SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K
Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1999 Commission File No. 0-11576
HARRIS & HARRIS GROUP, INC.
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(Exact Name of Registrant Specified in Its Charter)
New York 13-3119827
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Rockefeller Plaza, Rockefeller Center, New York, New York 10020
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 332-3600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $ .01 par value
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ X ]
The aggregate market value of the Common Stock held by non-affiliates of
Registrant as of February 29, 2000 was $173,717,623 based on the last sale
price as quoted by NASDAQ National Market on such date (only officers and
directors are considered affiliates for this calculation).
As of February 29, 2000, the registrant had 9,240,831 shares of common
stock, par value $.01 per share, outstanding.
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 26, 2000 are incorporated by
reference into Part III of this report.
TABLE OF CONTENTS
Page
PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . 11
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . 11
Item 4. Submission of Matters to a Vote of Security Holders . . 11
PART II
Item 5. Market for Company's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . 12
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . 15
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk. . . . . . . . . . . . . . . . . . . . . . . . . 27
Item 8. Consolidated Financial Statements
and Supplementary Data. . . . . . . . . . . . . . . . 28
Item 9. Disagreements on Accounting and Financial Disclosure. . 53
PART III
Item 10. Directors and Executive Officers of the Company . . . . 53
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . 53
Item 12. Security Ownership of Certain Beneficial Owners
and Management. . . . . . . . . . . . . . . . . . . . 53
Item 13. Certain Relationships and Related Transactions. . . . . 53
PART IV
Item 14. Exhibits, Consolidated Financial Statements,
Schedules and Reports on Form 8-K . . . . . . . . . . 54
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . 58
PART I
Item 1. Business
Harris & Harris Group, Inc. (the "Registrant" or "Company") is a venture
capital investment company, operating as a Business Development Company
("BDC") under the Investment Company Act of 1940 (the "1940 Act"). The
Company's objective is to achieve long-term capital appreciation, rather
than current income, from its investments. The Company has invested a
substantial portion of its assets in private development stage or start-up
companies and in the development of new technologies in a broad range of
industry segments. These private businesses tend to be thinly capitalized,
unproven, small companies based on risky technologies that lack management
depth and have not attained profitability or have no history of operations.
The Company may also invest, to the extent permitted under the 1940 Act, in
publicly traded securities, including high risk securities as well as
investment grade securities. The Company may participate in expansion
financing and leveraged buyout financing of more mature operating companies
as well as other investments. As a venture capital company, the Company
invests in and provides managerial assistance to its private investees which,
in its opinion, have significant potential for growth. There is no assurance
that the Company's investment objective will be achieved.
The Company was incorporated under the laws of the State of New York in
August 1981. Prior to September 30, 1992, the Company had a class of
securities registered, and filed under the reporting requirements, of the
Securities Exchange Act of 1934 (the "1934 Act") as an operating company.
On that date the Company commenced operations as a closed-end, non-
diversified investment company under the 1940 Act. On July 26, 1995, the
Company elected to become a BDC subject to the provisions of Sections 55
through 65 of the 1940 Act. As a BDC, the Company operates as an internally
managed investment company whereby its officers and employees, under the
general supervision of its Board of Directors, conduct its operations.
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 , in 1998 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
1
"Item 8. Consolidated Financial Statements and Supplementary Data" and
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Recent Developments - 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
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.
Moreover, the Company received a tax opinion in 1998 that the Company
interprets to mean that its tax-loss carryforward at December 31, 1998 of
approximately $7.0 million (resulting in a tax credit of approximately
$2.5 million) would be applicable as a qualifying RIC to its unrealized gains
as of December 31, 1998. That opinion was confirmed in one of the rulings
received from the IRS in February 1999.
The Company changed the nature of its ownership interest in the non-
qualifying investee company effective January 1, 1999 in order to meet the
Sub-Chapter M requirements. In 1999, because of changes in its investment
portfolio, the Company requested recertification from the SEC relating to
the Company's status under section 851(e) of the Code. On February 24, 2000,
the Company received the certification, and the Company plans to elect Sub-
Chapter M tax treatment for 1999. However, there can be no assurance that
the Company will qualify for Sub-Chapter M treatment in subsequent years.
In addition, under certain circumstances, even if the Company qualified for
Sub-Chapter M treatment in a given year 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 as a RIC.
Venture Capital Investments
The Company has invested a substantial portion of its assets in private
development stage or start-up companies. The Company may initially own 100
percent of the securities of a start-up investee company for a period of
time and may control such company for a substantial period. In connection
with its venture capital investments, the Company may be involved in
recruiting management, formulating operating strategies, product development,
marketing and advertising, assisting in financial plans, as well as providing
management in the initial start-up stages and establishing corporate goals.
The Company may assist in raising additional capital for such companies from
other potential investors and may subordinate its own investment to that of
other investors. The Company may introduce such companies to potential
joint-venture partners, suppliers and customers. In addition, the Company
may assist in establishing relationships with investment bankers and other
professionals. The Company may also assist with mergers and acquisitions.
The Company may also find it necessary or appropriate to provide additional
capital of its own. The Company may derive income from such companies for
the performance of any of the above services. Because of the speculative
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nature of these investments and the lack of any market for such securities,
there is significantly greater risk of loss than is the case with traditional
investment securities. The Company expects that some of its venture capital
investments will be a complete loss or will be unprofitable and that some
will appear likely to become successful, but never realize their potential.
The Company has in the past sought, and will continue in the future to seek,
investments that offer the potential for significantly higher returns but
that involve a significantly greater degree of risk than other investments.
The Company may control an investee company for which it has provided
venture capital, or it may be represented on the company's board of directors
by one or more of its officers or directors, who may also serve as officers
of such company. Particularly during the early stages of an investment, the
Company may in effect be conducting the operations of the investee company.
As a venture company emerges from the developmental stage with greater
management depth and experience, the Company expects that its role in the
company's operations will diminish. The Company seeks to assist each
investee company in establishing its own independent capitalization,
management and board of directors. The Company expects to be able to reduce
its active involvement in the management of its investment in those start-up
companies that become successful by a liquidity event, such as a public
offering or sale of a company.
The Company has invested a substantial portion of its assets in
securities that do not pay interest or dividends and that are subject to
legal or contractual restrictions on resale that may adversely affect the
liquidity and marketability of such securities.
In addition to the information discussed above, please see "Item 8.
Consolidated Financial Statements and Supplementary Data."
Intellectual Property
The Company believes there is a role for organizations like itself that
can assist in technology transfer. Scientists and institutions that develop
and patent intellectual property increasingly seek the rewards of
entrepreneurial commercialization of their inventions, particularly as
governmental, philanthropic and industrial funding for research has become
harder to obtain. The Company believes that several factors combine to give
it a high value-added role to play in the commercialization of technology:
its experience in organizing and developing successful new companies; its
willingness to invest its own capital at the highest risk- seed stage; its
access to high-grade institutional sources of intellectual property; its
experience in mergers, acquisitions and divestitures; its access to and
knowledge of the capital markets; and its willingness to do as much of the
early work as it is qualified and has time to do.
The Company invests principally but not exclusively in securities
issued by companies involved in: 1) research and development of a technology
and/or obtaining licensing rights to intellectual property or patents; 2)
outright acquisition of intellectual property or patents; and 3) formation
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and funding of companies or joint ventures to commercialize intellectual
property. Income from the Company's investments in intellectual property
or its development may take the form of participation in licensing or
royalty income or some other form of remuneration. At some point during
the commercialization of a technology, the Company's investment may be
transformed into ownership of securities of a development stage or start-up
company as discussed above. Investing in intellectual property is highly
risky.
Illiquidity of Investments
Many of the Company's investments consist of securities acquired
directly from the issuer in private transactions. These investments may be
subject to restrictions on resale or otherwise be illiquid. The Company
does not anticipate that there will be any established trading market for
such securities. Additionally, many of the securities that the Company may
invest in will not be eligible for sale to the public without registration
under the Securities Act of 1933, as amended, which could prevent or delay
any sale by the Company of such investments or reduce the amount of proceeds
that might otherwise be realized therefrom. Restricted securities generally
sell at a price lower than similar securities not subject to restrictions on
resale. Further, even if a portfolio company registers its securities and
becomes a reporting company under the 1934 Act, the Company may be
considered an insider by virtue of its board representation or otherwise
and would be restricted in sales of such company's securities.
Managerial Assistance
The Company generally is required by the 1940 Act to make significant
managerial assistance available with respect to investee companies that the
Company treats as qualifying assets for purposes of the 70 percent test (see
"Regulation"). "Making available significant managerial assistance" as
defined in the 1940 Act with respect to a BDC such as the Company means (a)
any arrangement whereby a BDC, through its directors, officers, employees or
general partners, offers to provide, and if accepted, does so provide,
significant guidance and counsel concerning the management, operations, or
business objectives and policies of a portfolio company; or (b) the exercise
by a BDC of a controlling influence over the management or policies of a
portfolio company by a BDC acting individually or as a part of a group
acting together which controls such portfolio company. The Company believes
that providing managerial assistance to its investees is critical to its
business development activities. The nature, timing and amount of managerial
assistance provided by the Company vary depending upon the particular
requirements of each investee company.
The Company may be involved with its investees in recruiting management,
product planning, marketing and advertising and the development of financial
plans, operating strategies and corporate goals. In this connection, the
Company may assist clients in developing and utilizing accounting procedures
to efficiently and accurately record transactions in books of account, which
will facilitate asset and cost control and the ready determination of results
4
of operations. The Company also seeks capital for its investees from other
potential investors and occasionally subordinates its own investment to
those of other investors. The Company may introduce its investees to
potential suppliers, customers and joint venture partners and assists its
investees in establishing relationships with commercial and investment
bankers and other professionals, including management consultants,
recruiters, legal counsel and independent accountants. The Company also
assists with joint ventures, acquisitions and mergers.
In connection with its managerial assistance, the Company may be
represented by one or more of its officers or directors on the board of
directors of an investee. As an investment matures and the investee
develops management depth and experience, the Company's role ordinarily will
become progressively less active. However, when the Company owns or acquires
a substantial proportion of a more mature investee company's equity, the
Company may remain active in and may initiate planning of major transactions
by the investee. The Company typically seeks to assist each investee company
in establishing its own independent and effective board of directors and
management.
Need for Follow-On Investments
Following its initial investment in investees, the Company has made and
anticipates that it will continue to make additional investments in such
investees as "follow-on" investments, in order to increase its investment
in an investee, and may exercise warrants, options or convertible securities
that were acquired in the original financing. Such follow-on investments may
be made for a variety of reasons including:
1) to increase the Company's exposure to an investee,
2) to acquire securities issued as a result of exercising convertible
securities that were purchased in the original financing,
3) to preserve the Company's proportionate ownership in a subsequent
financing, or
4) to attempt to preserve or enhance the value of the Company's
investment.
There can be no assurance that the Company will make follow-on investments
or have sufficient funds to make such investments; the Company has the
discretion to make any follow-on investments as it determines, subject to
the availability of capital resources. The failure to make such follow-on
investments may, in certain circumstances, jeopardize the continued viability
of an investee and the Company's initial investment, or may result in a
missed opportunity for the Company to increase its participation in a
successful operation. Even if the Company has sufficient capital to make a
desired follow-on investment, the Company may, under certain circumstances
be inhibited from doing so if such an investment would result in non-
compliance with BDC or RIC regulations.
5
Competition
Numerous companies and individuals are engaged in the venture capital
business and such business is intensely competitive. Many of the competitors
have significantly greater resources and managerial capabilities than the
Company and are therefore in a better position than the Company to obtain
access to attractive venture capital investments.
Regulation
The Small Business Investment Incentive Act of 1980 added the provisions
of the 1940 Act applicable to BDC's, which are a special type of closed-end
investment company. After filing its election to be treated as a BDC, a
company may not withdraw its election without first obtaining the approval
of holders of a majority of its outstanding voting securities. The following
is a brief description of the 1940 Act provisions applicable to BDC's, and
is qualified in its entirety by reference to the full text of the 1940 Act
and the rules issued thereunder by the SEC.
Generally, to be eligible to elect BDC status, a company must primarily
engage in the business of furnishing capital and managerial expertise to
companies which do not have ready access to capital through conventional
financial channels. Such portfolio companies are termed "eligible portfolio
companies." In general, in order to qualify as a BDC, a company must (i) be
a domestic company; (ii) have registered a class of its securities pursuant
to Section 12 of the 1934 Act; (iii) operate for the purpose of investing in
the securities of certain types of portfolio companies, namely, immature or
emerging companies and businesses suffering or just recovering from financial
distress (see following paragraph); (iv) make available significant
managerial assistance to such portfolio companies; (v) have a majority of
"disinterested" directors (as defined in the 1940 Act); and (vi) file a
proper notice of election with the SEC.
An eligible portfolio company generally is a domestic company that is
not an investment company and that (i) does not have a class of equity
securities on which "margin" credit can be extended or (ii) is controlled
by a BDC (control under the 1940 Act is presumed to exist where a BDC owns
at least 25 percent of the outstanding voting securities of the investee).
The 1940 Act prohibits or restricts companies subject to the 1940 Act
from investing in certain types of companies, such as brokerage firms,
insurance companies, investment banking firms and investment companies.
Moreover, the 1940 Act requires that at least 70 percent of the value of
the Company's assets consist of qualifying assets. Qualifying assets
include: (i) securities of companies that were eligible portfolio companies
at the time the Company acquired their securities; (ii) securities of
bankrupt or insolvent companies that were eligible at the time of the
Company's initial investment in those companies; (iii) securities received
in exchange for or distributed in or with respect to any of the foregoing;
and (iv) cash items, government securities and high quality short-term
debt. The 1940 Act also places restrictions on the nature of the
transactions in which, and the persons from whom, securities can be
purchased in order for the securities to be considered qualifying assets.
6
The Company is permitted by the 1940 Act, under specified conditions, to
issue multiple classes of senior debt and a single class of preferred stock
if its asset coverage, as defined in the 1940 Act, is at least 200 percent
after the issuance of the debt or the preferred stock (i.e., such senior
securities may not be in excess of its net assets).
The Company may sell its securities at a price that is below the
prevailing net asset value per share only after a majority of its
disinterested directors has determined that such sale would be in the best
interest of the Company and its stockholders and upon the approval by the
holders of a majority of its outstanding voting securities, including a
majority of the voting securities held by non-affiliated persons. If the
offering of the securities is underwritten, a majority of the disinterested
directors must determine in good faith that the price of the securities
being sold is not less than a price which closely approximates market value
of the securities, less any distribution discount or commission. As defined
by the 1940 Act, the term "majority of the Company's outstanding voting
securities" means the vote of (i) 67 percent or more of the Company's Common
Stock present at the meeting, if the holders of more than 50 percent of the
outstanding Common Stock are present or represented by proxy or (ii) more
than 50 percent of the Company's outstanding Common Stock, whichever is less.
Certain transactions involving certain closely related persons of the
Company, including its directors, officers and employees, may require the
prior approval of the SEC. However, the 1940 Act ordinarily does not restrict
transactions between the Company and investee companies.
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. The Company was unable to satisfy the requirements for Sub-
Chapter M for the 1998 tax year. (See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Recent
Developments -- Sub-Chapter M Status.") The Company plans to elect Sub-
Chapter M tax treatment for 1999. There can be no assurance that the
Company will qualify for Sub-Chapter M tax treatment in subsequent years.
In addition, under certain circumstances, even if the Company qualified for
Sub-Chapter M tax treatment in a given year and elected Sub-Chapter M
tax 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 as a RIC.
Employees
The Company currently employs directly four full-time employees and
one part-time employee and, in addition, employs two full-time employees
in a wholly owned subsidiary.
7
Risk Factors
Investing in the Company's Stock is Highly Speculative and You Could Lose
Some or All of the Amount You Invest
The value of the Company's common stock may decline and may be affected
by numerous market conditions, which could result in the loss of some or all
of your investment in the Company's shares. The securities markets
frequently experience extreme price and volume fluctuation which affect
market prices for securities of companies generally, and technology
companies in particular. Because of the Company's focus on the technology
sector, its stock price is likely to be impacted by these market conditions.
General economic conditions, and general conditions in the Internet and
information technology and life sciences and other high technology
industries, will also affect the Company's stock price.
Investing in the Company's Shares May be Inappropriate for Your Risk Tolerance
Investing in the Company's shares may be inappropriate for your risk
tolerance. The Company's investments in accordance with its investment
objective and principal strategies may result in an above average amount of
risk and volatility or loss of principal. The Company's investments in
portfolio companies are highly speculative and aggressive and, therefore,
an investment in its shares may not be suitable for you.
The Market for Venture Capital Investments is Highly Competitive. In Some
Cases, the Company's Status as a Regulated Business Development Company May
Hinder its Ability to Participate in Investment Opportunities.
The Company faces substantial competition in its investing activities
from private venture capital funds, investment affiliates of large
industrial, technology, service and financial companies, small business
investment companies, wealthy individuals and foreign investors. As a
regulated business development company, the Company is required to disclose
quarterly the name and business description of portfolio companies and value
of any portfolio securities. Most of the Company's competitors are not
subject to this disclosure requirement. The Company's obligation to
disclose this information could hinder its ability to invest in certain
portfolio companies. Additionally, other regulations, current and future,
may make the Company less attractive as a potential investor to a given
portfolio company than a private venture capital fund not subject to the same
regulations.
Regulatory Risks
Securities and tax laws and regulations governing the Company's
activities may change in ways negative to the Company's and its shareholders'
interests and interpretations of such laws and regulations may change with
unpredictable consequences.
8
The Company is Dependent Upon Key Management Personnel for Future Success
The Company is dependent for the selection, structuring, closing and
monitoring of its investments on the diligence and skill of its senior
management and other management members. The future success of the Company
depends to a significant extent on the continued service and coordination of
its senior management team, particularly the Chairman and Chief Executive
Officer. The departure of any of the executive officers or key employees
could materially adversely affect the Company's ability to implement its
business strategy. The Company does not maintain key man life insurance
on any of its officers or employees.
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 with risky
technologies that lack management depth and have not attained profitability
or have no history of operations. Because of the speculative nature and the
lack of a public market for these investments, there is significantly greater
risk of loss than is the case with traditional investment securities. The
Company expects that some of its venture capital investments will be a
complete loss or will be unprofitable and that some will appear to be likely
to become successful but never realize their potential. The Company has been
risk seeking rather than risk averse in its approach to venture capital and
other investments. Neither the Company's investments nor an investment in
the Company is intended to constitute a balanced investment program. The
Company has in the past relied, and continues to rely to a large extent,
upon proceeds from sales of investments rather than investment income to
defray a significant portion of its operating expenses.
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.
The Inability of the Company's Portfolio Companies to Successfully Market
Their Products Would Have a Negative Impact on its Investment Returns
Even if the Company's portfolio companies are able to develop
commercially viable products, the market for new products and services is
highly competitive and rapidly changing. Commercial success is difficult to
predict and the marketing efforts of the Company's portfolio companies may
not be successful.
9
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.")
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,
corporate level income tax) if it failed to make certain distributions.
(See "Management's Discussion and Analysis of Financial Condition -- Recent
Developments -- 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.
Because the Company Must Distribute Income, the Company Will Continue to Need
Additional Capital
The Company will continue to need capital to fund investments and to
pay for operating expenses. The Company must distribute at least 90 percent
of its net operating income other than net realized long-term capital gains
to its stockholders to maintain its RIC status. As a result such earnings
will not be available to fund investments. If the Company fails to generate
10
net realized long-term capital gains or to obtain funds from outside sources,
it could have a material adverse effect on the Company's financial condition
and results. The Company does not normally establish reserves for taxes on
unrealized capital gains. To the extent that the Company retains capital
gains, either as a C corporation or as a Sub-Chapter M corporation, it will
have to make provisions for federal taxes and possibly state and local taxes.
In addition, as a BDC, the Company is generally required to maintain a ratio
of at least 200 percent of total assets to total borrowings, which may
restrict its ability to borrow in certain circumstances.
