.
The Company changed the nature of its ownership interest in the non-
qualifying investee company (under the RIC regulations) effective January 1,
1999 in order to meet the Sub-Chapter M requirements. However, there can be
no assurance that the Company will qualify for Sub-Chapter M treatment for
1999 or subsequent years. In addition, under certain circumstances, even if
the Company were qualified for Sub-Chapter M treatment in 1999 and elected
Sub-Chapter M treatment for that year, the Company might take action in a
subsequent year to ensure that it would be taxed in that subsequent year as
a C Corporation, rather than a RIC.
The Company incurred ordinary and capital losses during its C Corporation
taxable years, of which $7.1 million will be eligible to be carried forward
to the Company's 1999 taxable years. Ordinarily, a corporation that elects
to qualify as a RIC may not use its ordinary loss carryforwards from C
Corporation taxable years to offset RIC investment company taxable income,
although a RIC may in certain cases use ordinary and capital loss
carryforwards to reduce net capital gains. In addition, a C Corporation
that elects to qualify as a RIC and that makes an appropriate election
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 intends to use its $7.1 million loss carryforward to offset
the long term capital gain realized when the Company sold its interest in
NBX Corporation. The Company anticipates realizing a tax benefit of
approximately $2.5 million as a result of such offset.
The IRS recently announced an intention to issue formal guidance in 1999
concerning conversions of C Corporation to RIC's. Such guidance may include
resolution of certain issues relevant to the conversion of the Company from a C
Corporation to a RIC.
If necessary for liquidity purposes or to fund investment opportunities,
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
Tax Consequences of Net Capital Gains
The following simplified examples illustrate the tax treatment under
Sub-Chapter M of the Code for the Company and its shareholders with regard
to three possible alternatives, assuming a net long-term capital gain of
$1.00 per share, consisting entirely of sales of non-real property assets
held for more than 12 months.
Under Alternative A: 100 percent of net capital gain declared as a
dividend and distributed to shareholders:
1. No taxation at the Company level.
2. Shareholders receive a $1.00 per share dividend and pay a
maximum tax of 20 percent* or $.20 per share, retaining $.80 per share.
Under Alternative B: 100 percent of net capital gain retained by the
Company and designated as "undistributed capital gain" dividend:
1. The Company pays a corporate level income tax of 35 percent on
the undistributed gain or $.35 per share and retains 65 percent of the gain
or $.65 per share.
2. Shareholders increase their cost basis in their stock by $.65
per share. They pay a 20 percent* capital gains tax on 100 percent of the
undistributed gain of $1.00 per share or $.20 per share in tax. Offsetting
this tax, shareholders receive a tax credit equal to 35 percent of the
undistributed gain or $.35 per share.
Under Alternative C: 100 percent of net capital gain retained by the
Company, with no designated undistributed capital gain dividend:
1. The Company pays a corporate level income tax of 35 percent on
the retained gain or $.35 per share plus an excise tax of four percent of
$.98 per share, or about $.04 per share.
2. There is no tax consequence at the shareholder level.
*Assumes all capital gains qualify for long-term rates of 20 percent.
Risk Factors
Investment in Small, Private Companies
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
30
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. Accordingly, the inability to liquidate assets
could have an adverse effect on the Company's ability to meet its operating
expenses in the ordinary course.
Valuation of Portfolio Investments
There is typically no public market of equity securities of the small
private companies in which the Company invests. As a result, the valuation
of the equity securities in the Company's portfolio is subject to the good
faith estimate of the Company's Board of Directors. (See "Asset Valuation
Policy Guidelines" in "Footnote to Consolidated Schedule of Investments.")
In the absence of a readily ascertainable market value, the estimated value
of the Company's portfolio of equity securities may differ significantly
from the values that would be placed on the portfolio if a ready market for
the equity securities existed. Any changes in estimated net asset value are
recorded in the Company's statement of operations as "Change in unrealized
appreciation on investments." (See "Management's Discussion and Analysis
of Financial Condition and Results of Operations.")
Illiquidity of Portfolio Investments
Most of the investments of the Company are or will be equity securities
acquired directly from small companies. The Company's portfolio of equity
securities are and will usually be subject to restrictions on resale or
otherwise have no established trading market. The illiquidity of most of
the Company's portfolio of equity securities may adversely affect the
ability of the company to dispose of such securities at times when it may be
advantageous for the Company to liquidate such investments.
Fluctuations of Quarterly Results
The Company's quarterly operating results could fluctuate as a result of
a number of factors. These include, among others, variations in and the
timing of the recognition of realized and unrealized gains or losses, the
degree to which the Company encounters competition in its markets and general
economic conditions. As a result of these factors, results for any one
quarter should not be relied upon as being indicative of performance in
future quarters. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Risk of Loss of Pass Through Tax Treatment
If the Company meets certain diversification and distribution
requirements under the Code, it may qualify as a RIC under the Code for
pass-through tax treatment. The Company would cease to qualify for pass-
through tax treatment if it were unable to comply with these requirements,
or if it ceased to qualify as a BDC under the 1940 Act. The Company also
could be subject to a four percent excise tax (and, in certain cases,
31
corporate level income tax) if it failed to make certain distributions.