Reserves for Taxes
As a Sub-Chapter M corporation, the Company does not have to pay
federal income taxes on realized capital gains to the extent that such
gains are distributed to shareholders. Accordingly, it does not
establish reserves for taxes on its unrealized capital gains. If the
Company were not to qualify or were to elect not to qualify for Sub-
Chapter M tax status, it would have to establish such reserves for taxes,
which would reduce its net asset value, net of a reduction in the reserve
for employee profit sharing, accordingly. To the extent that the Company
as a Sub-Chapter M corporation were to make a deemed distribution of net
realized capital gains and were to retain such net realized capital gains,
it would have to establish appropriate reserves for taxes upon making such
a decision.
Year 2000 Problem
The "Year 2000 problem" refers to the inability of many computers,
computer-based systems and related software, and other electronics to
process dates accurately during the Year 2000 and beyond. As of March 20,
2000, the Company has not experienced any business disruption as a result
of the Year 2000 problem. Although Year 2000 problems may not become
evident until long after January 1, 2000, the Company does not expect
significant Year 2000 related business disruptions in the future.
Item 2. Properties
The Company maintains its offices at One Rockefeller Plaza, New York,
New York 10020, where it leases approximately 4,700 square feet of office
space pursuant to a lease agreement expiring in 2003. A portion of this
space was sublet in 1997 and 1998 to an early-stage company in which the
Company then had an equity interest. In 1999, the same space was sublet
to an unaffiliated party. See "Note 7 of Notes to Consolidated Financial
Statements and Schedules" contained in "Item 8. Consolidated Financial
Statements and Supplementary Data."
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of its shareholders
during the fourth quarter of the 1999 fiscal year.
11
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters
Stock Transfer Agent
The Bank of New York, 101 Barclay Street, Suite 12W, New York, New York
10286 (Telephone 800-524-4458, Attention: Ms. Diane Ajjan) serves as transfer
agent for the Company's common stock. Certificates to be transferred should be
mailed directly to the transfer agent, preferably by registered mail.
Market Prices
The Company's common stock is traded on the Nasdaq National Market
under the symbol "HHGP." The following table sets forth the range of the
high and low selling price of the Company's shares during each quarter of
the last two years, as reported by the National Association of Securities
Dealers, Inc. The quarterly stock prices quoted represent interdealer
quotations and do not include markups, markdowns or commissions.
<TABLE>
<S> <C> <C>
1999 Quarter Ending Low High
March 31 $1.3125 $2.1250
June 30 $1.625 $2.00
September 30 $1.71875 $3.125
December 31 $2.9375 $14.250
1998 Quarter Ending Low High
March 31 $2.1875 $3.4375
June 30 $2.2500 $3.6875
September 30 $1.125 $2.3750
December 31 $1.25 $1.5938
</TABLE>
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. To initially qualify as a RIC, the Company had, among other
things, to pay a dividend to shareholders equal to the Company's cumulative
realized earnings and profits ("E&P") from its pre-RIC taxable years. The
Company paid a $0.75 dividend per share (approximately $8.0 million) on May
12, 1998 to shareholders of record on April 27, 1998.
On February 23, 1999, the Company announced that subsequent to the
acquisition of NBX Corporation by 3Com Corporation, the Board of Directors
of the Company declared a cash dividend of $0.35 per share (approximately
$3.7 million) to shareholders of record on March 19, 1999, payable on March
25, 1999. (See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Recent Developments -- Sub-Chapter M
Status" and "Note 6 of Notes to Consolidated Financial Statements" contained
in "Item 8. Consolidated Financial Statements and Supplementary Data.")
Prior to 1998, the Company had not paid dividends since 1991.
12
Recent Sales of Unregistered Securities
The Company did not sell unregistered shares in the years ended December
31, 1999 and 1998 other than the restricted common stock shares sold to
Directors as part of their compensation program. In 1997, the Board of
Directors voted that, effective January 1, 1998, 50 percent of all directors'
fees be used to purchase Company common stock directly from the Company.
During 1998, the Directors purchased a total of 24,491 shares. (See "Note
4 of Notes to Consolidated Financial Statements" contained in "Item 8.
Consolidated Financial Statements and Supplementary Data.") On March 1,
1999, the Directors voted to purchase their shares in the open market rather
than directly from the Company. In 1999, the Directors purchased a total of
29,305 shares, 5,816 shares directly from the Company, prior to March 1,
1999, and 23,489 shares in the open market.
Shareholders
As of February 29, 2000, there were approximately 150 holders of record
of the Company's common stock which, the Company has been informed, hold the
Company's common stock for approximately 8,500 beneficial owners.
13
Item 6. Selected Financial Data
The following tables should be read in conjunction with the Consolidated
Financial Statements and Supplementary Data included in Item 8 of this
Form 10-K.
<TABLE>
<CAPTION>
BALANCE SHEET DATA
Financial Position as of December 31:
<S> <C> <C> <C> <C> <C>
1999 1998 1997 1996 1995
Total assets $65,320,768 $25,358,859 $39,273,784 $38,555,290 $37,524,555
Total
liabilities $11,685,963 $ 2,802,150 $ 5,618,850 $ 2,622,687 $ 962,646
Net asset
value $53,634,805 $22,556,709 $33,654,934 $35,932,603 $36,561,909
Net asset
value per
share $ 5.80 $ 2.13 $ 3.15 $ 3.44 $ 3.54
Dividends paid $ 0.35 $ 0.75 $ 0.0 $ 0.0 $ 0.0
Shares
outstanding 9,240,831 10,591,232 10,692,971 10,442,682 10,333,902
Operating Data for year ended December 31:
1999 1998 1997 1996 1995
Investment
income $ 287,684 $ 585,486 $ 561,546 $ 1,013,417 $ 1,109,517
Net operating
loss (9,636,336) (2,815,112) (1,550,641) (1,291,065) (1,099,409)
Net realized
gain (loss)
on investments 8,615,670 (1,718,528) (2,027,177) (2,465,175) 1,371,349
Net realized
(loss) income (1,020,666) (4,533,640) (3,577,818) (3,756,240) 271,940
Net increase in
unrealized
appreciation
on investments 38,102,047 1,655,830 969,243 2,967,248 158,219
Net increase
(decrease) in
net assets
resulting
from operations 37,081,381 (2,877,810) (2,608,575) (788,992) 430,159
Increase (decrease)
in net
assets
resulting from
operations per
outstanding
share $ 4.01 $ (0.27) $ (0.24) $ (0.08) $ 0.04
</TABLE>
Certain reclassifications have been made to the December 31, 1997 and
December 31, 1998 financial statements to conform to the December 31, 1999
presentation.
14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The information contained in this section should be read in conjunction
with Company's 1999 Consolidated Financial Statements and notes thereto.
Forward-Looking Statements
The information contained herein contains certain forward-looking
statements. These statements include the plans and objectives of management
for future operations and financial objectives, portfolio growth and
availability of funds. These forward-looking statements are subject to the
inherent uncertainties in predicting future results and conditions. Certain
factors that could cause actual results and conditions to differ materially
from those projected in these forward-looking statements are set forth herein.
Other factors that could cause actual results to differ materially include
the uncertainties of economic, competitive and market conditions, and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company.
Although the Company believes that the assumptions underlying the forward-
looking statements included herein are reasonable, any of the assumptions
could be inaccurate and therefore there can be no assurance that the forward-
looking statements included or incorporated by reference herein will prove to
be accurate. Therefore, the inclusion of such information should not be
regarded as a representation by the Company or any other person that the
objectives and plans of the Company will be achieved.
Statement of Operations
The Company accounts for its operations under Generally Accepted
Accounting Principles for investment companies. On this basis, the
principal measure of its financial performance is captioned "Net increase
(decrease) in net assets resulting 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, fees and
other income and its operating expenses, net of applicable income tax
benefit (provision). The second element is "Net realized gain (loss) on
investments," which is the difference between the proceeds received from
dispositions of portfolio securities and their stated cost, net of applicable
income tax benefit (provision). These two elements are combined in the
Company's financial statements and reported as "Net realized loss." The
third element, "Net increase in unrealized appreciation on investments,"
is the net change in the fair value of the Company's investment portfolio,
net of increase (decrease) in deferred income taxes that would become
payable if the unrealized appreciation were realized through the sale or
other disposition of the investment portfolio.
"Net realized gain (loss) on investments" and "Net increase (decrease)
in unrealized appreciation on investments" are directly related. When a
security is sold to realize a gain (loss), net unrealized appreciation
decreases (increases) and net realized gain increases (decreases).
15
Financial Condition
The Company's total assets were $65,320,768 and its net assets were
$53,634,805 at December 31, 1999, versus $25,358,859 and $22,556,709 at
December 31, 1998.
Net asset value per share ("NAV") was $5.80 at December 31, 1999, versus
$2.13 at December 31, 1998. NAV was reduced by $0.35 in 1999 and by $0.75
in 1998 by the cash dividends paid by the Company.
Among the significant changes that affected total assets, net assets and
NAV during 1999 were: (1) the acquisition of NBX Corporation by 3Com
Corporation, which increased the value of the Company's holdings by
approximately $5,868,568; (2) an increase in the value of the Company's
holding in SciQuest.com, Inc. of $31,981,750 as a result of a successful IPO
and subsequent increase in market value; (3) an increase in the market value
of the Company's holding in Alliance Pharmaceutical Corp. of $3,839,000;
(4) the acquisition of InSite Marketing Technology, Inc. by Silknet Software,
Inc. and subsequent increase in the market value of the Company's holding in
Silknet totaling $4,899,062; (5) an increase in the market value of the
Company's holding in Nanophase Technologies Corporation of $1,935,016;
(6) the payment of a cash dividend of $0.35 per share, which reduced assets
by approximately $3,647,017; (7) the addition to a deferred income tax
liability, which reduced assets by $586,710; (8) the purchase of 275,648
treasury shares in the open market for $540,720 and the successful tender
offer for 1,080,569 shares for a total of $1,832,831, which repurchases
reduced assets by a total of $2,373,551 while increasing NAV at December 31,
1999 by $0.59; and (9) the operating loss that reduced assets by $9,636,336.
(See "Consolidated Statements of Operations" contained in "Item 8.
Consolidated Financial Statements and Supplementary Data.")
The Company's shares outstanding as of December 31, 1999 were 9,240,831,
versus 10,591,232 at December 31, 1998. The Company's outstanding shares were
reduced as a result of its purchases in the open market of 243,523 shares in
the first quarter and 32,125 shares in the second quarter as well as the
tender offer for 1,080,569 shares completed in the third quarter. However,
during 1999, the treasury shares were decreased by purchases of a total of
5,816 shares of treasury shares by directors. (See "Note 4 of Notes to
Consolidated Financial Statements" contained in "Item 8. Consolidated
Financial Statements and Supplementary Data.")
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, are dependent on new, commercially unproven technologies
and have no history of operations. At December 31, 1999, $41,556,607 or
63.6 percent of the Company's total assets consisted of investments at fair
value in publicly traded securities (that were private businesses at the
time the Company made the investments), of which net unrealized appreciation
was $38,864,873; $18,892,731 or 29.0 percent of the Company's total assets
consisted of non-publicly traded securities at fair value in private
businesses and publicly traded companies, of which net unrealized
appreciation was $8,553,549. See "Recent Development -- Portfolio
16
Companies." At December 31, 1998, $1,570,642 or 6.2 percent of the
Company's total assets consisted of investments at fair value in publicly
traded securities, of which net unrealized appreciation was $156,440;
$19,562,386 or 77.1 percent of the Company's total assets consisted of
investments at fair value in private businesses, of which net unrealized
appreciation was $10,250,204. The increase in the value of publicly
traded securities from $1,570,642 in 1998 to $41,556,607 in 1999 is
primarily owing to the Company's investments in then-privately held InSite
Marketing Technology, Inc., and SciQuest.com, Inc., which subsequently
became publicly traded securities, through an acquisition by a publicly
traded company and an IPO, respectively.
A summary of the Company's investment portfolio is as follows:
<TABLE>
<S> <C> <C>
December 31, 1999 December 31, 1998
Investments, at cost $16,653,130 $14,124,643
Unrealized appreciation 46,882,521 10,407,548
----------- -----------
Investments, at fair value $63,535,651 $24,532,191
=========== ===========
</TABLE>
__________________
The accumulated unrealized appreciation on investments net of deferred taxes
is $45,098,711 at December 31, 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) exercise warrants or options that were acquired in
a prior financing; (3) 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, because it prefers other opportunities, or
because it is inhibited by compliance with BDC or RIC requirements, even
though the follow-on investment opportunity appears attractive.
The following table is a summary of the cash investments and loans made
by the Company in its private placement portfolio during the year ended
December 31, 1999:
<TABLE>
<S> <C>
New Investments: Amount
Adaptive Web Technologies, Inc. $1,000,000
Alliance Pharmaceutical Corp. 1,202,000
Kriton Medical, Inc. 1,000,001
Sundial Marketplace Corporation 500,000
----------
Sub-Total $3,702,001
17
Loans:
Sundial Marketplace Corporation $ 250,000
Exercise of Warrants Held:
Questech Corporation $ 50,000
SciQuest.com, Inc. $ 75,000
----------
$ 125,000
----------
Total $4,077,001
==========
</TABLE>
Results of Operations
Investment Income and Expenses:
The Company had a net operating loss of $9,636,336 in 1999, $2,815,112
in 1998 and $1,550,641 in 1997. These net operating losses reflect accruals
for employee profit-sharing in those years of $8,110,908, $899,751 and
$423,808, respectively. If the unrealized appreciation as of December 31,
1999 subsequently decreases or if the gains are not realized, the profit-
sharing accrual will be decreased accordingly, resulting in a credit to
expenses, thereby reducing expenses for such subsequent year by that amount.
The Company's investment objective is to achieve long-term capital
appreciation rather than current income from its investments. Therefore, a
significant portion of the investment portfolio is structured to attempt to
enhance 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 also received or accrued net after-tax
distributions from its investment in PHZ Capital Partners, L.P. in 1999 of
$490,950, in 1998 of $50,000 and in 1997 of $52,500. The Company does not
regard distributions from PHZ as predictable.
The Company had total investment income of $287,684 in 1999, $585,486
in 1998 and $561,546 in 1997. The Company had interest income from fixed-
income securities of $234,347 in 1999, $355,591 in 1998 and $490,807 in 1997.
The decrease from 1998 to 1999 of $121,244 or 34.1 percent and the decrease
from 1997 to 1998 of $135,216 or 27.5 percent were the result primarily of
declines in the balances of the Company's fixed-income portfolio during 1999
and 1998 as a result of the payment of the dividends, additional investments
and operating expenses. The Company received consulting and administrative
fees which totaled $29,870 in 1997. The Company did not receive any
consulting or administrative fees in 1998 or 1999.
The Company had interest income from affiliated companies of $48,526
in 1999, $124,877 in 1998 and $40,000 in 1997. The decrease from 1998 to
1999 of $76,351 or 61.1 percent is owing to a decrease in loans outstanding.
The increase from 1997 to 1998 of $84,877 or 212.2 percent is owing to the
receipt of interest income (either in funds or in additional shares) on
loans to investee companies.
18
The Company had other income of $3,911 in 1999, $102,468 in 1998 and
$869 in 1997, some of which reflected income from an affiliated company,
BioSupplyNet, to reimburse the Company for consulting fees previously paid
and expensed by the Company on behalf of BioSupplyNet. Other income also
includes rental income.
Operating expenses were $9,924,020 in 1999, $3,634,786 in 1998 and
$3,045,290 in 1997. The increase from 1998 to 1999 of $6,289,234 or 173.0
percent is primarily owing to an increase in the accrual for the Company's
profit-sharing plan of $8,110,908 or an 801.5 percent increase over the
prior year as a result of the net increase in unrealized appreciation of
the Company's investments of approximately $40,709,767. (See "Note 3 of
Notes to Consolidated Financial Statements" contained in "Item 8.
Consolidated Financial Statements and Supplementary Data.") Approximately
$8,295,916 of the accrued profit-sharing plan balance will not be paid out
until such time as the gains are actually realized. If the unrealized
appreciation as of December 31, 1999 decreases or if the gains are not
realized, the profit-sharing accrual will be decreased accordingly,
resulting in a credit to expenses, thereby reducing expenses for such year
by that amount. A total of $1,024,696 or 90 percent of the profit-sharing
on the 1999 net realized gains was paid in March 2000, and $113,855, or the
remaining 10 percent, will be paid when the Company files its tax return for
the year 1999. (See "Note 3 of Notes to Consolidated Financial Statements"
contained in "Item 8. Consolidated Financial Statements and Supplementary
Data.")
Other than the increase in the profit-sharing accrual and a decrease in
professional fees, which decreased by $79,591 or 19.3 percent as a result of
lower legal fees, expenses remained stable. Salaries and benefits increased
from 1998 to 1999 by $3,579 or less than one percent; administration and
operations decreased from 1998 to 1999 by $11,712 or 3.5 percent;
depreciation decreased from 1998 to 1999 by $12,481 or 26.0 percent as a
result of assets that were fully depreciated as of the end of 1998; rent
increased from 1998 to 1999 by $3,472 or 2.2 percent; directors' fees and
expenses decreased from 1998 to 1999 by $8,925 or 6.9 percent because the
Company had one fewer director in 1999 than in 1998.
During 1999, the Company had no interest expense and no outstanding debt.
The increase in operating expenses from 1997 to 1998 of $589,496 or 19.4
percent is primarily owing to: an increase in the accrual for the Company's
profit-sharing plan of $899,751 or 112.3 percent over the prior year (See
"Note 3 of Notes to Consolidated Financial Statements" contained in "Item 8.
Consolidated Financial Statements and Supplementary Data"); the final payment
on the Harris & Harris Group Senior Professorship pledge to the Massachusetts
Institute of Technology of $728,862; mitigated by a decrease in salaries and
benefits of $676,136, or 44.9 percent.
The Company has in the past relied, and continues to rely to a large
extent, on proceeds from sales of investments, rather than on investment
income, to defray a significant portion of its operating expenses. Because
such sales are unpredictable, the Company attempts to maintain adequate
working capital to provide for fiscal periods when there are no such sales.
19
Realized Gains and Losses on Sales of Portfolio Securities:
During the three years ended December 31, 1999, 1998 and 1997, the
Company sold various investments and received distributions, realizing net
gains (losses) of $10,976,714, ($1,718,528) and ($3,147,002), respectively.
During 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 $612,170. The Company also incurred losses of approximately
$381,004 on the sale of various publicly traded investments.
During 1998, the Company realized losses on the sales of its: privately
held investment in MultiTarget, Inc. of $209,999; publicly held investments
that were once privately held, including (1) CORDEX Petroleums, Inc. in the
amount of $357,736; (2) Princeton Video Image, Inc., $288,369; and (3) Voice
Control Systems, Inc. (which purchased the Company's investee company,
PureSpeech, Inc.), $724,826. The Company also had a realized net loss of
$187,598 in various publicly traded securities. During 1998, the Company
received a cash distribution of $50,000 from PHZ Capital Partners, L.P.
Net losses of $1,171,496 had been recognized in prior years and realized in
1998. Realizing losses and gains from prior years increases (for losses)
or decreases (for gains) the Unrealized Appreciation on Investments.
During 1997, the Company realized losses on the sales of its investments
in: nFX Corporation of $2,631,720; Harber Brothers Productions, Inc.,
$1,205,000; Gel Sciences, Inc., $633,028; Dynecology, Inc., $99,900; and
Micracor Corporation, $66,444. These losses were offset by gains on the
sales of: Highline Capital Management LLC, $750,000; various publicly traded
securities, $686,590; and accrued a distribution of $52,500 from PHZ Capital
Partners, L.P.
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 8. Consolidated Financial Statements and Supplementary
Data.")
Net unrealized appreciation on investments increased by $36,474,973 or
350.5 percent during the year ended December 31, 1999, from $10,407,548 to
$46,882,521. The most significant increases in valuation during 1999 were
in: SciQuest.com, Inc., $31,981,750; Silknet Software, Inc. (which acquired
InSite Marketing Technology, Inc.), $4,899,062; Alliance Pharmaceutical
Corp., $3,839,000; and Nanophase Technologies Corporation, $1,935,016.
(See "Consolidated Schedule of Investments" contained in "Item 8.
Consolidated Financial Statements and Supplementary Data" and "Recent
Developments -- Portfolio Companies.") The increase in valuations was
offset by the reclassification of the Company's gain in NBX Corporation of
$4,716,062 from unrealized to realized.
20
Net unrealized appreciation on investments increased by $2,248,816 or
27.6 percent during the year ended December 31, 1998, from $8,158,732 to
$10,407,548. The most significant increases in valuations during 1998 were
in: NBX Corporation, $1,865,766; NeuroMetrix, Inc., $4,400,125; and PHZ
Capital Partners, L.P., $443,432. The most significant decrease during
1998 was in Nanophase Technologies Corporation, $5,508,466. Other changes
included an increased valuation of Genomica Corporation, offset primarily
by decreased valuations in MedLogic Global Corporation and Princeton Video
Image, Inc.
Net unrealized appreciation on investments increased by $1,491,143 or
22.4 percent during the year ended December 31, 1997, from $6,667,589 to
$8,158,732. The most significant increases in valuations during 1997 were
in Nanophase Technologies Corporation, $3,775,701; NBX Corporation,
$2,850,296; and PHZ Capital Partners, L.P., $405,622. The most significant
decreases were in Princeton Video Image, Inc., $1,563,605 and PureSpeech,
Inc., $1,243,977 (which was subsequently acquired by Voice Control Systems,
Inc.).
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash, receivables and
freely marketable securities. The Company's secondary sources of liquidity
are restricted securities of companies that are publicly traded. At
December 31, 1999, December 31, 1998 and December 31, 1997, respectively,
the Company's total primary liquidity was $6,622,216, $5,547,984 and
$13,060,370. On the corresponding dates, the Company's total secondary
liquidity was $38,230,812, $0 and $8,075,978. The Company's tertiary source
of liquidity is its holding in PHZ Capital Partners,L.P., from which the
Company received or accrued net after-tax distributions in 1999, 1998 and
1997 of approximately $490,950, $50,000 and $52,500, respectively.
The increase in cash, receivables and marketable securities from
December 31, 1998 to December 31, 1999 is primarily owing to an increase
in the value of marketable securities (which, with the exception of
Nanophase Technologies Corporation, are restricted), including increases in
the value of: SciQuest.com, Inc., $31,981,750; Nanophase Technologies
Corporation, $1,935,016; Silknet Software, Inc. (which acquired InSite
Marketing Technology, Inc.), $4,899,062; Alliance Pharmaceutical Corp.,
$3,839,000; and to the receipt of total proceeds of $12,432,940 in cash and
in funds in escrow ($1,475,276, against which the Company recorded a 10
percent reserve from the sale of NBX Corporation). These increases
were offset by the (1) payment of a dividend of $0.35 per share or
$3,647,017; (2) the investments of $1,000,001 in Kriton Medical, Inc.;
$1,202,000 in Alliance Pharmaceutical Corp.; $750,000 in Sundial Marketplace
Corporation; and $1,000,000 in Adaptive Web Technologies, Inc.; and (3) the
purchase of treasury shares in the open market for a total of $540,720 and
the purchase of 1,080,569 shares tendered in the Company's tender offer for
a total of $1,832,831 including approximately $71,500 of related fees; and
(4) the use of funds in the amount of $1,777,657 for 1999 cash operating
expenses.
At December 31, 1999, the Company valued its holdings in SciQuest.com,
Inc., Silknet Software, Inc. and Alliance Pharmaceutical Corp. at
$32,831,750, $5,399,062 and $5,041,000, respectively. These holdings were
21
subject to trading restrictions and were valued at discounts from market
value, for both the trading restrictions and a "blockage" or illiquidity
factor in the calculation of the values of SciQuest.com and Alliance
Pharmaceutical and for the trading restrictions and a 10 percent escrow in
the case of Silknet Software. (See "Consolidated Schedule of Investments"
contained in "Item 8. Consolidated Financial Statements and Supplemental
Data.")
On January 27, 2000, the Company placed privately, with an unaffiliated
investor, for $3 million in cash, a one-year, 12 percent note ("Note") with
one-year warrants to purchase 25,263 shares of the Company's common stock at
$11.8750 per share. The Note may be prepaid at any time. Unless the Note
is prepaid, six months after its issuance, the investor will receive
additional one-year warrants to purchase an additional $300,000 worth of the
Company's common stock at the then-current market price. On February 28,
2000, the Company announced its intent to pre-pay the Note with proceeds of
its sale of 43,400 shares of SciQuest.com, Inc. common stock at approximately
$77.2264 per share on February 25, 2000. The Company continues to hold
417,639 shares of SciQuest.com common stock. Because the Company intends to
use most of the proceeds of the SciQuest.com sale to pre-pay the Note,
most or all of the realized long-term capital gains from this sale,
approximately $3.3 million, will be retained by the Company and will not be
distributed to shareholders as a cash dividend.
From 1998 to 1999, the amounts receivable from brokers decreased by
$380,707 or 100 percent. Funds in escrow increased by $1,327,748 or 100
percent, owing to the escrowed funds net of a reserve of $147,528 received
by the Company on the sale of NBX Corporation. The Company received the
entirety of the escrowed funds plus accrued interest for a total of
$1,541,136 on March 6, 2000. The Company's liabilities for accrued profit
sharing and deferred income tax liability increased significantly during
1999. Accrued profit sharing increased by $8,110,908 or 612.8 percent to
$9,434,467 as a result of the gain on the sale of NBX Corporation and
the increase in the unrealized appreciation on investments. Ninety percent
of the profit-sharing amount attributable to 1999 net realized income or
approximately $1,024,696 was paid out in March 2000. The remaining 10
percent or approximately $113,855 will be paid out after the Company has
filed its federal tax return for the year. There was no profit sharing paid
out during 1999 or previous years.
The deferred income tax liability increased by $586,710 or 63.0 percent
to $1,517,774. The deferred tax liability reflects utilization of
approximately $6.3 million 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 a result of the utilization of the
net operating and capital loss carryforwards, the Company had to accrue
additional tax reserves against the remaining built-in gains as of
December 31, 1998.
The Company's primary sources of liquidity, including cash, receivables
and freely marketable securities, are more than adequate to cover the
Company's gross cash operating expenses over the next 12 months. Such gross
cash operating expenses totaled $1,777,657, $2,687,099 and $2,572,514 in
1999, 1998 and 1997, respectively. The Company's secondary sources of
liquidity are the restricted securities of companies, all of which are
scheduled to become freely tradable at various times in the year 2000.
22
The Company cannot predict the amount, if any, of net after-tax distributions
that it might receive from its holding in PHZ in the year 2000.
In the future, to the extent that the Company decides to buy back shares
or make new investments and follow-on investments, the Company would either
have to raise capital externally and thereby incur interest or dividend
expenses and/or issue new shares of its stock or raise capital internally
by selling appreciated securities in its portfolio. To the extent that the
Company chooses to sell appreciated securities, if it wishes to retain all
or part of the gains instead of distributing them as cash dividends to
shareholders as a RIC, it would have to declare a deemed distribution. In
the event that the Company declares a deemed distribution or in the event
that the Company is taxed as a "C" Corporation, it would owe a federal tax
of 35 percent, and might owe state and local taxes, on any net realized
gains, and the Company's asset value would decline by the amount of the tax
accrual. To the extent that the Company distributes net realized gains to
its shareholders in the form of cash dividends, such cash dividends would also
reduce the Company's asset value accordingly.
Recent Developments Portfolio Companies
On January 5, 2000, the Company announced that it had purchased for
$1,000,000 approximately a 15 percent equity interest in MyPersonalAdvocate.com,
Inc., a business-to-business e-commerce and e-services trust-based marketing
start-up.
On January 13, 2000 the Company announced that it would discontinue the
operations of, and liquidate, Adaptive Web Technologies, Inc. Adaptive was
founded in late 1999, with $1,000,000 in funding from the Company. Because
Adaptive was able to determine early in the process of research and analysis
not to proceed with the development and commercialization effort, the Company
anticipates that the amount of money expended to date by Adaptive is unlikely
to prove to be material and that it will recapture most of its $1,000,000
investment in Adaptive.
On January 20, 2000, the Company invested $500,000 in iPacer
Corporation, an Internet technology startup, in the form of a six percent
Convertible Promissory Note due March 31, 2000.
On February 7, 2000, the Company announced that Kana Communications,
Inc. and Silknet Software, Inc. had signed a merger agreement, whereby each
of the Company's Silknet shares would be exchanged tax free for 0.83 Kana
Communications shares. There can be no assurance that the merger will be
consummated.
On February 9, 2000, the Company announced that it had exercised a
warrant to purchase 200,000 common shares of Alliance Pharmaceutical Corp.
for $490,000. The exercise price was $2.45 per share, and the warrant had
an expiration date of May 20, 2004. The Company also converted its
$1,200,000 note due May 20, 2002 into 600,000 shares of Alliance
23
Pharmaceutical. The conversion price was $2.00 per share. The Company now
owns 800,000 common shares of Alliance Pharmaceutical. These shares are
currently restricted under Rule 144.
On February 28, 2000, the Company announced its sale of 43,400 shares of
SciQuest.com, Inc. common stock (NASDAQ: SQST) at approximately $77.2264 per
share on February 25, 2000. The Company continues to hold 417,639 shares of
SciQuest.com common stock.
On March 8, 2000, the Company increased its investment in Sundial
Marketplace Corporation by purchasing from Sundial a $150,000 note with
equity features under certain circumstances. Thus, the Company has now
invested a total of $900,000 in Sundial.
On March 14, 2000, the Company announced that it had invested an
additional $500,000 in Genomica Corporation as part of a $15,000,000 private
placement of Genomica's Series C convertible preferred stock. Including this
new investment, the Company owns approximately a 3.4 percent fully diluted
interest in Genomica. On March 15, 2000, the Company noted that Genomica
had filed an S-1 registration statement with the Securities and Exchange
Commission.
Recent Developments -- 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. Further, the Company could be subject to a four percent excise tax if
it fails to distribute 98 percent of its annual taxable income and would be
subject to income tax if it fails to distribute 100 percent of its taxable
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.
24
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 effective January 1, 1999 in order to meet the
Sub-Chapter M requirements.
In 1999, because of changes in its investment portfolio, the Company
requested recertification from the SEC relating to the Company's status under
section 851(e) of the Code. On February 24, 2000, the Company received the
certification, and the Company intends to elect Sub-Chapter M tax treatment
for 1999. Although the SEC certification for 1999 was issued, there can be
no assurance that the Company will receive such certification for 2000 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
2000 or that, if it does qualify in 2000, it will continue to qualify in
subsequent years. The Company plans to elect Sub-Chapter M tax treatment
for 1999. In addition, under certain circumstances, even if the Company
were qualified for Sub-Chapter M treatment in 2000 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 as a RIC.
The Company incurred ordinary and capital losses during its C
Corporation taxable years that remain available for use and may be carried
forward to its 2000 and subsequent taxable years. 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").
On February 17, 1999, the Company received rulings from the IRS
regarding issues relevant to the Company's tax status as a RIC, including a
ruling from the IRS concluding that the Company can carry forward its C
Corporation losses to offset any Built-In Gains resulting from sales of its
C Corporation Assets. That ruling may enable the Company to retain some or
all of the proceeds from such sales without disqualifying itself as a RIC or
incurring corporate level income tax, depending on whether the Company's
sale of C Corporation Assets with Built-In Gains will generate C Corporation
E&P. In general, a RIC is not permitted to have, as of the close of any RIC
taxable year, E&P accumulated during any C Corporation taxable year. However,
because the realization of Built-In Gains will occur while the Company is a
RIC, a strong argument exists that, under current law and IRS pronouncements,
the sale of C Corporation Assets with Built-In Gains during RIC taxable
years will not generate C Corporation E&P. In 1999, the Company used the
$6.3 million loss carryforward (which resulted in a tax credit of
approximately $2.2 million) to reduce the taxes resulting from Built-In
Gains. The December 31, 1999 NAV includes the utilization of the ordinary
and capital loss carryforwards against Built-in Gains of approximately $0.03
per share. (See "Note 6 of Notes to Consolidated Financial Statements"
25
contained in "Item 8. Consolidated Financial Statements and Supplementary
Data.")
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.
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 federal taxation at the Company level.
2. Taxable shareholders receive a $1.00 per share dividend and pay
a maximum federal 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" or deemed dividend:
1. The Company pays a corporate-level federal 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. Taxable shareholders increase their cost basis in their stock by
$.65 per share. They pay a 20 percent* federal 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 or deemed dividend:
*Assumes all capital gains qualify for long-term rates of 20 percent.
26
1. The Company pays a corporate-level federal 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.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The Company's business activities contain elements of risk. The Company
considers a 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 Policy Guidelines in the Footnote
to Consolidated Schedule of Investments.
Neither the Company's investments nor an investment in the Company is
intended to constitute a balanced investment program. The Company has
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.
Because 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."
27
Item 8. Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
The following reports and consolidated financial schedules of Harris
& Harris Group, Inc. are filed herewith and included in response to Item 8.
Documents Page
Report of Independent Public Accountants. . . . . . . . . . . 29
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 1999 and 1998 . . . . . . . . . . . . 30
Consolidated Statements of Operations for the
years ended December 31, 1999, 1998 and 1997 . . . . . . 31
Consolidated Statements of Cash Flows for the
years ended December 31, 1999, 1998 and 1997. . . . . . . 32
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 1999, 1998 and 1997. . . . . . . 33
Consolidated Schedule of Investments as of
December 31, 1999 . . . . . . . . . . . . . . . . . . . . 34-38
Footnote to Consolidated Schedule of Investments. . . . . . . 39-41
Notes to Consolidated Financial Statements. . . . . . . . . . 42-51
Selected Per Share Data and Ratios for the
years ended December 31, 1999, 1998, 1997, 1996
and 1995. . . . . . . . . . . . . . . . . . . . . . . . . 52
Schedules other than those listed above have been omitted because
they are not applicable or the required information is presented in the
consolidated financial statements and/or related notes.
28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Harris & Harris Group, Inc.:
We have audited the accompanying consolidated statements of assets and
liabilities of Harris & Harris Group, Inc. (a New York corporation) as of
December 31, 1999 and 1998, including the consolidated schedule of
investments as of December 31, 1999, and the related consolidated statements
of operations, cash flows and changes in net assets for the three years ended
December 31, 1999, and the selected per share data and ratios for each of the
five years ended December 31, 1999. These consolidated financial statements
and selected per share data and ratios are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and selected per share data and ratios
based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
consolidated financial statements and selected per share data and ratios are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned as of December 31,
1999 and 1998, by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
As explained in Note 2, the consolidated financial statements include
securities valued at $18,892,731 (35.22 percent of net assets), whose values
have been estimated by the Board of Directors in the absence of readily
ascertainable market values. However, because of the inherent uncertainty
of valuation, those estimated values may differ significantly from the values
that would have been used had a ready market for the securities existed, and
the differences could be material.