(See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Sub-Chapter M Status.") The lack of Sub-Chapter M
tax treatment could have a material adverse effect on the total return, if
any, obtainable from an investment in the Company. If the Company fails to
qualify as a RIC, the Company would become subject to federal income tax as
if it were an ordinary C Corporation, which would result in a substantial
reduction in the Company's net assets and the amount of income available for
distribution to the Company's stockholders.
Risks Relating to the Year 2000 Issue
The "Year 2000" computer problem has arisen because many computer
applications worldwide will not properly recognize the date change from
December 31, 1999, to January 1, 2000. The computer applications may revert
to 1900 or some other date because of the way in which dates were encoded
and calculated, potentially causing production of erroneous data,
miscalculations, system failures and other operational problems.
The Company has undertaken the evaluation of the Year 2000 impact on its
critical computer hardware and software. The Company has not incurred, nor
does it anticipate that it will incur, any material cost in addressing its
Year 2000 problem. The Company is developing a strategic plan focusing on
achieving Year 2000 compliance. Certain systems are being replaced and or
modified to be Year 2000 compliant. At the present time, it is not possible
to determine whether any such events are likely to occur or to quantify any
potential negative impact they may have on the Company's future results of
operations and financial condition.
Ultimately, the potential impact of the Year 2000 issue will depend not
only on the success of the corrective measures undertaken by the Company,
but also on the way in which the Year 2000 issue is addressed by vendors,
service providers, counterparties, utilities, governmental agencies and
other entities with which the Company does business.
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 actualresults 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
32
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
The Company's business activities contain elements of risk. The Company
considers the principal type of market risk to be valuation risk.
Investments are stated at "fair value" as defined in the 1940 Act and in
the applicable regulations of the Securities and Exchange Commission. All
assets are valued at fair value as determined in good faith by, or under the
direction of, the Board of Directors. See the Asset Valuation Guidelines in
the Footnote to Consolidated Schedule of Investments.
The Company considers the management of risk essential to conducting its
businesses and to maintaining profitability. Accordingly, the Company's risk
management systems and procedures are designed to identify and analyze the
Company's risks, to set appropriate policies and limits and to continually
monitor these risks and limits by means of reliable administrative and
information systems and other policies and programs.
The Company manages its market risk by maintaining a portfolio of equity
interests that is diverse by industry, geographic area, property type, size
of individual investment and borrower. However, neither the Company's
investments nor an investment in the Company is intended to constitute a
balanced investment program. The Company does have exposure to public-
market price fluctuations to the extent of its publicly traded portfolio.
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 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.
Since there is typically no public market for the equity interests of
the small companies in which the Company invests, the valuation of the
equity interests in the Company's portfolio is subject to the estimate of
the Company's Board of Directors in accordance with the Company's Asset
Valuation Policy Guidelines. In the absence of a readily ascertainable
market value, the estimated value of the Company's portfolio of equity
interests may differ significantly from the values that would be placed on
the portfolio if a ready market for the equity interests existed. Any
changes in valuation are recorded in the Company's consolidated
statements of operations as "Net increase (decrease) in unrealized
appreciation on investments."
33
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
On Wednesday, April 28th, 1999, the Company held its Annual Meeting
of Shareholders for the following purposes: 1) to elect directors of
the Company; and 2) to ratify, confirm and approve the Board of
Directors' selection of Arthur Andersen LLP as the Company's
independent public accountant for its fiscal year ending December
31, 1999. At the close of business on the record date (March 8,
1999), an aggregate of 10,436,648 shares of common stock were issued
and outstanding.
All of the nominees at the April 28, 1999 Annual Meeting were elected
directors:
<TABLE>
<S> <C> <C>
Nominees For Withheld
Dr. C. Wayne Bardin 9,602,691 112,800
Dr. Phillip A. Bauman 9,602,691 112,800
G. Morgan Browne 9,602,391 113,100
Harry E. Ekblom 9,602,076 113,415
Dugald A. Fletcher 9,601,776 113,715
Charles E. Harris 9,601,391 114,100
Glenn E. Mayer 9,602,076 113,415
James E. Roberts 9,602,691 112,800
</TABLE>
Mr. William R. Polk did not stand for re-election.
With respect to proposal number two, described as a proposal "to
ratify, confirm and approve the Board of Directors' selection
of Arthur Andersen LLP" as the Company's independent public
accountant for its fiscal year ending December 31, 1999, the
affirmative votes cast were 9,618,491, the negative votes cast were
72,100 and those abstaining were 24,900.
Item 5. Other Information
Recent Sales of Unregistered Securities
None
34
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 Consolidated
Statements of Operations.
27.0* Financial Data Schedule.
(b) The Company did not file any reports on Form 8-K during the
six months ended June 30, 1999.
EXHIBIT INDEX
Item Number (of Item 601 of Regulation S-K)
27. Financial Data Schedule
35
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 13, 1999
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
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<NAME> HARRIS & HARRIS GROUP, INC.
<S> <C>
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