In our opinion, the consolidated financial statements and selected per
share data and ratios referred to above present fairly, in all material
respects, the financial position of Harris & Harris Group, Inc. as of
December 31, 1999 and 1998, the results of its consolidated operations,
its consolidated cash flows and the consolidated changes in its net assets
for the three years ended December 31, 1999, and the selected per share data
and ratios for each of the five years ended December 31, 1999 in conformity
with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
------------------------
New York, New York
March 20, 2000
29
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
ASSETS
<S> <C> <C>
December 31, 1999 December 31, 1998
Investments, at value (See
accompanying consolidated schedule
of investments and notes). . . . . . $ 63,535,651 $ 24,532,191
Cash and cash equivalents . . . . . . . 133,256 164,143
Funds in escrow (Note 7). . . . . . . . 1,327,748 0
Receivable from brokers . . . . . . . . 0 380,707
Interest receivable . . . . . . . . . . 44,189 666
Prepaid expenses. . . . . . . . . . . . 74,328 90,649
Note receivable . . . . . . . . . . . . 32,663 32,663
Other assets. . . . . . . . . . . . . . 172,933 157,840
--------------- ----------------
Total assets. . . . . . . . . . . . . . $ 65,320,768 $ 25,358,859
=============== ================
LIABILITIES & NET ASSETS
Accounts payable and accrued
liabilities. . . . . . . . . . . . . $ 700,566 $ 505,118
Accrued profit sharing (Note 3) . . . . 9,434,467 1,323,559
Deferred rent . . . . . . . . . . . . . 33,156 42,409
Deferred income tax liability (Note 6). 1,517,774 931,064
--------------- -----------------
Total liabilities . . . . . . . . . . . 11,685,963 2,802,150
--------------- -----------------
Commitments and contingencies
(Notes 7 and 8)
Net assets. . . . . . . . . . . . . . . $ 53,634,805 $ 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 12/31/99
and at 12/31/98. . . . . . . . . . . 106,930 106,930
Additional paid in capital. . . . . . . 16,159,504 16,158,381
Accumulated net realized loss . . . . . (5,192,860) (525,177)
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $1,783,810 at 12/31/99
and $3,410,884 at 12/31/98 . . . . . 45,098,711 6,996,664
Treasury stock, at cost (1,452,140
shares at 12/31/99 and 101,739
at 12/31/98) . . . . . . . . . . . . (2,537,480) (180,089)
-------------- -----------------
Net assets. . . . . . . . . . . . . . . $ 53,634,805 $ 22,556,709
============== =================
Shares outstanding. . . . . . . . . . . 9,240,831 10,591,232
============== =================
Net asset value per outstanding share . $ 5.80 $ 2.13
============== =================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
30
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
<S> <C> <C> <C>
Year Ended Year Ended Year Ended
Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997
Investment income:
Interest from:
Fixed-income securities. . $ 234,347 $ 355,591 $ 490,807
Affiliated companies . . . 48,526 124,877 40,000
Dividend income--
unaffiliated companies. . 900 2,550 0
Consulting and
administrative fees . . . 0 0 29,870
Other income . . . . . . . . 3,911 102,468 869
----------- ----------- -----------
Total investment income. . 287,684 585,486 561,546
Expenses:
Profit-sharing accrual
(Note 3). . . . . . . . . 8,110,908 899,751 423,808
Salaries and benefits. . . . 834,700 831,121 1,507,257
Professional fees. . . . . . 331,889 411,480 327,038
Administration and
operations. . . . . . . . 319,167 330,879 392,114
Rent . . . . . . . . . . . . 162,987 159,515 130,092
Directors' fees and
expenses. . . . . . . . . 120,328 129,253 100,496
Depreciation . . . . . . . . 35,455 47,936 48,968
Custodian fees . . . . . . . 8,586 10,513 15,517
Restructuring charges. . . . 0 0 100,000
Other expense (Note 7) . . . 0 728,862 0
Interest expense . . . . . . 0 85,476 0
------------ ------------ ------------
Total expenses . . . . . . 9,924,020 3,634,786 3,045,290
------------ ------------ ------------
Operating loss before
income taxes. . . . . . . (9,636,336) (3,049,300) (2,483,744)
Income tax benefit (Note 6). 0 234,188 933,103
------------ ------------ ------------
Net operating loss . . . . . . (9,636,336) (2,815,112) (1,550,641)
Net realized gain (loss)
on investments:
Realized gain (loss) on
sale of investments . . . 10,976,714 (1,718,528) (3,147,002)
------------ ------------ ------------
Total realized gain (loss) 10,976,714 (1,718,528) (3,147,002)
Income tax (expense)
benefit (Note 6). . . . . (2,361,044) 0 1,119,825
------------ ------------ ------------
Net realized gain (loss) on
investments . . . . . . . 8,615,670 (1,718,528) (2,027,177)
------------ ------------ ------------
Net realized loss. . . . . . . (1,020,666) (4,533,640) (3,577,818)
Net increase in unrealized
appreciation on investments:
Increase as a result of
investment sales. . . . . 704,801 2,135,176 93,999
Decrease as a result of
investment sales. . . . . (4,939,595) (963,680) (2,892,408)
Increase on investments
held. . . . . . . . . . . 43,186,960 9,766,320 7,297,164
Decrease on investments
held. . . . . . . . . . . (2,477,193) (8,689,000) (3,007,612)
------------ ------------- ------------
Change in unrealized
appreciation on
investments . . . . . . 36,474,973 2,248,816 1,491,143
Income tax benefit
(provision) (Note 6). . . 1,627,074 (592,986) (521,900)
------------ ------------ ------------
Net increase in unrealized
appreciation on
investments . . . . . . . 38,102,047 1,655,830 969,243
------------ ------------ ------------
Net increase (decrease) in net
assets resulting from operations:
Total. . . . . . . . . . . . $ 37,081,381 $ (2,877,810) $ (2,608,575)
============ ============ ============
Per outstanding share. . . . $ 4.01 $ (0.27) $ (0.24)
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
31
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<S> <C> <C> <C>
Year Ended Year Ended Year Ended
Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997
Cash flows (used in)
provided by operating activities:
Net increase (decrease) in net assets
resulting from operations . $37,081,381 $ (2,877,810) $ (2,608,575)
Adjustments to reconcile net
decrease in net assets
resulting from operations
to net cash (used in) provided
by operating activities:
Net realized and unrealized (gain) loss
on investments . . . . . . . (47,451,687) (480,288) 1,708,359
Deferred income taxes . . . . 586,710 263,367 (1,442,094)
Depreciation. . . . . . . . . 35,455 47,936 48,968
Other . . . . . . . . . . . . 0 (2,927) 0
Changes in assets and liabilities:
Funds in escrow . . . . . . . (1,327,748) 0 0
Receivable from brokers . . . 380,707 (380,707) 0
Prepaid expenses. . . . . . . 16,321 (5,523) (3,625)
Interest receivable . . . . . (43,523) 110,440 87,236
Taxes receivable. . . . . . . 0 0 2,119,492
Notes receivable. . . . . . . 0 (32,663) 0
Other assets. . . . . . . . . (41,281) 86,312 40,296
Accounts payable
and accrued liabilities . . 195,448 81,235 49,555
Accrued profit sharing (Note 3) 8,110,908 899,751 423,808
Deferred rent . . . . . . . . (9,253) (9,253) (9,252)
Collection on notes receivable 10,000 800,000 0
Purchase of fixed assets. . . (9,261) (16,426) (10,169)
----------- ----------- ---------
Net cash (used in) provided
by operating activities (2,465,823) (1,516,556) 403,999
Cash provided by (used in)
investing activities:
Net sale (purchase) of
short-term investments
and marketable securities . . 12,515,222 14,715,834 (155,667)
Investment in private
placements and loans . . . . (4,077,001) (960,308) (4,511,434)
----------- ----------- -----------
Net cash provided by (used in)
investing activities 8,438,221 13,755,526 (4,667,101)
Cash flows (used in)
provided by financing activities:
Payment of dividend. . . . . (3,647,017) (8,019,728) 0
Purchase of
treasury stock (Note 4). . (2,373,551) (254,786) 0
Proceeds from exercise
of stock options (Note 3). 0 0 253,250
Proceeds (payment of)
from note payable (Note 7) 0 (4,000,000) 4,000,000
Proceeds from sale
of stock (Note 4). . . . . 17,283 54,099 0
----------- ------------ ----------
Net cash (used in) provided
by financing activities (6,003,285) (12,220,415) 4,253,250
----------- ------------ ----------
Net (decrease) increase
in cash and cash equivalents:
Cash and cash equivalents
at beginning of the year 164,143 145,588 155,440
Cash and cash equivalents
at end of the year 133,256 164,143 145,588
----------- ----------- ----------
Net (decrease) increase in
cash and cash equivalents. . $ (30,887) $ 18,555 $ (9,852)
=========== =========== ==========
Supplemental disclosures
of cash flow information:
Income taxes paid . . . . . . $ 122,560 $ 372 $ 5,909
Interest paid . . . . . . . . $ 0 $ 85,476 $ 0
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
32
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
<S> <C> <C> <C>
Year Ended Year Ended Year Ended
Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997
Changes in net assets from operations:
Net operating loss . . . . . $ (9,636,336) $ (2,815,112) $ (1,550,641)
Net realized gain
(loss) on investments. . . 8,615,670 (1,718,528) (2,027,177)
Net (decrease) increase in unrealized
appreciation on investments
as a result of sales . . . (4,234,794) 1,171,496 (1,818,966)
Net increase in unrealized
appreciation on
investments held . . . . . 42,336,841 484,334 2,788,209
------------- ------------ -------------
Net increase (decrease)
in net assets resulting
from operations. . . . . . . 37,081,381 (2,877,810) (2,608,575)
Changes in net assets from
capital stock transactions:
Payment of dividend. . . . . (3,647,017) (8,019,728) 0
Purchase of treasury stock . (2,373,551) (254,786) 0
Proceeds from exercise of stock
options and warrants . . . 0 0 253,250
Proceeds from sale of stock 17,283 54,099 0
Tax benefit of restricted
stock award and common
stock transactions . . . . 0 0 77,656
----------- ----------- ----------
Net (decrease) increase in
net assets resulting from
capital stock transactions . (6,003,285) (8,220,415) 330,906
------------ ------------ -----------
Net increase (decrease)
in net assets . . . . . . . . 31,078,096 (11,098,225) (2,277,669)
Net assets:
Beginning of the year. . . . 22,556,709 33,654,934 35,932,603
------------- ------------- -------------
End of the year . . . . . . $ 53,634,805 $ 22,556,709 $ 33,654,934
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
33
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 1999
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in
Unaffiliated Companies (14)(15)(16) -- 71.8% of total investments
Publicly Traded Portfolio (Common stock
unless noted otherwise) -- 60.2% of total investments
Silknet Software, Inc. (1)(2)(8) --
Provides customer-centric e-business
applications and systems -- 0.24% of
fully diluted equity . . . . . . . . (C) 40,864 $ 5,399,062
SciQuest.com, Inc. (1)(2)(9) -- Internet
e-commerce source for scientific products
-- 1.25% of fully diluted equity . . (C) 461,039 32,831,750
------------
Total Publicly Traded Portfolio (cost: $1,350,000) . . . . $ 38,230,812
Private Placement Portfolio (Illiquid) -- 11.6% of total investments
Alliance Pharmaceutical Corp. (2)(4)(10) --
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 convertible into 200,000 common shares
@ $2.45 expiring 5/20/04. . . . . . .(C) 200,000 $ 5,041,000
Exponential Business Development Company
(1)(2)(5) -- Venture capital partnership
focused on early stage companies
Limited partnership interest . . . .(A) -- 25,000
Genomica Corporation (1)(2)(6)(11) --
Develops software that enables the
study of complex genetic diseases --
4.47% of fully diluted equity
Common Stock . . . . . . . . . . . (B) 199,800
Series A Voting
Convertible Preferred Stock . . . . (B) 1,660,200 1,209,730
Kriton Medical, Inc. (1)(2)(4)(6) --
Research and development of medical
devices -- 1.88% of fully diluted equity
Series B
Convertible Preferred Stock. . . . .(A) 476,191 1,000,001
MedLogic Global Corporation (1)(2)(6)
-- Medical cyanoacrylate adhesive
-- 0.37% of fully diluted equity
Series B
Convertible Preferred Stock . . . .(D) 54,287
Common Stock . . . . . . . . . . .(D) 25,798 101,876
-----------
Total Private Placement Portfolio
(cost: $4,261,080) . . . . . . . . . . . . . . . . . . . $ 7,377,607
-----------
Total Investments in
Unaffiliated Companies (cost: $5,611,080) . . . . . . . $ 45,608,419
</TABLE>
The accompanying notes are an integral part of this consolidated schedule.
34
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 1999
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Investments in Non-Controlled
Affiliates (14)(16) -- 21.7% of total investments
Publicly Traded Portfolio - 5.2% of total investments
Nanophase Technologies Corporation (1)(7)
Manufactures and markets
inorganic crystals of nanometric
dimensions -- 5.16% of
fully diluted equity. . . . . . . (C) 758,016 $ 3,325,795
-----------
Total Publicly Traded Portfolio (cost $1,341,734). . . . . . . $ 3,325,795
-----------
Private Placement Portfolio (Illiquid) (14)(16) -- 16.5% of total investments
NeuroMetrix, Inc. (1)(2)(6) --
Developing devices for detection
of neuromuscular disorders --
16.19% 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)(12) -- Organizes
and manages investment partnerships
-- 20.0% of fully diluted equity
Limited partnership interest . . . . (D) -- 1,770,802
Questech Corporation (1)(2)(6) --
Manufactures and markets proprietary
decorative tiles and signs -- 12.30% of
fully diluted equity
Common Stock . . . . . . . . . . . . (D) 580,037 2,035,930
Warrants at
$5.00 expiring 11/15/09. . . . . . . (A) 1,965
Warrants at
$4.00 expiring 11/28/01. . . . . . . (A) 152,422 167
Sundial Marketplace Corporation
(1)(2)(4)(6) -- Business-to-
business e-commerce company
providing retail wireless
communications services --
20% of fully diluted equity
Series A
Convertible Preferred Stock. . . . . (A) 2,000,000 500,000
12% Convertible Note . . . . . . . . (A) $ 250,000 250,000
-----------
Total Private
Placement Portfolio (cost: $5,614,538). . .. . . . . . . . . $10,515,124
-----------
Total Investments
in Non-Controlled Affiliates (cost: $6,956,272). . . . . . . $13,840,919
</TABLE>
The accompanying notes are an integral part of this consolidated schedule.
35
<TABLE>
<CAPTION>
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 1999
<S> <C> <C> <C>
Method of Shares/
Valuation (3) Principal Value
Private Placement Portfolio
in Controlled Affiliates
(14)(16) (Illiquid) --
1.6% of total investments
Adaptive Web Technologies
Inc.(1)(2)(4)(6)(13) --
100.0% of fully diluted
equity
Series A Convertible
Preferred Stock . . . . . . . (A) 1,000,000 $ 1,000,000
------------
Total Private Placement Portfolio
in Controlled Affiliates (cost: $1,000,000). . . . . . . . . $ 1,000,000
U.S. Government Obligations -- 4.9% of total investments
U.S. Treasury Bill dated
07/15/99 due date
01/13/00 -- 3.9% yield . . . . (K) $ 1,200,000 $ 1,198,308
U.S. Treasury Bill dated
07/29/99 due date
01/27/00 -- 4.2% yield . . . . (K) $ 1,500,000 1,495,245
U.S. Treasury Bill dated
11/04/99 due date
05/04/00 -- 5.3% yield . . . . (K) $ 400,000 392,760
-----------
Total Investments in U.S. Government Obligations
(cost: $3,085,778). . . . . . . . . . . . . . . . . . . . . . . $ 3,086,313
-----------
Total Investments -- 100% (cost: $16,653,130). . . . . . . . . . $63,535,651
===========
</TABLE>
The accompanying notes are an integral part of this consolidated schedule.
36
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 1999
Notes to Consolidated Schedule of Investments
(1) Represents a non-income producing security. Equity investments that
have not paid dividends within the last 12 months are considered to
be non-income producing.
(2) Legal restrictions on sale of investment.
(3) See Footnote to Consolidated Schedule of Investments for a
description of the Method of Valuation A to L.
(4) These investments were made during 1999.
(5) No changes in valuation occurred in these investments during the year
ended December 31, 1999.
(6) These investments are in development stage companies. A development
stage company is defined as a company that is devoting substantially
all of its efforts to establishing a new business, and either has
not yet commenced its planned principal operations or has commenced
such operations but has not realized significant revenue from them.
(7) As of December 31, 1999, the market price per share of Nanophase
Technologies Corporation ("NANX") was $4.875. The Company's holding
in Nanophase Technologies Corporation before a discount for
illiquidity was valued at $3,695,328. During January and February
2000, the Company sold 85,100 shares of Nanophase Technologies
Corporation stock in the open market for a total of $420,555 or
$4.94 per share. On March 20, 2000, the market price per share of
Nanophase Technologies Corporation was $13.1875.
(8) On October 5, 1999, Silknet Software, Inc. ("SILK") acquired InSite
Marketing Technology, Inc. The Company is subject to a lock-up
agreement on the Silknet Software stock that expires on October 5,
2000. On December 31, 1999, the market price per share of Silknet
Software, Inc. was $165.75. The Company's holding in Silknet
Software before a discount for trading restrictions and a 10
percent escrow was valued at $6,773,208. On February 7, 2000,
Kana Communications, Inc. and Silknet Software, Inc. announced a
merger agreement, in which the Silknet Software shares will be
exchanged tax free for 0.83 Kana Communications (pre two-for-one
stock split) shares. See Note 8 of Notes to Consolidated Financial
Statements. On March 20, 2000, the market prices per share of
Silknet Software and Kana Communications were $165.375 and
$103.00 (post two-for-one stock split), respectively.
(9) The Company is subject to a lock-up agreement on the stock which
expires on May 18, 2000. On December 31, 1999, the market price per
share of SciQuest.com, Inc. ("SQST") was $79.50. The Company's
holding in SciQuest.com before a discount for trading restrictions
was valued at $36,652,600. On February 25, 2000, the Company sold
43,400 shares of SciQuest.com at $77.23 per share. On March 20,
2000, the market price per share of SciQuest.com, Inc. was $38.25.
The accompanying notes are an integral part of this consolidated schedule.
37
(10) As of December 31, 1999, the market price per share of Alliance
Pharmaceutical Corp. ("ALLP") was $7.375. The Company's holding in
Alliance Pharmaceutical, before a discount for delays in converting
the note and warrants to registered shares, was valued at $5,410,000,
including valuing the warrants at their in the money common stock
value. On February 9, 2000, the Company exercised the warrant to
purchase 200,000 common shares of Alliance Pharmaceutical Corp.
and converted its $1,200,000 note due May 20, 2002 into 600,000
shares of common stock. These shares are currently restricted under
Rule 144. On March 20, 2000, the market price per share of Alliance
Pharmaceutical Corp. was $13.1875.
(11) In 1996, 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, Charles E. Harris, Chairman and CEO of Harris &
Harris Group, became a trustee of CSHL. (See "Note 8 of Notes to
Consolidated Financial Statements.")
(12) 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.
(13) On January 13, 2000, the Company announced its decision not to
proceed with the development and commercialization of, and to
liquidate, Adaptive Web Technologies, Inc. (See "Note 8 of Notes
to Consolidated Financial Statements.")
(14) Investments in unaffiliated companies consist of investments in which
Harris & Harris Group, Inc. (the "Company") owns less than 5 percent
of the investee company. Investments in non-controlled affiliated
companies consist of investments in which the Company owns more than
5 percent but less than 25 percent of the investee company.
Investments in controlled affiliated companies consist of investments
in which the Company owns more than 25 percent of the investee company.
(15) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $5,611,080. The gross unrealized
appreciation based on tax cost for these securities is $40,929,238.
The gross unrealized depreciation on the cost for these securities
is $931,899.
(16) The percentage ownership of each investee disclosed in the
Consolidated Schedule of Investments expresses the potential common
equity interest in each such investee. The calculated percentage
represents the amount of issuer's common stock the Company owns or
can acquire as a percentage of the issuer's total outstanding common
stock plus common shares reserved for issued and outstanding
warrants, convertible securities and stock options.
The accompanying notes are an integral part of this consolidated schedule.
38
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 or more independent 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:
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.
39
Some examples of such events are: (1) a major recapitalization; (2) a major
refinancing; (3) a significant third-party transaction; (4) the development
of a meaningful public market for the company's common stock; (5) significant
positive or negative changes in the company's business.
B. Private Market: The private market method uses actual third-party
transactions in the company's securities as a basis for valuation, using
actual, executed, historical transactions in the company's securities by
responsible third parties. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a
basis for valuation.
C. Public Market: The public market method is used when there is an
established public market for the class of the company's securities held by
the Company. The Company discounts market value for securities that are
subject to significant legal, contractual or practical restrictions,
including large blocks in relation to trading volume. Other securities,
for which market quotations are readily available, are carried at market
value as of the time of valuation.
Market value for securities traded on securities exchanges or on the
Nasdaq National Market is the last reported sales price on the day of
valuation. For other securities traded in the over-the-counter market and
listed securities for which no sale was reported on that day, market value
is the mean of the closing bid price and asked price on that day.
This method is the preferred method of valuation when there is an
established public market for a company's securities, as that market provides
the most objective basis for valuation.
D. Analytical Method: The analytical method is generally used to value
an investment position when there is no established public or private market
in the company's securities or when the factual information available to the
Company dictates that an investment should no longer be valued under either
the cost or private market method. This valuation method is inherently
imprecise and ultimately the result of reconciling the judgments of the
Company's Investment and Valuation Committee members, based on the data
available to them. The resulting valuation, although stated as a precise
number, is necessarily within a range of values that vary depending upon the
significance attributed to the various factors being considered. Some of the
factors considered may include the financial condition and operating results
of the company, the long-term potential of the business of the company, the
values of similar securities issued by companies in similar businesses, the
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.
40
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.
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.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE COMPANY
Harris & Harris Group, Inc. (the "Company") is a venture capital
investment company operating as a business development company ("BDC")
under the Investment Company Act of 1940 ("1940 Act"). A BDC is a
specialized type of investment company under the 1940 Act. The Company
operates as an internally managed investment company whereby its officers
and employees, under the general supervision of its Board of Directors,
conduct its operations.
The Company elected to become a BDC on July 26, 1995, after receiving
the necessary approvals. From 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.
Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent wholly
owned subsidiary of the Company. Enterprises holds the lease for the office
space, which it subleases to the Company and an unaffiliated party; owns a
financial relations and consulting firm; is a partner in Harris Partners I,
L.P. and is taxed as a C corporation. Harris Partners I L.P. is a limited
partnership and 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).
The Company intends for 1999 to elect treatment 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 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Recent
Developments Sub Chapter M 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 ben eliminated in consolidation.
Cash and Cash Equivalents. Cash and cash equivalents include money
market instruments with maturities of less than three months.
42
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
Consolidated 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 specific identification for financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, the Company recorded income
taxes using the liability method in accordance with the provision of
Statement of Financial Accounting Standards No. 109. Accordingly, deferred
tax liabilities had been established to reflect temporary differences
between the recognition of income and expenses for financial reporting and
tax purposes, the most significant difference of which relates to the
Company's unrealized appreciation on investments.
The December 31, 1999 consolidated financial statements include a
provision for deferred taxes on the remaining net built-in gains as of
December 31, 1998, net of the unutilized operating and capital loss
carryforwards incurred by the Company through December 31, 1998.
The Company pays federal, state and local income taxes on behalf of its
wholly owned subsidiary, Harris & Harris Enterprises, which is a C
corporation. (See Note 6. Income Taxes.)
Reclassifications. Certain reclassifications have been made to the
December 31, 1997 and December 31, 1998 financial statements to conform to
the December 31, 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 December 31,1999 and 1998,
and the reported amounts of revenues and expenses for the three years ended
December 31, 1999. Actual results could differ from these estimates.
NOTE 3. STOCK OPTION PLAN, WARRANTS OUTSTANDING AND EMPLOYEE PROFIT-
SHARING PLAN
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.
43
The Company accounted for the 1988 Plan under APB Opinion No. 25, under
which no compensation cost has been recognized. Had compensation cost for
the 1988 Plan been determined consistent with the fair value method required
by FASB Statement No. 123 ("FASB No. 123"), the Company's net realized loss
and net asset value per share would have been reduced to the following pro-
forma amounts:
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
Net Realized Loss:
As Reported N/A N/A $(3,577,818)
Pro Forma N/A N/A $(3,921,583)
Net Asset Value per share:
As Reported N/A N/A $ 3.15
Pro Forma N/A N/A $ 3.12
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
Stock volatility N/A N/A 0.60
Risk-free interest rate N/A N/A 6.3%
Option term in years N/A N/A 7
Stock dividend yield N/A N/A - -
</TABLE>
A summary of the status of the Company's 1988 Plan at December 31, 1997
changes during the year then ended is presented in the table and narrative
below:
<TABLE>
<S> <C> <C>
December 31, 1997
-----------------
Shares Weighted
Average
------- --------
Exercise Price
--------------
Outstanding at beginning of year 1,080,000 $4.584
Granted 300,000 $3.875
Exercised 158,000 $1.603
Forfeited 397,000 $5.267
Expired - - - -
Canceled 825,000 $4.569
Outstanding at end of year 0 0
Exercisable at end of year 0 0
Weighted average fair
value of options granted $2.50 - -
</TABLE>
During 1997, the Chairman of the Company exercised a warrant to purchase
237,605 shares of common stock at a price of $2.0641.
44
As of January 1, 1998, the Company began implementing the Harris &
Harris Group, Inc. Employee Profit Sharing Plan (the "1998 Plan") that
provides for profit sharing equal to 20 percent of the net realized income
of the Company as reflected on the Consolidated Statement of Operations of
the Company for such year, less the nonqualifying gain, if any. Under the
1998 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
1998 Plan, unrealized gains and losses, and loss carry-overs from other
years ("Qualifying Income"). The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 will be considered
nonqualifying gain, which will reduce "Qualifying Income."
As soon as practicable following year end, 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 1998
Plan participants pursuant to the distribution percentages set forth in the
1998 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 percent; Mel P. Melsheimer, 4.233
percent; Rachel M. Pernia, 1.524 percent; and Jacqueline M. Matthews, 0.453
percent. If a participant leaves the Company for other than cause, the
amount earned will be accrued and paid to such participant, and the
remaining amount allocable under the 1998 Plan will be redistributed by the
Compensation Committee and paid to the other participants.
Notwithstanding any provisions of the 1998 Plan, in no event may the
aggregate amount of all awards payable for any 1998 Plan year during which
the Company remains a "business development company" within the meaning of
the Investment Company Act of 1940, as amended (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 1998 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 1998 Plan accrual at each quarter end based
on the unrealized gains at that date, net of operating expenses for the
year. Any adjustments to the 1998 Plan accrual are then reflected in the
Consolidated Statement of Operations for the quarter. The 1998 Plan accrual
is not paid out until the gains are realized. During 1999, the Company
accrued profit-sharing expense of $8,110,908, of which $8,295,916 represents
a profit sharing accrual on unrealized gains and will not be paid out until
the gains are realized, bringing the cumulative accrual under the 1998 Plan
to $9,434,467 at December 31, 1999.
The 1998 Plan was terminated as of December 31, 1999 subject to the
payment of any amounts owed under the 1998 Plan. As of January 1, 2000, the
Company adopted the Harris & Harris Group Employee Profit-Sharing Plan
(the "2000 Plan") with substantially the same terms as the 1998 Plan, except
for a limitation on the amount of an award that may be paid out to any one
participant during any one year if the shareholders do not approve the
performance goals of the 2000 Plan. The Shareholders are being asked to
approve the performance
45
goals under the 2000 Plan in accordance with Section 162(m) of the Internal
Revenue Code at the Annual Meeting of Shareholders to be held on April 26,
2000. If the Shareholders do not approve the performance goals, the Company
could implement the 2000 Plan in its current form, or modify or terminate
the 2000 Plan. At present, the Company has no plans to take any particular
action in the event of a negative shareholder vote.
In March 2000, the Company paid out under the 1998 Plan 90 percent of
the profit sharing on the 1999 realized gains of approximately $1,024,696;
the remaining 10 percent or approximately $113,855 will be paid out on the
completion and filing of the Company's 1999 federal tax return.
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 market, rather than from the
Company. During 1998, the directors bought a total of 24,491 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 December 31, 1998, the Company had purchased a total of
126,230 shares for a total of $254,786 or an average of $2.02 per share.
However, the treasury shares purchased were decreased by the directors'
purchases of a total of 24,491 shares of Company stock.
In the first six months of 1999, the Company purchased a total of
275,648 shares of treasury shares in the open market for a total of $540,720
or $1.96 per share.
On July 14, 1999, the Company announced an offer to purchase up to
1,100,000 shares of its common stock for cash at a price equal to $1.63 per
share. A total of 1,080,569 shares were tendered for a total cost,
including related expenses of approximately $71,500, of $1,832,831. Of
these shares, 1,075,269 were tendered by one shareholder, which tendered all
of its holdings.
Since 1998, as a result of the shares purchased in the open market and
through the tender offer in 1999, the Company has purchased a total of
1,482,447 shares for a total of $2,628,337, including commissions and
expenses, at an average price of $1.77 per share.
NOTE 5. EMPLOYEE BENEFITS
On October 19, 1999, Charles E. Harris signed an Employment Agreement
with the Company (disclosed in a Form 8-K filed on October 27, 1999) ("The
Employment Agreement"), which superseded an employment agreement that was
about to expire on December 31, 1999. The Employment Agreement expires on
December 31, 2004 ("Term"); on January 1, 2000 and on each day thereafter,
the Term extends automatically by one day unless at any time the Company or
Mr. Harris, by written notice, decides not to extend the Term, in which case
the Term will expire five years from the date of the written notice.
During the period of employment, Mr. Harris shall serve as the Chairman
and Chief Executive Officer of the Company; be responsible for the general
management of the affairs of the Company and all its subsidiaries, reporting
directly to the Board of Directors of the Company; serve as a member of the
46
Board for the period of which he is and shall from time to time be elected or
reelected; and serve, if elected, as President of the Company and as an officer
and director of any subsidiary or affiliate of the Company.
Mr. Harris is to receive compensation under his Employment Agreement in
the form of base salary of $202,980, with automatic yearly adjustments to
reflect inflation. In addition, the Board may increase such salary, and
consequently decrease it, but not below the level provided for by the
automatic adjustments described above. Mr. Harris is also entitled to
participate in the Company's Profit-Sharing Plan as well as in all
compensation or employee benefit plans or programs, and to receive all
benefits, perquisites, and emoluments for which salaried employees are
eligible. Under the Employment Agreement, the Company is to furnish Mr.
Harris with certain perquisites which include a company car, membership in
certain clubs and up to a $5,000 annual reimbursement for personal,
financial or tax advice.
The Employment Agreement provides Mr. Harris with life insurance for the
benefit of his designated beneficiaries in the amount of $2,000,000; provides
reimbursement for uninsured medical expenses, not to exceed $10,000 per annum,
adjusted for inflation, over the period of the contract; provides Mr. Harris
and spouse with long-term care insurance; and disability insurance in the
amount of 100 percent of his base salary. These benefits are for the term of
the contract.
The Employment Agreement provides for the Company to adopt a supplemental
executive retirement plan (the "SERP") for the benefit of Mr. Harris. Under
the SERP, the Company will cause an amount equal to one-twelfth of the Mr.
Harris's current base salary to be credited each month (a "Monthly Credit") to
a special account maintained for this purpose on the books of the Company for
the benefit of Mr. Harris (the "SERP Account"). The amounts credited to the
SERP Account will be deemed invested or reinvested in such mutual funds or U.S.
Government securities as determined by Mr. Harris. The SERP Account will be
credited and debited to reflect the deemed investment returns, losses and
expenses attributed to such deemed investments and reinvestments. Mr. Harris's
benefit under the SERP will equal the balance in the SERP Account and such
benefit will always be 100 percent vested (i.e., not forfeitable). Mr. Harris
will determine the form and timing of the distribution of the balance in the
SERP Account; provided, however, in the event of the termination, the balance
in the SERP Account will be distributed to Mr. Harris or his beneficiary, as
the case may be, in a lump-sum payment within 30 days of such termination. The
Company will establish a rabbi trust for the purpose of accumulating funds to
satisfy the obligations incurred by the Company under the SERP. During 1999,
the Company accrued $41,442 in accordance with this provision of the SERP. Mr.
Harris's rights to benefits pursuant to this SERP will be no greater than those
of a general creditor of the Company.
The Employment Agreement provides severance pay in the event of
termination without cause or by constructive discharge and also provides for
certain death benefits payable to the surviving spouse equal to the
executive's base salary for a period of two years.
In addition, Mr. Harris is entitled to receive severance pay pursuant to
the severance compensation agreement that he entered into with the Company,
effective August 15, 1990. The severance compensation agreement provides that
if, following a change in control of the Company, as defined in the agreement,
such individual's employment is terminated by the Company without cause or by
the executive within one year of such change in control, the individual shall
be entitled to receive compensation in a lump sum payment equal to 2.99 times
the individual's average annualized compensation and payment of other welfare
benefits. If Mr. Harris's termination is without cause or is a constructive
47
discharge, the amount payable under the Employment Agreement will be reduced
by the amounts paid pursuant to the severance compensation agreement.
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. As of January 1, 1999, the Company adopted the Harris &
Harris Pension Plan and Trust, a money purchase plan which would allow the
Company to stay compliant with the 401(k) top-heavy regulations and deduction
limitation regulations. Contributions to the plan are at the discretion of
the Company. During 1999, contributions to both plans that have been charged
to salaries and benefits totaled approximately $37,000.
On June 30, 1994, the Company adopted a plan to provide medical and
health insurance for retirees, their spouses and dependents who, at the time
of their retirement, have ten years of service with the Company and have
attained 50 years of age or have attained 45 years of age and have 15 years of
service with the Company. On February 10, 1997, the Company amended this plan
to include employees who "have seven full years of service and have attained
58 years of age." The coverage is secondary to any government provided or
subsequent employer provided health insurance plans. Based upon actuarial
estimates, the Company provided an original reserve of $176,520 that was
charged to operations for the period ending June 30, 1994. As of December
31, 1999 the Company had a reserve of $317,600 for the plan.
NOTE 6. INCOME TAXES
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
$0.75 per share to meet this requirement (for a total of $8,019,728). The
cash dividend was paid on May 12, 1998.
The Company intends to elect Sub-Chapter M status for the year ended
December 31, 1999. Accordingly, on February 23, 1999, the Company declared a
cash dividend of $0.35 per share (for a total of $3,647,017) as a result of
the long-term capital gain generated in 1999 by the acquisition of NBX
Corporation by 3Com Corporation. The Company utilized its net operating loss
and capital loss carryforwards of approximately $6.3 million in order to
retain most of the remaining long-term capital gain to invest in new
opportunities. Approximately $300,000 of the long-term capital gain was not
distributed during 1999. Therefore, the Company incurred approximately
$26,044 in excise taxes.
The Company had incurred net ordinary and capital losses for a total of
approximately $7.0 million (which results in a tax credit of approximately
$2.5 million) during its C Corporation taxable years of which $0.8 million
still remains available for use. A corporation that elects to qualify as a
RIC continues to be taxable as a C Corporation on any gains realized within 10
years of its qualification as a RIC from sales of assets that were held by the
corporation on the effective date of the election ("C Corporation Assets") to
the extent of any gain built into the assets on such date ("Built-In Gain").
On February 17, 1999, the Company received a ruling from the IRS concluding
that the Company can carry forward its C Corporation losses to offset any
Built-In Gains resulting from sales of its C Corporation Assets. That ruling
48
may enable the Company to retain some or all of the proceeds from such sales
without disqualifying itself as a RIC or incurring corporate level income tax,
depending on whether the Company's sale of C Corporation Assets with Built-In
Gains will generate C Corporation E&P. In general, a RIC is not permitted to
have, as of the close of any RIC taxable year, E&P accumulated during any C
Corporation taxable year. However, because the realization of Built-In Gains
will occur while the Company is a RIC, a strong argument exists that, under
current law and IRS pronouncements, the sale of C Corporation Assets with
Built-In Gains during RIC taxable years will not generate C Corporation E&P.
The Company intends to use the remaining $0.8 million loss carryforward (which
results in a tax credit of approximately $0.3 million) to reduce its taxes
which are the result of Built-In Gains.
Continued qualification as a RIC requires the Company to satisfy certain
portfolio diversification requirements in future years. The Company's ability
to satisfy those requirements may not be controllable by the Company. (See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation - Recent Developments - Sub-Chapter M Status.")
There can be no assurance that the Company will qualify as a RIC for 2000
or subsequent years or that, if it does qualify, it will continue to elect RIC
status.
For the years ended December 31, 1999, 1998 and 1997, the Company's
income tax (benefit) provision was allocated as follows:
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
Investment operations $ 0 $ (234,188) $ (933,103)
Realized gain (loss) on investments 2,361,044 0 (1,119,825)
Increase in unrealized
appreciation on investments (1,627,074) 592,986 521,900
------------ ----------- ------------
Total income tax (benefit) provision $ 733,970 $ 358,798 $(1,531,028)
============ =========== ============
</TABLE>
The above tax (benefit) provision consists of the following:
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
Current -- Federal $ 2,361,044 $ 95,430 $ 0
Deferred -- Federal (1,627,074) 263,368 (1,531,028)
------------ ---------- -------------
Total income tax (benefit) provision $ 733,970 $ 358,798 $ (1,531,028)
============ ========== ==============
</TABLE>
The Company's net deferred tax liability at December 31, 1999 and 1998
consists of the following:
<TABLE>
<S> <C> <C>
1999 1998
Unrealized appreciation on investments $1,783,810 $ 3,410,884
Net operating and capital loss carryforward (266,036) (2,479,820)
----------- ------------
Net deferred income tax liability $1,517,774 $ 931,064
=========== ============
</TABLE>
49
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 year ended December 31,
1999, was $162,987. 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
percent (7.3125 percent). In March 1998, the Company paid down $2,500,000;
in April 1998, the Company paid the remaining balance and did not draw
against the line for the remainder of the year. This Demand Promissory Note
for a line of credit is no longer available to the Company.
The Company had a total of $1,475,276 of funds in escrow as a result of
the acquisition of NBX Corporation by 3Com Corporation. The funds were 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 account reflected
$1,327,748 net of the reserve of $147,528. The Company received the full
escrow monies including interest for a total of $1,541,136 on March 6, 2000.
NOTE 8 SUBSEQUENT EVENTS
On January 5, 2000, the Company announced that it had purchased for
$1,000,000 approximately a 15 percent equity interest in MyPersonalAdvocate.com,
Inc., a business-to-business e-commerce and e-services trust-based marketing
start-up.
On January 13, 2000 the Company announced that it would discontinue the
operations of, and liquidate, Adaptive Web Technologies, Inc. Adaptive was
founded in late 1999, with $1,000,000 in funding from the Company. Because
Adaptive was able to determine early in the process of research and analysis
not to proceed with the development and commercialization effort, the Company
anticipates that the amount of money expended to date by Adaptive is unlikely to
prove to be material and that it will recapture most of its $1,000,000
investment in Adaptive.
On January 20, 2000, the Company invested $500,000 in iPacer Corporation,
an Internet technology startup, in the form of a six percent Convertible
Promissory Note, maturing on March 31, 2000.
On January 27, 2000, the Company announced that it had placed privately,
with an unaffiliated investor, for $3 million in cash, a one-year 12 percent
note with one-year warrants to purchase 25,263 shares of the Company's common
stock at $11.8750 per share. The note may be prepaid at any time. Unless
the note is prepaid, six months after its issuance, the investor will receive
additional one-year warrants to purchase an additional $300,000 worth of the
Company's common stock at the then-current market price. On February 28,
2000, the Company announced its intent to pre-pay the Note from the proceeds
50
of its sale of 43,400 shares of SciQuest.com, Inc. common stock (NASDAQ:
SQST) at $77.2264 per share on February 25, 2000. The Company continues to
hold 417,639 shares of SciQuest.com common stock. Because the Company
intends to use most of the proceeds of the SciQuest.com sale to pre-pay
indebtedness, most or all of the realized long-term capital gains from this
sale, approximately $3.3 million, will be retained by the Company and will
not be distributed to shareholders as a cash dividend.
On February 7, 2000, the Company announced that Kana Communications, Inc.
and Silknet Software, Inc. had signed a merger agreement, whereby each of the
Company's Silknet shares would be exchanged tax free for 0.83 Kana
Communications shares. There can be no assurance that the merger will be
consummated.
On February 9, 2000, the Company announced that it had exercised a
warrant to purchase 200,000 common shares of Alliance Pharmaceutical Corp.
for $490,000. The exercise price was $2.45 per share, and the warrant had
an expiration date of May 20, 2004. The Company also converted its
$1,200,000 note due May 20, 2002 into 600,000 shares of Alliance
Pharmaceutical. The conversion price was $2.00 per share. The Company now
owns 800,000 common shares of Alliance Pharmaceutical. These shares are
currently restricted under Rule 144.
On March 8, 2000, the Company increased its investment in Sundial
Marketplace Corporation by purchasing from Sundial a $150,000 note with
equity features under certain circumstances. Thus, the Company has now
invested a total of $900,000 in Sundial.
On March 14, 2000, the Company announced that it had invested an
additional $500,000 in Genomica Corporation as part of a $15,000,000 private
placement of Genomica's Series C convertible preferred stock. Including
this new investment, the Company owns approximately a 3.4 percent fully
diluted interest in Genomica. On March 15, 2000, Genomica filed an S-1
registration statement with the Securities and Exchange Commission.
51
<TABLE>
<CAPTION>
SELECTED PER SHARE DATA AND RATIOS
Per share operating performance:
<S> <C> <C> <C> <C> <C>
Year Ended Year Ended Year Ended Year Ended Year Ended
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31,
1999 1998 1997 1996 1995
Net asset value,
beginning of
period $ 2.13 $ 3.15 $ 3.44 $ 3.54 $ 3.43
Net operating
loss (1.04) (0.26) (0.14) (0.12) (0.11)
Net realized
(loss) gain
on investments 0.93 (0.16) (0.19) (0.24) 0.14
Net (decrease)
increase in
unrealized
appreciation as
a result of sales (0.46) 0.11 (0.17) 0.16 (0.01)
Net increase in
unrealized
appreciation on
investments held 4.58 0.05 0.26 0.13 0.03
Net decrease as a
result of dividend (0.35) (0.75) 0.0 0.0 0.0
Net increase
(decrease) from
capital stock
transactions 0.01 (0.01) (0.05) (0.03) 0.06
---------- ----------- ---------- ---------- ----------
Net asset value,
end of period* $ 5.80 $ 2.13 $ 3.15 $ 3.44 $ 3.54
========= ========== ========== ========== ==========
Dividends paid
per share $ 0.35 $ 0.75 $ 0.00 $ 0.00 $ 0.00
Market value per
share, end of
period $ 11.50 $ 1.50 $ 3.50 $ 3.75 $ 7.875
Deferred income
tax per share $ 0.16 $ 0.09 $ 0.06 $ 0.21 $ 0.050
Ratio of expenses
to average net
assets 34.08% 10.9% 9.1% 8.1% 8.3%
Ratio of net
operating loss to
average net assets (3.50)% (10.4)% (4.5)% (3.5)% (3.2)%
Investment return based on:
Stock price 666.7% (45.5)% (6.7)% (52.4)% 23.5%
Net asset value 188.7% (8.3)% (8.4)% (2.8)% 3.2%
Portfolio turnover 53.54% 19.71% 77.2% 51.3% 51.2%
Net assets, end
of period $53,634,805 $22,556,709 $33,654,934 $35,932,603 $36,561,909
Number of shares
outstanding 9,240,831 10,591,232 10,692,971 10,442,682 10,333,902
</TABLE>
*The net asset value as of December 31, 1999 reflects the decline in net
asset value as a result of the $0.35 dividend paid in 1999 and $0.75
dividend paid in 1998.
The accompanying notes are an integral part of this schedule.
52
Item 9. Disagreements on Accounting and Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Company
The information set forth under the captions "Election of Directors"
on page 2, "Executive Officers" on page 8 and "Section 16(a) Beneficial
Ownership Reporting Compliance" on page 15 in the Company's Proxy Statement
for Annual Meeting of Shareholders to be held April 26, 2000, filed pursuant
to Regulation 14A under the Securities Exchange Act of 1934 on or about
March 24, 2000 (the "2000 Proxy Statement") is herein incorporated by
reference.
Item 11. Executive Compensation
The information set forth under the captions "Summary Compensation
Table" on pages 9 and 10 and "Compensation of Directors" on page 14 in the
2000 Proxy Statement is herein incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the caption "Security Ownership of
Directors and Executive Officers and other principal holders of the
Company's voting securities" on page 7 in the 2000 Proxy Statement is
herein incorporated by reference.
Item 13. Certain Relationships and Related Transactions
There were no relationships or transactions within the meaning of
this item during the year ended December 31, 1999.
53
PART IV
Item 14. Exhibits, Consolidated Financial Statements, Schedules and
Reports on Form 8-K
(a) The following documents are filed as a part of this report:
(1) The following Consolidated Financial Statements of the Company
are set forth under Item 8:
Consolidated Statements of Assets and Liabilities as of
December 31, 1999 and 1998
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Changes in Net Assets for the years
ended December 31, 1999, 1998 and 1997
Consolidated Schedule of Investments as of December 31, 1999
Footnote to Consolidated Schedule of Investments
Notes to Consolidated Financial Statements
Selected Per Share Data and Ratios for the years ended
December 31, 1999, 1998, 1997, 1996 and 1995
(2) Report of Independent Public Accountants.
(3) The following exhibits are filed with this report or are
incorporated herein by reference to a prior filing, in accordance
with Rule 12b-32 under the Securities Exchange Act of 1934.
(Asterisk denotes exhibits filed with this report.)
3.1(a) Restated Certificate of Incorporation of the Company, as
amended, incorporated by reference to Exhibit 3.1 (a) to
the Company's Form 10-K for the year ended December 31, 1995.
3.1(b) Restated By-laws of the Company, incorporated by reference
to Exhibit 3.1(b) to the Company's Form 10-K for the year
ended December 31, 1995 and the Company's Form 10-Q for
the quarter ended September 30, 1998.
4.1 Specimen certificate of common stock certificate,
incorporated by reference to Exhibit 4 to Company's
Registration Statement on Form N-2 filed October 29, 1992.
9.1 Harris & Harris Group, Inc. Custodian Agreement with JP
Morgan, incorporated by reference to Exhibit 9.1 to the
Company's Form 10-K for the year ended December 31, 1995.
10.1 Amended and Restated Employment Agreement between Harris &
Harris Group, Inc. and Charles E. Harris dated January
1, 1998.
10.5 Severance Compensation Agreement by and between the
Company and Charles E. Harris dated August 15, 1990,
incorporated by reference to exhibit 10 (s) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1990.
54
10.13 Stock Purchase Agreement, Standstill Agreement and
Termination and Release by and among Harris & Harris Group,
Inc. and American Bankers Life Assurance Company of Florida
dated May 18, 1995, incorporated by reference to Exhibit
10.13 to the Company's Form 10-K for the year ended
December 31, 1995.
10.14 Form of Indemnification Agreement which has been
established with all directors and executive officers of
the Company, incorporated by reference to Exhibit 10.14 to
the Company's Form 10-K for the year ended December 31,
1995.
10.16 Demand Promissory Note, Corporate Certificate-Borrowing,
Statement of Purpose for an Extension of Credit Secured by
Margin Stock by and among Harris & Harris Group, Inc. and
J.P. Morgan.
10.17 Harris & Harris Group, Inc. Employee Profit Sharing Plan,
incorporated by reference as Exhibit (c) to the Company's
Form 8-K filed June 15, 1998.
10.18 Employment Agreement Between Harris & Harris Group, Inc.
and Charles E. Harris, dated October 19, 1999, incorporated
by reference as Exhibit (C) to the Company's Form 8-K filed
on October 27, 1999.
10.19* Deferred Compensation Agreement Between Harris & Harris
Group, Inc. and Charles E. Harris.
10.20* Trust Under Harris & Harris Group, Inc. Deferred
Compensation Agreement.
10.21* Note due January 26, 2001; Form of Warrant to Purchase
25,263 Shares of Harris & Harris Group, Inc. common stock.
10.22* Harris & Harris Group, Inc. Employee Profit-Sharing Plan.
11.0* Computation of Per Share Earnings is set forth under Item 8.
23* Consent of Arthur Andersen LLP.
27.0* Financial Data Schedule.
(b) Reports on Form 8-K. On October 27, 1999, the Company filed a
Form 8-K to disclose the Employment Agreement between Charles E. Harris,
Chief Executive Officer of Harris & Harris Group, Inc. and Harris & Harris
Group, Inc.
*Exhibits attached.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
HARRIS & HARRIS GROUP, INC.
Date: March 21, 2000 By: /s/ Charles E. Harris
----------------------
Charles E. Harris
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Company and in the capacities and on the dates indicated.
Signatures Title Date
/s/ Charles E. Harris Chairman of the Board, March 21, 2000
- --------------------- Chief Compliance Officer and
Charles E. Harris Chief Executive Officer
/s/ Mel P. Melsheimer President, Chief Operating March 21, 2000
- --------------------- Officer and Chief Financial Officer
Mel P. Melsheimer
/s/ Rachel M. Pernia Vice President, Controller, March 21, 2000
- ---------------------- Treasurer and Principal
Rachel M. Pernia Accounting Officer
56
/s/ C. Wayne Bardin Director March 20, 2000
- --------------------
C. Wayne Bardin
/s/ Phillip A. Bauman Director March 18, 2000
- ---------------------
Phillip A. Bauman
/s/ G. Morgan Browne Director March 17, 2000
- ---------------------
G. Morgan Browne
/s/ Harry E. Ekblom Director March 18, 2000
- ---------------------
Harry E. Ekblom
/s/ Dugald A. Fletcher Director March 17, 2000
- ----------------------
Dugald A. Fletcher
/s/ Glenn E. Mayer Director March 17, 2000
- -----------------------
Glenn E. Mayer
/s/ James E. Roberts Director March 17, 2000
- -----------------------
James E. Roberts
57
EXHIBIT INDEX
The following exhibits are filed with this report in accordance with
Rule 12b-32 under the Securities Exchange Act of 1934.
Exhibit No. Description
10.19 Deferred Compensation Agreement Between Harris & Harris Group,
Inc. and Charles E. Harris.
10.20 Trust Under Harris & Harris Group, Inc. Deferred Compensation
Agreement.
10.21 Note due January 26, 2001; Form of Warrant to Purchase 25,263
Shares of Harris & Harris Group, Inc. common stock.
10.22 Harris & Harris Group, Inc. Employee Profit-Sharing Plan.
11.0 Computation of Per Share Earnings is set forth under Item 8.
23 Consent of Arthur Andersen LLP.
27.0 Financial Data Schedule.
DEFERRED COMPENSATION AGREEMENT
AGREEMENT made as of the second day of February, 2000, by and
between Harris & Harris Group, Inc., a corporation organized under the laws
of the State of New York (the "Company"), and Charles E. Harris (the
"Executive").
WHEREAS, the Company and the Executive are parties to an
employment agreement;
WHEREAS, the employment agreement obligates the Company to adopt a
supplemental executive retirement plan for the benefit of the Executive;
WHEREAS, in order to effect the foregoing, the Company and the
Executive wish to enter into a Deferred Compensation Agreement on the terms
and conditions set forth below.
NOW, THEREFORE, in consideration of the premises and covenants
hereinafter contained, the parties hereto agree as follows:
Section 1. Deferred Compensation Account; Contributions to Trust.
(1) The Company shall credit to a book reserve (the
"Deferred Compensation Account") commencing as of October 19, 1999 and for
each month thereafter, an amount equal to 8.25% of the Executive's Base Salary
(as defined in the employment agreement between the Company and the Executive
dated October 19, 1999 (the "Employment Agreement")) for such month; provided
that the Executive is employed with the Company on the last business day of
such month. The Deferred Compensation Account shall be debited with amounts
representing all losses and distributions from the Trust (as hereinafter
defined) and shall be credited with all earnings of and deposits to the Trust
or amounts otherwise contributed to the Trust.
(2) Any amounts represented by credits made to the Deterred
Compensation Account in accordance with the first sentence of paragraph (1)
above shall be contributed by the Company on the last business day of each
month to the trust (the "Trust") established under the Trust Agreement
substantially in the form of Exhibit A annexed hereto (the "Trust Agreement");
provided, however, that amounts represented by credits in respect of all
completed calendar months from October 19, 1999 to the date of execution
hereof shall be contributed to the Trust within 5 business days after
execution of this Agreement. Amounts contributed to the Trust shall be
invested and reinvested in accordance with the provisions of the Trust
Agreement. To the extent that the Company is required to withhold hospital
insurance tax or other taxes in respect of credits to the Deferred
Compensation Account representing earnings of the Trust prior to distribution
of such earnings to the Executive pursuant to Section 2 below, the Company
and the Executive may agree that such withholding obligation shall be
satisfied from amounts otherwise payable to the Executive and, in the absence
of such agreement, such withholding obligation shall be satisfied from
amounts held in the Trust or amounts otherwise contributed to the Trust.
(3) The Executive agrees on behalf of himself and his
designated beneficiary to assume all risk in connection with any debits or
credits made to him under the Trust by reason of losses or earnings on
investments made in accordance with the provisions of the Trust Agreement.
Section 2. Benefit Payments.
(1) The Executive shall determine the form and timing of
the distribution of amounts held in the Trust; provided that, however, no
distribution shall be made from the Trust unless the Executive shall have
provided the Company with a written request for a distribution (such request
shall specify the timing and form of the distribution) at least six months in
advance of the day such distribution is to be made from the Trust, and further
provided that, such request shall have been forwarded to the Trustee at least
six months in advance of the day such distribution is to be made from the
Trust. In addition, where the Executive requests a distribution from the
Trust while still employed by the Company, a six percent reduction shall be
imposed on such distribution, and a corresponding debit shall be made to the
Deferred Compensation Account. Notwithstanding the foregoing, in the event a
termination of the Period of Employment (as defined in the Employment
Agreement) occurs pursuant to paragraph 6 ("Disability"), 7 ("Death") or 8
("Effect of Termination of Employment") of the Employment Agreement, the
Company shall pay (or cause to be paid from the Trust) to the Executive or
to the Executive's beneficiary or estate (in the event of his death) in
cash a lump sum equal to the amount reflected in the Deferred Compensation
Account as of the effective date of the Executive's termination.
(2) The beneficiary referred to in paragraph (1) above may
be designated or changed by the Executive (without the consent of any prior
beneficiary) on a form provided by the Company and delivered to the Company
before the Executive's death. If no such beneficiary shall have been
designated, or if no designated beneficiary shall survive the Executive, the
lump sum payment payable under paragraph (1) above shall be payable to the
Executive's estate.
Section 3. Vesting.
The Executive's interest in the Deferred Compensation Account
shall be 100% vested and non-forfeitable.
Section 4. Unfunded Arrangement.
It is the intention of the parties hereto that the arrangement
described in this Agreement be unfunded for tax purposes and for purposes of
Title I of the Employee Retirement Income Security Act of 1974, as amended.
Nothing contained in this Agreement or the Trust Agreement and no action taken
pursuant to the provisions of this Agreement or the Trust Agreement shall
create or be construed to create a fiduciary relationship between the Company
and the Executive, his designated beneficiary or any other person. Any funds
that may be invested under the provisions of the Trust Agreement shall
continue for all purposes to be a part of the general funds of the Company and
no person other than the Company shall by virtue of the provisions of this
Agreement have any interest in such funds. To the extent that any person
acquires a right to receive payments from the Company under this Agreement,
such right shall be no greater than the right of any unsecured general
creditor of the Company. This Agreement constitutes a mere promise by the
Company to make a benefit payment in the future.
Section 5. Nonalienation of Benefits.
The right of the Executive or any other person to the payment of
deferred compensation or other benefits under this Agreement shall not be
subject in any manner to anticipation, alienation, sale, transfer, assignment,
pledge, encumbrance, attachment or garnishment by creditors of the Executive
or the Executive's beneficiary or estate.
Section 6. No Right to Employment.
Nothing contained herein shall be construed as conferring upon the
Executive the right to continue in the employ of the Company as an executive
or in any other capacity.
Section 7. Effect on Other Benefits.
Any deferred compensation payable under this Agreement shall not
be deemed salary or other compensation to the Executive for the purpose of
computing benefits to which he may be entitled under any pension plan or other
arrangement of the Company for the benefit of its employees.
Section 8. Binding Agreement.
This Agreement shall be binding upon and inure to the benefit of
the Company, its successors and assigns and the Executive and his heirs,
executors, administrators and legal representatives.
Section 9. Governing Law.
This Agreement shall be construed in accordance with and governed
by the laws of the State of New York without regard to its conflict of laws
principles.
Section 10. Validity.
The invalidity or unenforceability of any provision or provisions
of this Agreement shall not affect the validity or enforceability of any other
provision of this Agreement, which shall remain in full force and effect.
Section 11. Counterparts.
This Agreement may be executed in one or more counterparts, each
of which shall be deemed to be an original but all of which together will
constitute one and the same instrument.
Section 12. Arbitration.
Any dispute or controversy arising under or in connection with
this Agreement shall be settled exclusively by arbitration in the City of New
York in accordance with the rules of the American Arbitration Association then
in effect. Judgment may be entered on the arbitrator's award in any court
having jurisdiction. The expense of such arbitration shall be shared equally
by the Company and by the Executive; provided that the arbitrator shall be
entitled to include as part of the award to the prevailing party the reason
able legal fees and expenses incurred by such party in an amount not to exceed
$25,000 in connection with enforcing its rights hereunder.
Section 13. Amendment.
The Agreement may be amended in whole or in part by a written
instrument executed by both parties hereto.
IN WITNESS WHEREOF, the Company has caused this Agreement to be
executed by its duly authorized officers and the Executive has hereunto set
his hand and seal as of the date first above written.
HARRIS & HARRIS GROUP, INC.
By: /s/ Mel P. Melsheimer
---------------------
Mel P. Melsheimer,
President
TRUST UNDER
HARRIS & HARRIS GROUP, INC.
DEFERRED COMPENSATION AGREEMENT
This Trust Agreement made this second day of February, 2000, by
and between Harris & Harris Group, Inc., a corporation organized under the
laws of the State of New York (the "Company") and Charles E. Harris (the
"Trustee"); WHEREAS, the Company has entered into a deferred compensation
agreement (the "Deferred Compensation Agreement") (attached hereto as Appendix
"A") effective as of October 19, 1999, with Charles E. Harris (the
"Executive") pursuant to the Executive's employment agreement;
WHEREAS, the Company may incur liability under the terms of the
Deferred Compensation Agreement with respect to the Executive;
WHEREAS, the Deferred Compensation Agreement contemplates the
establishment of this trust (hereinafter called the "Trust") and the
contribution by the Company to the Trust of amounts that shall be held
therein, in order to assist the Company in meeting its obligations under
the Deferred Compensation Agreement;
WHEREAS, the assets of this Trust shall be subject to the claims
of the Company's creditors in the event of the Company's Insolvency, as herein
defined, until paid to the Executive (or his beneficiary) in such manner and
at such times as specified in the Deferred Compensation Agreement;
WHEREAS, it is the intention of the parties that this Trust shall
constitute an unfunded arrangement and shall not affect the status of the
Deferred Compensation Agreement as an unfunded plan maintained for the purpose
of providing deferred compensation for a highly compensated employee for
purposes of Title I of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA");
NOW, THEREFORE, the parties do hereby establish the Trust and
agree that the Trust shall be comprised, held and disposed of as follows:
Section 1. Establishment of Trust.
(1) The Company hereby deposits with the Trustee in trust the
sum of $58,801.33, which shall become the principal of the Trust to be
held, administered and disposed of by the Trustee as provided in this Trust
Agreement.
(2) The Trust hereby established shall be irrevocable, but is
subject to termination in accordance with Section 12 hereof.
(3) The Trust is intended to be a grantor trust, of which the
Company is the grantor, within the meaning of subpart E, part 1, subchapter J,
chapter 1, subtitle A of the Internal Revenue Code of 1986, as amended, and
shall be construed accordingly.
(4) The principal of the Trust, and any earnings thereon shall
be held separate and apart from other funds of the Company and shall be used
exclusively for the purposes herein set forth. The Executive and his
beneficiary shall have no preferred claim on, or any beneficial ownership
interest in, any assets of the Trust. Any rights created under the Deferred
Compensation Agreement and this Trust Agreement shall be a mere unsecured
contractual right of the Executive and his beneficiary against the Company.
Any assets held by the Trust will be subject to the claims of the Company's
general creditors under federal and state law in the event that the Company is
considered Insolvent, as defined in Section 3(1) herein.
(5) On the last business day of each month, or otherwise as
required pursuant to the Deferred Compensation Agreement, the Company shall
contribute in cash to the Trustee hereunder an amount equal to the
contributions required to be made pursuant to the terms of the Deferred
Compensation Agreement. The Trustee shall not have any right or duty to
compel such contributions.
Section 2. Payments to Executive and Beneficiary.
(1) The Trustee shall make payment to the Executive or his
beneficiary in accordance with the directions of the Company. With respect to
payments to Trust Beneficiaries, the Company shall be solely responsible for
determining the amounts of income that are taxable and reportable, determining
the nature and amounts of taxes to be withheld and for withholding, remitting
and reporting all such income and taxes to the applicable government entities.
The Trustee shall have no duties with respect thereto.
(2) The entitlement of the Executive or his beneficiary to
benefits shall be determined by the Company in accordance with the provisions
of the Deferred Compensation Agreement.
(3) The Company may make payment of benefits directly to the
Executive or his beneficiary as they become due under the terms of the
Deferred Compensation Agreement. The Company shall notify the Trustee of its
decision to make a direct payment of benefits prior to the time amounts
payable to the Executive or his beneficiary are due. In the event that the
Company pays the entire amount due to the Executive or his beneficiary
pursuant to the terms of the Deferred Compensation Agreement, then the
Trustee, upon receipt of a certification from the Company that such payment
has been made, shall return all remaining Trust assets to the Company.
Section 3. Trustee Responsibility Regarding Payments When the Company
Is Insolvent.
(1) The Trustee shall cease payment to the Executive and his
beneficiary if the Company is Insolvent. The Company shall be considered
"Insolvent" for purpose of this Trust Agreement if (i) the Company is unable
to pay its debts as they become due, or (ii) the Company is subject to a
pending procedure as a debtor under the United States Bankruptcy Code.
(2) At all times during the continuance of this Trust, as
provided in Section 1(4) hereof, the principal and income of the Trust shall
be subject to claims of general creditors of the Company under federal and
state law as set forth below.
(1) The Board of Directors and the Chief
Financial Officer of the Company shall have the duty to inform the
Trustee in writing of the Company's becoming Insolvent. If a
person claiming to be a creditor of the Company alleges in
writing to the Trustee that the Company has become Insolvent, the
Trustee shall determine whether the Company is Insolvent and,
pending such determination, the Trustee shall discontinue payment
of benefits hereunder.
(2) Unless the Trustee has actual knowl
edge of the Company's becoming Insolvent, or has received notice
from the Company or a person claiming to be a creditor alleging
that the Company is Insolvent, the Trustee shall have no duty to
inquire whether the Company is Insolvent. The Trustee may in all
events rely on such evidence concerning the Company's solvency as
may be furnished to the Trustee and that provides the Trustee with
a reasonable basis for making a determination concerning the
Company's solvency.
(3) If at any time the Trustee has
determined that the Company is Insolvent, the Trustee shall
discontinue payments to the Executive or his beneficiary and shall
hold the assets of the Trust for the benefit of the Company's
general creditors. Nothing in this Trust Agreement shall in any
way diminish any right of the Executive or his beneficiary to
pursue rights as a general creditor of the Company with respect to
benefits due under the Deferred Compensation Agreement or otherwise.
(4) The Trustee shall resume the payment
of benefits to the Executive or his beneficiary in accordance with
Section 2 of this Trust Agreement only after the Trustee has
determined that the Company is not Insolvent (or is no longer
Insolvent).
(3) Provided that there are sufficient assets, if the Trustee
discontinues the payment of benefits from the Trust pursuant to Section 3(2)
hereof and subsequently resumes such payments, the first payment following
such discontinuance shall include the aggregate amount of all payments due to
the Executive or his beneficiary under the terms of the Deferred Compensation
Agreement for the period of such discontinuance, less the aggregate amount of
any payments made to the Executive or his beneficiary by the Company in lieu
of the payments provided for hereunder during any such period of
discontinuance.
Section 4. Payments to Company.
Except as provided in Sections 2(3) and 3 hereof, the Company
shall have no right or power to direct the Trustee to return to the Company or
to divert to others any of the Trust assets before all payments of benefits
have been made to the Executive and his beneficiary pursuant to the terms of
the Deferred Compensation Agreement.
Section 5. Accounts and Investment Authority.
(1) The Trustee shall determine the manner in which the assets
shall be invested; subject to the investment guidelines established for the
Trust by the Company from time to time. Without limitation of and in addition
to the foregoing, the term "investments" as used in this Section shall include
stocks of all kinds and classes (other than stocks of the Company or any
affiliate), bonds, notes, debentures, savings bank accounts and other interest
bearing deposits (including accounts or deposits in the Trustee's Banking
Department), mortgages and other obligations, insurance contracts and
annuities, common trust funds, shares or participations in any investment
company, fund or trust, including a registered investment company from which
the Trustee or its affiliates received compensation for providing investment
advisory, custodial, transfer agency or other services, and all other
property, tangible and intangible, real, personal and mixed of every kind and
nature. The Company acknowledges that interests in registered investment
companies are not bank deposits and are not insured by, guaranteed by,
obligations of, or otherwise supported by the United States of America, the
Federal Deposit Insurance Corporation, PNC Bank, National Association or any
bank or government entity. In making such investments, the Trustee shall not
be restricted by any state law or statute designating investments eligible for
trust funds.
(2) The Trustee is authorized to hold uninvested, from time to
time, without liability for interest thereon, such amounts as are necessary
for the cash requirements of the Plan; and to hold assets of the Trust in
cash or equivalents, government securities, or straight debt securities in
varying proportions when and for so long as, in the opinion of the Trustee,
prevailing market and economic considerations indicate that it is in the best
interest of the Trust to do so.
(3) The Trustee is authorized to cause any securities or other
property to be registered in its own name or in the name of one or more of its
nominees or a nominee or nominees of any national registered securities
depository which it has selected and to hold any investment in bearer or other
negotiable form provided that the books and records of the Trustee at all
times show that such investments are part of the Trust. In compliance
herewith, the Trustee may give to any registrar, transfer agent, or insurer,
including but not limited to corporations, state, or Federal authorities or
agents, any bond or other guarantee which may be required. Any registrar,
transfer agent, or insurer shall be fully protected and saved harmless from
any action either at law or in equity for acting upon or in compliance with
the instructions received in writing from the Trustee.
(4) The Trustee shall have the power to vote upon any stocks,
bonds or other securities; to give general or special proxies or powers of
attorney with or without power of substitution; to exercise any conversion
privileges, subscription rights, or other options, and to make any payments
incidental thereto; to oppose or to consent to, or otherwise participate in,
corporate reorganizations or other changes affecting corporate securities, to
delegate discretionary powers, and to pay any assessments or charges in
connection therewith; and generally to exercise any of the powers of an owner
with respect to stocks, bonds, securities, or other properties held as part of
the Trust.
(5) The Trustee shall have the power to settle, compromise, or
submit to arbitration any claims, debts, or damage due or owing to or from the
Trust, to commence or defend suits or legal or administrative proceedings, and
to represent the Trust in all legal and administrative proceedings, provided,
however, the Trustee shall not be obligated to take any action or to appear
and participate in any action which would subject it to expense or liability
unless it is first indemnified in an amount and manner satisfactory to it, or
is furnished with funds sufficient, in its sole judgment, to cover the same.
(6) In addition to the foregoing powers, the Trustee shall have
all of the powers, rights and privileges conferred upon trustees by the
fiduciary laws of the Commonwealth of Pennsylvania to the extent such law is
not preempted by federal law, and the power to do all acts, take all
proceedings, and execute all rights and privileges, although not specifically
mentioned herein, as the Trustee may deem necessary to administer the Trust
and to carry out the purposes of this Trust.
(7) Notwithstanding anything to the contrary, the Company may
reserve to itself the exclusive authority to direct the Trustee as to the
acquisition, retention or disposition of all or any portion of the assets of
the Trust and, to the extent the Company reserves such authority, the Trustee
shall not be responsible for the management and control of such assets other
than to serve as custodian of them. Upon receipt by the Trustee of a written
notice from the Company advising the Trustee that the Company has reserved
such authority, the Trustee shall, pursuant to such notice, invest all or any
portion of the Trust designated in such notice only in accordance with the
instructions of the Company. The Trustee shall be under no duty to question
any instruction of the Company. Any such instruction may be of a continuing
nature or otherwise and may be changed or revoked in writing by the Company at
any time. In the absence of such a written direction, the Trustee shall have
full authority as to the acquisition, retention or disposition of the assets
of the Trust. The Company may revoke or amend the investment powers that it
reserves to itself provided such revocation or amendment is in writing and is
consented to in advance by the Trustee.
(8) In no event may the Trustee invest in securities (including
stock or rights to acquire stock) or obligations issued by the Company or
affiliate, other than a de minimis amount held in common investment vehicles
in which the Trustee invests.
Section 6. Disposition of Income.
During the term of this Trust, all income received by the Trust,
net of expenses, shall be accumulated and reinvested.
Section 7. Accounting by Trustee.
The Trustee shall separately keep accurate and detailed records of
all investments, receipts, disbursements, and all other transactions required
to be made, including such specific records as may be agreed upon in writing
between the Company and the Trustee. Within 60 days following the close of
each calendar quarter and within 120 days after the removal or resignation of
the Trustee, the Trustee shall deliver to the Company a written account of its
administration of the Trust during such quarter or during the period from the
close of the last preceding quarter to the date of such removal or
resignation, setting forth all investments, receipts, disbursements and other
transactions effected by it for the Executive, including a description of all
securities and investments purchased and sold with the cost or net proceeds of
such purchases or sales (accrued interest paid or receivable being shown
separately), and showing all cash, securities and other property held in the
Trust for the Executive at the end of such quarter or as of the date of such
removal or resignation, as the case may be. The Company may approve the
account either by written notice of approval delivered to the Trustee or by
failure to object in writing to the Trustee within one hundred and eighty
(180) days from the date on which the account was delivered to the Trustee.
Upon receipt of written approval of the accounting, or upon the expiration of
the 180-day period without written objections, the account shall be approved,
and the Trustee shall be released and discharged with respect to the account
as if the account had been settled and allowed by a decree of a court of
competent jurisdiction. Nothing herein contained, however, shall be deemed to
preclude the Trustee of its right to have its account settled by a court of
competent jurisdiction.
Section 8. Responsibility of Trustee.
(1) The Trustee shall act with the care, skill, prudence and
diligence under the circumstances then prevailing that a prudent person acting
in like capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims; provided, however, that the
Trustee shall incur no liability to any person for any action taken pursuant
to a direction, request or approval given by the Company or the Executive that
is contemplated by, and in conformity with, the terms of the Deferred
Compensation Agreement or this Trust; and provided further, that the Trustee
shall incur no liability to any person for any reasonable action or failure
to act taken pursuant to a reasonable determination of the existence or
nonexistence of an event of Insolvency pursuant to Section 3 hereunder. In
the event of a dispute between the Company and a party, the Trustee may apply
to a court of competent jurisdiction to resolve the dispute.
(2) If the Trustee undertakes, defends or settles any pending or
threatened claim or litigation arising in connection with this Trust, the
Company agrees to indemnify the Trustee against the Trustee's costs, expenses
and liabilities (including, without limitation, attorneys' fees and expenses)
relating thereto and to be primarily liable for such payments. If the Company
does not pay such costs, expenses and liabilities in a reasonably timely
manner, the Trustee may obtain payment from the Trust.
(3) The Trustee may consult with legal counsel (who may also be
counsel for the Company generally) with respect to any of its duties or
obligations hereunder and shall be fully protected in reasonably relying upon
the advice of counsel.
(4) Provided there is a prior consultation with the Company, the
Trustee may hire agents, accountants, actuaries, investment advisors,
financial consultants or other professionals to assist it in performing any
of its duties or obligations hereunder.
(5) The Trustee shall have, without exclusion, all powers
conferred on the Trustee by applicable law, unless expressly provided
otherwise herein.
(6) Notwithstanding any power granted to the Trustee pursuant to
this Trust Agreement or to applicable law, the Trustee shall not have any
power that could give this Trust the objective of carrying on a business and
dividing the gains therefrom, within the meaning of section 301.7701-2 of the
Procedure and Administrative Regulations promulgated pursuant to the Internal
Revenue Code of 1986, as amended.
Section 9. Compensation and Expenses of Trustee.
The Company shall pay all administrative and Trustee's fees and
expenses. If the Company fails to pay such fees and expenses in a reasonably
timely manner, Trustee may obtain payment from the Trust.
Section 10. Resignation and Removal of Trustee.
(1) The Trustee may resign at any time by written notice to the
Company, which shall be effective 30 days after receipt of such notice unless
the Company and the Trustee agree otherwise.
(2) The Trustee may be removed by the Company on 30 days notice
or upon shorter notice accepted by Trustee.
(3) Upon resignation or removal of the Trustee and appointment
of a successor Trustee, all assets shall subsequently be transferred to the
successor Trustee. The transfer shall be completed within 30 days after
receipt of notice of resignation, removal or transfer, unless the Company
extends the time limit.
(4) If the Trustee resigns or is removed, a successor shall be
appointed, in accordance with Section 11 hereof, by the effective date of
resignation or removal under paragraphs (1) or (2) of this section. If no
such appointment has been made, the Trustee may apply to a court of competent
jurisdiction for appointment of a successor or for instructions. All expenses
of the Trustee in connection with the proceeding shall be allowed as
administrative expenses of the Trust.
Section 11. Appointment of Successor.
(1) If the Trustee resigns or is removed in accordance with
Section 10(1) or (2) hereof, the Company may appoint any third party, such as
a bank trust department or other party that may be granted corporate trustee
powers under state law, as a successor to replace the Trustee upon resignation
or removal. The appointment shall be effective when accepted in writing by
the new Trustee, who shall have all of the rights and powers of the former
Trustee, including ownership rights in the Trust assets. The former Trustee
shall execute any instrument necessary or reasonably requested by the Company
or the successor Trustee to evidence the transfer.
(2) The successor Trustee need not examine the records and acts
of any prior Trustee and may retain or dispose of existing Trust assets,
subject to Sections 7 and 8 hereof. The successor Trustee shall not be
responsible for and the Company shall indemnify and defend the successor
Trustee from any claim or liability resulting from any action or inaction of
any prior Trustee or from any other past event, or any condition existing at
the time it becomes successor Trustee.
Section 12. Amendment or Termination.
(1) This Trust Agreement may be amended by a written instrument
executed by the Trustee and the Company; provided, however, that no amendment
that alters or impairs the rights of the Executive hereunder may be made
without the prior written consent of the Executive.
(2) The Trust shall not terminate until the date on which the
Executive and his beneficiary are no longer entitled to benefits pursuant to
the terms of the Deferred Compensation Agreement. Upon termination of the
Trust any assets remaining in the Trust shall be returned to Company.
(3) Upon written approval of the Executive or his beneficiary
entitled to payment pursuant to the terms of the Deferred Compensation
Agreement, the Company may terminate this Trust prior to the time all benefit
payments under the Deferred Compensation Agreement have been made. All assets
in the Trust at termination shall be returned to the Company.
Section 13. Miscellaneous.
(1) Any provision of this Trust Agreement prohibited by law
shall be ineffective to the extent of any such prohibition, without
invalidating the remaining provisions hereof.
(2) Benefits payable to the Executive and his beneficiary under
this Trust Agreement may not be anticipated, assigned (either at law or in
equity), alienated, pledged, encumbered or subjected to attachment,
garnishment, levy, execution or other legal or equitable process.
(3) This Trust Agreement shall be construed in accordance with
and governed by the laws of the Commonwealth of Pennsylvania without regard to
its conflict of laws principles.
Section 14. Effective Date.
The effective date of this Trust Agreement shall be as of
February 2, 2000.
IN WITNESS WHEREOF, the parties hereto have executed the Trust as
of the date first above written.
HARRIS & HARRIS GROUP, Inc.
By:/s/ Mel P. Melsheimer
---------------------
Mel P. Melsheimer, President
PNC BANK, Trustee
By:/s/ Denise M. Gargan
---------------------
Denise M. Gargan, Vice President
NOTE DUE JANUARY 26, 2001
THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR ANY STATE SECURITIES LAWS AND MAY NOT BE TRANSFERRED, SOLD OR
OFFERED FOR SALE EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT AS TO
THIS NOTE UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAWS OR AN
OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH
REGISTRATION IS NOT REQUIRED.
$3,000,000 January 26, 2000
FOR VALUE RECEIVED, Harris & Harris Group, Inc., a New York corporation
(the "Company"), hereby promises to pay to (the "holder"), in lawful money of
the United States of America, the principal sum of three million dollars
($3,000,000) on January 26, 2001, and to pay interest (computed on the basis
of a 360-day year of twelve 30-day months) on the unpaid principal amount
hereof at the rate of 12% per annum in the manner provided below.
Payments of principal and interest shall be made to the holder hereof in
such coin and currency of the United States of America as at the time of
payment shall be legal tender for the payment of public and private debts, at
the office of the Company at One Rockefeller Plaza, 14 West 49th Street, New
York, NY 10020.
The principal amount of this Note shall be due and payable on January
26, 2001. Accrued interest shall be paid by the Company semi-annually on July
26, 2000 and on January 26, 2001.
If any amounts under this Note become due and payable on a day that
banks in the State of New York are not open for business, such amounts shall
be paid on the next succeeding day that such banks shall be open for business.
This Note may be prepaid in whole or in part without premium or penalty,
provided that accrued and unpaid interest on the principal amount prepaid
shall be paid simultaneously with such prepayment.
The occurrence of any one or more of the following events shall
constitute an Event of Default under this Note: (i) the failure to pay
principal of or interest on this Note within 15 days of the due date; (ii)
breach by the Company of any covenant on its part to be performed under this
Note (other than as set forth in clause (i) of this paragraph) and the
continuance of such breach for a period of thirty days after notice thereof
from the holders; (iii) a proceeding being filed or commenced against the
Company for dissolution or liquidation, or the Company voluntarily or
involuntarily terminating or dissolving or being terminated or dissolved; or
(iv) insolvency or the appointment of a custodian, trustee, liquidator or
receiver for any of the property of, or an assignment for the benefit of
creditors by or the filing of a petition under any bankruptcy, insolvency, or
debtor's relief law, or for any readjustment of indebtedness, composition or
extension by or against the Company.
Upon the occurrence and during the continuance of an Event of Default,
the holder of the Note may at its option by notice in writing to the Company
declare this Note to be, and this Note shall become, due and payable;
provided, however, that upon the occurrence of an Event of Default specified
in clauses (iii) or (iv) above, this Note shall automatically become due and
payable, without notice or demand. If an Event of Default occurs, the Company
agrees to pay to the holder all expenses incurred by the holder, including
reasonable attorney's fees, in enforcing and collecting this Note.
Failure of or delay by the holder hereof to assert any right contained
herein will not be deemed to be a waiver thereof. The holder of this Note may
not waive any of his rights, except by an instrument in writing signed by the
holder.
Upon the granting of this loan, the holder of the note shall receive
from the Company a one-year warrant to purchase that number of shares of
Common Stock of the Company equal to 10% of the principal amount due under the
Note divided by the applicable Exercise Price (as defined below). At the six
month anniversary of the issuance of this Note, commencing with July 26, 2000,
if the Company has not repaid in full the principal and interest due on the
Note, the Company shall issue to the holder a one-year warrant to purchase
that number of shares of Common Stock of the Company equal to 10% of the
outstanding principal amount due under the Note divided by the applicable
Exercise Price (as defined below). The Exercise Price of each such warrant
shall be the closing market price (as reported by Nasdaq) on the date of
issuance of such warrant. The terms and conditions of each such warrant will
be substantially the same as the Warrant which is attached hereto as Exhibit A
and Exhibit B.
This Note is a general unsecured obligation of the Company.
This Note shall be governed by and construed in accordance with the laws
of the State of New York without regard to any laws that might otherwise
govern under applicable principles of conflicts of laws.
IN WITNESS WHEREOF, Harris & Harris Group, Inc. has executed and
delivered this Note as of the date first stated above.
HARRIS & HARRIS GROUP, INC.
By: /s/ Mel P. Melsheimer
________________________________
Mel P. Melsheimer
President
CERTIFICATION
I, the note holder, do hereby certify to Harris & Harris Group, Inc.
(the "Company") that:
(i) I am an "Accredited Investor" as the term is defined in
Regulation D in that my personal net worth, or my joint net
worth with my wife, is in excess of $1,000,000.
(ii) I am in a financial position to hold any investment in the Company
for an indefinite period of time, am able to bear the economic
risk of the investment in the Company, and can withstand a
complete loss of the investment in the Company; and
(iii) I have had the opportunity to ask questions of, and receive answers
from, the Company, or any person acting on its behalf, concerning
my investment and the Company, and to obtain such additional
information as I deemed necessary or desirable.
(iv) I have examined or have had the opportunity to examine before the
date hereof all the documents and information regarding my
investment and the Company that I deemed necessary or desirable.
(v) I have the knowledge and experience in business and financial
matters to read and interpret financial statements of and
concerning the Company and to evaluate the merits and risks of
the investment.
IN WITNESS WHEREOF, I have executed this Certification this 26th day of
January, 2000.
/s/ Note Holder
----------------
NEITHER THIS WARRANT NOR THE SECURITIES ISSUABLE UPON EXERCISE HEREOF NOR ANY
INTEREST OR PARTICIPATION HEREIN OR THEREIN MAY BE SOLD, ASSIGNED, PLEDGED,
HYPOTHECATED, ENCUMBERED OR IN ANY OTHER MANNER TRANSFERRED OR DISPOSED OF
EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, AS AMENDED, APPLICABLE
STATE SECURITIES LAWS AND THE TERMS AND CONDITIONS HEREOF. THE HOLDER OF THIS
WARRANT AND THE SECURITIES ISSUABLE UPON EXERCISE HEREOF ARE SUBJECT TO THE
RESTRICTIONS HEREIN SET FORTH.
VOID AFTER 5:00 P.M. NEW YORK TIME, ON THE EXPIRATION DATE.
FORM OF WARRANT TO PURCHASE
25,263 SHARES
WARRANT TO PURCHASE
COMMON STOCK
OF HARRIS & HARRIS GROUP, INC.
This certifies that, for good and valuable consideration received, (the
"Warrantholder"), is entitled to purchase from Harris & Harris Group, Inc., a
corporation incorporated under the laws of New York (the "Company"), subject
to the terms and conditions hereof, at any time before 5:00 P.M., New York
time, on January 26, 2001 (or, if such day is not a Business Day, as defined
herein, at or before 5:00 P.M., New York time, on the next following Business
Day), the number of fully paid and nonassessable shares of Common Stock (par
value $.01) of the Company (the "Common Stock") stated above at the Exercise
Price (as defined herein). The Exercise Price and the number of shares
purchasable hereunder are subject to adjustment as provided in Article III
hereof.
ARTICLE I
Section 1.01: Definition of Terms. As used in this Warrant, the
following capitalized terms shall have the following respective meanings.
(a) Business Day: A day other than a Saturday, Sunday or other
day on which banks in the State of New York are authorized by law to
remain closed.
(b) Common Stock Equivalents: Securities that are convertible
into or exercisable for shares of Common Stock.
(c) Closing Market Price: The closing price shall be the last
sale price regular way or, in case no such reported sales takes place on
such day, the average of the last reported bid and asked prices regular
way, in either case as reported by Nasdaq, or other similar organization
if Nasdaq is no longer reporting such information, or if not so
available, the fair market price as determined in good faith by the
Board of Directors.
(d) Exercise Price: $11.8750 per share, subject to adjustment
from time to time pursuant to the provisions of Article III hereof.
(e) Expiration Date: 5:00 p.m., New York time, on January 26,
2001 (or, if such day is not a Business Day, at or before 5:00 p.m., New
York time, on the next following Business Day).
(f) Person: An individual, partnership, joint venture,
corporation, trust, unincorporated organization or government or any
department or agency thereof.
(g) SEC: The Securities and Exchange Commission or any other
federal agency at the time administering the Securities Act or the
Exchange Act.
(h) Securities Act: The Securities Act of 1933, as amended.
(i) Warrants: This Warrant and all other warrants that may be
issued in its place (together evidencing the right to purchase an
aggregate 25,263 shares of Common Stock, subject to adjustment from time
to time in accordance with Article III).
(j) Warrant Shares: Common Stock purchasable upon exercise of
the Warrants.
ARTICLE II
Duration and Exercise of Warrant
Section 2.01: Duration of Warrant. Subject to the terms contained
herein, this Warrant may be exercised at any time prior to 5:00 P.M. New York
time, on the Expiration Date. If this Warrant is not exercised at or before
5:00 P.M., New York time, on the Expiration Date, it shall become void, and
all rights hereunder shall thereupon cease.
Section 2.02: Exercise of Warrant.
(a) The Warrantholder may exercise this Warrant, in whole or in
part, upon surrender of this Warrant with the Subscription Form hereon
duly executed, to the Company at its principal office in New York, New
York, together with the full Exercise Price for each share of Common
Stock to be purchased in lawful money of the United States, or by
certified check, bank draft or postal or express money order payable in
the United States Dollars to the order of the Company and upon
compliance with and subject to the conditions set forth herein.
(b) Upon receipt of this Warrant with the Subscription Form duly
executed and accompanied by payment of the aggregate Exercise Price for
the shares of Common Stock for which this Warrant is then being
exercised, the Company will cause to be issued certificates for the
total number of whole shares of Common Stock for which this Warrant is
being exercised in such denominations as are required for delivery to
the Warrantholder, and the Company shall thereupon deliver such
certificates to the Warrantholder.
(c) The Warrantholder, by acceptance hereof, acknowledges that
this Warrant and the shares of Common Stock to be issued upon exercise
hereof are being acquired for investment, and that the Warrantholder
will not offer, sell or otherwise dispose of this Warrant or any shares
of Common Stock to be issued upon exercise or conversion hereof except
under circumstances that will not result in a violation of the
Securities Act or any state securities laws.
(d) All shares of Common Stock issued upon exercise hereof shall
be stamped or imprinted with a legend in substantially the following
form (in addition to any legend required by state securities laws).
"The securities registered by this stock
certificate have not been registered under
the Securities Act of 1933 (the "Act") or
applicable state securities laws (the
"State Acts") and shall not be sold,
pledged, hypothecated, donated or
otherwise transferred by the Warrantholder
except upon the issuance to the Company of
a favorable opinion of its counsel and/or
submission to the Company of such other
evidence as may be satisfactory to counsel
for the Company, to the effect that any
such transfer shall not be in violation of
the Act and the State Acts."
(e) In case the Warrantholder shall exercise this Warrant with
respect to less than all of the shares of Common Stock that may be
purchased under the Warrant, the Company will execute a new warrant
certificate in the form of this Warrant for the balance of the shares of
Common Stock that may be purchased upon exercise of this Warrant and
deliver such new warrant certificate to the Warrantholder.
(f) The Company covenants and agrees that it will pay when due
and payable any and all taxes which may be payable in respect of the
issue of this Warrant or in respect of the issue of any Warrant Shares.
The Company shall not, however, be required to pay any tax imposed on
income or gross receipts or any tax which may be payable in respect of
any transfer involved in the issuance or delivery of this Warrant or of
Warrant Shares in a name other than that of the Warrantholder at the
time of surrender and, until the payment of such tax, shall not be
required to issue such Warrant Shares.
Section 2.03: Transfer of Warrant.
(a) This Warrant may not be transferred or assigned in whole or
in part without consent of the Company and compliance with all
applicable federal and state securities laws by the transferor and the
transferee (including the delivery of investment representation letters
and legal opinions reasonably satisfactory to the Company, if such are
requested by the Company). Subject to the provisions of this Warrant
with respect to compliance with the Securities Act, title to this
Warrant may be transferred by endorsement and delivery in the same
manner as a negotiable instrument transferrable by endorsement and
delivery.
(b) On surrender of this Warrant for exchange, properly endorsed
and subject to the provisions of this Warrant with respect to compliance
with the Securities Act and with the limitations on assignments and
transfers contained in this Article II, the Company at its own expense
shall issue to or on the order of the Warrantholder a new warrant or
warrants of the like tenor, in the name of the Warrantholder (on payment
by the Warrantholder of any applicable transfer taxes) as he may direct,
for the number of shares issuable upon exercise hereof.
ARTICLE III
Adjustment of Shares of Common Stock
Purchasable and of Exercise Price
The Exercise Price and the number and kind of Warrant Shares shall be
subject to adjustment from time to time upon the happening of certain events
as provided in this Article III.
Section 3.01: Mechanical Adjustments.
(a) If at any time prior to the full exercise of this Warrant,
the Company shall (i) pay a dividend or make a distribution on its
shares of Common Stock in shares of Common Stock; (ii) subdivide its
outstanding Common Stock into a greater number of shares; or (iii)
combine its outstanding Common Stock into a smaller number of shares,
the total number of shares of Common Stock purchasable upon the exercise
of this Warrant shall be adjusted so that, upon the subsequent exercise
of this Warrant in full, the Warrantholder shall be entitled to receive
at the same aggregate Exercise Price the number of shares of Common
Stock which he would have owned or have been entitled to receive
immediately following the happening of any of the events described above
had this Warrant been exercised in full immediately prior to the
happening of such event. Any adjustment made pursuant to this Section
3.01 shall, in the case of a stock dividend or distribution, become
effective as of the record date therefor and, in the case of a
subdivision or combination, shall be made effective as of the effective
date thereof. Such adjustment shall be made successively whenever any
event listed in this paragraph 3.01(a) shall occur.
(b) In the event of any adjustment of the total number of shares
of Common Stock purchasable upon the exercise of this Warrant pursuant
to Section 3.01(a), the Exercise Price per share applicable to this
Warrant should be adjusted to the amount resulting from dividing the
number of shares covered by this Warrant immediately after such
adjustment into the total amount payable upon exercise of this Warrant
in full immediately prior to such adjustment.
(c) In case the Company shall hereafter fix a record date for
making a distribution to the holders of the Common Stock of assets or
evidences of its indebtedness (excluding cash dividends or distributions
out of earnings and dividends or distributions referred to in paragraph
(a) of this Section 3.01) or Common Stock subscription rights, options
or warrants for Common Stock or Common Stock Equivalents, then in each
such case, the Exercise Price in effect after such record date shall be
adjusted to the price determined by multiplying the Exercise Price in
effect immediately prior thereto by a fraction, the numerator of which
shall be the total number of shares of Common Stock outstanding at such
time multiplied by the Current Market Price, less the fair market value
(as determined by the Company's Board of Directors) of said assets or
evidences of indebtedness so distributed or of such Common Stock
subscription rights, option and warrants or of such Common Stock
Equivalents, and the denominator of which shall be the total number of
shares of Common Stock outstanding at such time multiplied by such
Current Market Price. Such adjustment shall be made successively
whenever the record date for such a distribution is fixed and shall
become effective immediately after such record date.
(d) Whenever the Exercise Price payable upon exercise of each
Warrant is adjusted pursuant to paragraph (c) of this Section 3.01, the
Warrant Shares shall simultaneously be adjusted by multiplying the
number of Warrant Shares then issuable upon exercise of each Warrant by
the Exercise Price in effect on the date thereof and dividing the
product so obtained by the Exercise Price as adjusted.
(e) No adjustment in the Exercise Price shall be required unless
such adjustment would require an increase or decrease of at least five
cents ($.05) in such price; provided, however, that any adjustments
which by reason of this paragraph (d) are not required to be made shall
be carried forward and taken into account in any subsequent adjustment.
All calculations under this Section 3.01 shall be made to the nearest
cent or to the nearest one-hundredth of a share, as the case may be.
Notwithstanding anything in this Section 3.01 to the contrary, the
Exercise Price shall not be reduced to less than the then existing par
value of the Common Stock as a result of any adjustment made hereunder.
Section 3.02: Notice of Adjustment. Whenever the number of Warrant
Shares or the Exercise Price is adjusted as herein provided, the Company shall
prepare and deliver to the Warrantholder a certificate signed by the
President, any Vice President, Treasurer or Secretary, setting forth the
adjusted number of shares purchasable upon the exercise of this Warrant and
the Exercise Price of such shares after such adjustment, setting forth a brief
statement of the facts requiring such adjustment and setting forth the
computation by which such adjustment was made.
Section 3.03: No Adjustment for Dividends. No adjustment in respect
of any cash dividends shall be made during the term of this Warrant or upon
the exercise of this Warrant.
Section 3.04: Preservation of Purchase Rights in Certain
Transactions. In case of any consolidation of the Company with or merger of
the Company into another corporation or in case of any sale or conveyance to
another corporation of the property of the Company as an entirety or
substantially as an entirety, the Company agrees that a condition of such
transaction will be that the Company or such successor or purchasing
corporation, as the case may be, shall execute with the Warrantholder an
agreement granting the Warrantholder the right thereafter, upon payment of the
Exercise Price in effect immediately prior to such action, to receive upon
exercise of this Warrant the kind and amount of shares and other securities
and property which he would have owned or have been entitled to receive after
the happening of such consolidation, merger, sale or conveyance had this
Warrant been exercised immediately prior to such action. Such agreement shall
provide for adjustments, which shall be as nearly equivalent as may be
practicable to the adjustments provided for in this Article III. The
provisions of this Section 3.04 shall similarly apply to successive
consolidations, mergers, sales or conveyances.
Section 3.05: Form of Warrant after Adjustments. The form of this
Warrant need not be changed because of any adjustments in the Exercise Price
or the number or kind of the Warrant Shares, and Warrants theretofore or
thereafter issued may continue to express the same price and number and kind
of shares as are stated in this Warrant as initially issued.
ARTICLE IV
Other Provisions Relating to Rights of Warrantholder
Section 4.01: No Rights as Shareholders: Notices to Warrantholders.
Nothing contained in this Warrant shall be construed as conferring upon the
Warrantholder or his transferees the right to vote or to receive dividends or
to consent or to receive notice as shareholders in respect of any meeting of
shareholders for the election of directors of the Company or any other matter,
or any rights whatsoever as shareholders of the Company. If, however, at any
time prior to the expiration or exercise in full of the Warrants, any of the
following events shall occur:
(a) the Company shall declare any dividend payable in any
securities upon its shares of Common Stock or make any distribution
(other than a cash dividend) to the holders of its shares of Common
Stock; or
(b) the Company shall offer to the holders of its shares of
Common Stock any additional shares of Common Stock or Common Stock
Equivalents or any right to subscribe thereto; or
(c) a dissolution, liquidation or winding up of the Company
(other than in connection with a consolidation, merger, or sale of all
or substantially all of its property, assets, and business as an
entirety) shall be proposed;
then, in any one or more of said events, the Company shall give notice
of such event to the Warrantholder. Such giving of notice shall be initiated
(i) at least 25 days prior to the date fixed as a record date or the date of
closing the Company's Stock transfer books for the determination of the
shareholders entitled to such dividend, distribution or subscription rights,
or for the determination of the shareholders entitled to vote on such proposed
dissolution, liquidation or winding up. Such notice shall specify such record
date or the date of closing the stock transfer books, as the case may be.
Failure to provide such notice shall not affect the validity of any action
taken in connection with such dividend, distribution or subscription rights,
or proposed dissolution, liquidation or winding up.
Section 4.02: Lost, Stolen, Mutilated or Destroyed Warrants. If
this warrant certificate is lost, stolen, mutilated or destroyed, the Company
may, on such terms as to indemnify or otherwise as it may in its discretion
impose (which shall, in the case of a mutilated Warrant, include the surrender
thereof), issue a new warrant certificate of like denomination and tenor as,
and in substitution for this Warrant.
Section 4.03: Reservation of Shares.
(a) The Company covenants and agrees that at all times it shall
reserve and keep available for the exercise of this Warrant such number
of authorized shares of Common Stock as are sufficient to permit the
exercise in full of this Warrant.
(b) The Company covenants that all shares of Common Stock issued
on exercise of this Warrant will be validly issued, fully paid,
nonassessable and free of pre-exemptive rights.
Section 4.04: No Fractional Shares. Anything contained herein to
the contrary notwithstanding, the Company shall not be required to issue any
fraction of a share in connection with the exercise of this Warrant, and in
any case where the Warrantholder would, except for the provisions of this
Section 4.04 be entitled under the terms of this Warrant to receive a fraction
of a share upon the exercise of this Warrant, the Company shall, upon the
exercise of this Warrant and receipt of the Exercise Price, issue the number
of whole shares purchasable upon exercise of this Warrant. The Company shall
not be required to make any cash or other adjustment in respect of such
fraction of a share to which the Warrantholder would otherwise be entitled.
ARTICLE V
Treatment of Warrantholder
Section 5.01. Prior to due presentment for registration of transfer of
this Warrant, the Company may deem and treat the Warrantholder as the absolute
owner of this Warrant (notwithstanding any notation of ownership or other
writing hereon) for the purpose of any exercise hereof and for all other
purposes and the Company shall not be affected by any notice to the contrary.
ARTICLE VI
Other Matters
Section 6.01: Expenses of Transfer. The Company will from time to
time promptly pay, subject to the provisions of paragraph (f) of Section 2.02,
all taxes and charges that may be imposed upon the Company in respect to the
issuance or delivery of Warrant Shares upon the exercise of this Warrant by
the Warrantholder.
Section 6.02: Amendments and Waivers. The provision of this
Warrant, including the provisions of this sentence, may not be amended,
modified or supplemented, and waiver or consents to departures from the
provisions hereof may not be given unless the Company has obtained the written
consent of the Warrantholder.
Section 6.03: Governing Law. This Warrant shall be governed by and
construed in accordance with the laws of the State of New York without regard
to any laws that might otherwise govern under applicable principles of
conflicts of laws.
Section 6.04: Severability. In the event that any one or more of
the provisions contained herein, or the application thereof in any
circumstances, is held invalid, illegal or unenforceable, the validity,
legality and enforceability of any such provisions in every other respect and
of the remaining provisions contained herein shall not be affected or impaired
thereby.
Section 6.05 Integration/Entire Agreement. This Warrant is
intended to be a complete and exclusive statement of the agreement and
understanding of the parties hereto in respect of the subject matter contained
herein. There are no restrictions, promises, warranties, or undertakings
other than those set forth or referred to herein. This Warrant supersedes all
prior agreements and understandings between the parties with respect to such
subject matter.
Section 6.06: Notices. Notices or demands pursuant to this Warrant
to be given or made by the Warrantholder to or on the Company shall be
sufficiently given or made if sent (i) by recognized international courier
such as Federal Express or DHL, or (ii) by first class mail, postage prepaid,
addressed, until another address is designated in writing by the Company, as
follows:
Harris & Harris Group, Inc.
One Rockefeller Plaza
14 West 49th Street
New York, NY 10020
With a copy to:
Sutherland Asbill & Brennan LLP
1275 Pennsylvania Avenue, N.W.
Suite 200
Washington, DC 20004-2415
ATTN: Steven B. Boehm
Any action or demand authorized by this Warrant to be given or made by
the Company to or on the Warrantholder shall be sufficiently given or made if
sent (i) by recognized international courier such as Federal Express or DHL,
or (ii) by first class mail, postage prepaid addressed, until another address
is designated in writing, as follows:
Warrantholder
New York, New York 10004
Section 6.07: Headings. The Article headings herein are for
convenience only and are not part of this Warrant and shall not affect the
interpretation thereof.
IN WITNESS WHEREOF, this Warrant has been duly executed by the Company
as of the 26th day of January, 2000.
HARRIS & HARRIS GROUP, INC.
By: /s/ Mel P. Melsheimer
______________________________
Mel P. Melsheimer
President
SUBSCRIPTION FORM
(To be Executed by the Warrantholder if He Desires
to Exercise the Warrant in Whole or in Part)
TO:
The Undersigned ______________________________________
(Name of Warrantholder)
(____________________________)
(Please insert SS# or other identifying
number of subscriber)
hereby irrevocably elects to exercise the right of purchase represented by the
within Warrant for, and to purchase thereunder, _____ shares of Common Stock
provided for therein and tenders payment herewith to the order of Harris &
Harris Group, Inc. in the amount of $___________. The undersigned requests
that certificates for such shares of Common Stock be issued as follows:
Name: _________________________________________________
Address: _________________________________________________
Deliver to: _________________________________________________
Address: _________________________________________________
and, if said number of shares of Common Stock shall not be all the shares of
Common Stock purchasable hereunder, that a new Warrant for the balance
remaining of the shares of Common Stock purchasable under the within Warrant
be registered in the name of, and delivered to, the undersigned at the address
stated below:
Address: _________________________________________________
Date: ___________ __, 200_
Signature: __________________________
Note: The signature of this Subscription must correspond with the
name as written upon the face of this Warrant in every particular
without alteration or enlargement or any change whatsoever.
HARRIS & HARRIS GROUP, INC.
EMPLOYEE PROFIT SHARING PLAN
Effective as of January 1, 2000
Purpose of Plan
The purpose of this Plan is to provide a special incentive for
designated key employees of Harris & Harris Group, Inc., a New York
corporation (the "Company") to increase the future profits of the Company, by
allowing such employees to share in the historical after-tax profits of the
Company as set forth herein.
SECTION 1.
Definitions
As used herein, unless otherwise required by the context, the following
terms shall have these meanings:
"Award" shall mean an award made or due to a Participant pursuant
to the provisions of the Plan.
"Award Percentage" shall mean, with respect to any Participant for
any Plan Year, the percentage established by the Committee for such
Participant for such Plan Year (or, in the case of a Terminating Participant,
for the Plan Year in which the Participant became a Terminating Participant);
provided, however, that the aggregate Award Percentages for all Full
Participants and New Participants for any Plan Year may not exceed 20%. For
the Plan Year beginning January 1, 2000, the Award Percentages shall be as
follows for the following named Participants: Charles E. Harris--13.790%; Mel
P. Melsheimer--4.233%; Rachel M. Pernia--1.524%; Jacqueline M. Matthews--
0.453%. An Award Percentage established for a Plan Year may not be changed
during that Plan Year. Except for the Plan Year commencing January 1, 2000,
the Award Percentages shall be established no later than January 1 of each
Plan Year. In the event that the Award Percentages are not established by
that date, the Award Percentages from the prior Plan Year shall continue to
apply.
"Board" shall mean the board of directors of the Company.
"Cause" shall mean: (1) that an employee has materially failed to
perform the duties and responsibilities of his or her position with the
Company for reasons other than disability or has been insubordinate; (2) that
an employee has violated any securities law or regulation, lost appropriate
required licensing, been convicted of a felony or a crime involving moral
turpitude (regardless of whether involving the Company), or has not complied
to a significant degree with any policy of the Company; or (3) that an
employee has committed any act of fraud, embezzlement, or similar conduct
against the Company or any of its shareholders constituting dishonesty,
intentional breach of fiduciary obligation, or intentional and material
wrongdoing or gross misfeasance or that results in a material economic
detriment to the assets, business, or prospects of the Company or any of its
shareholders. Whether there is Cause for the termination of any person's
employment shall be determined by the chief executive officer or president of
the Company and, with respect to the chief executive officer or president, the
Board.
"Committee" shall mean the Compensation Committee of the Board.
"Fair Market Value" shall mean, with respect to any asset of the
Company, the value thereof most recently determined by the Committee, using
the valuation methodologies set forth in the Company's 10-K or other filings
under the 1940 Act with respect to the determination of the "net asset value"
of the Company's assets, provided, however, that in no event shall this Plan
be interpreted as giving the Committee the power to determine the "net asset
value" of the Company's assets for purposes of the 1940 Act.
"Full Participant" shall mean any Participant who is neither a
Terminating Participant nor a New Participant.
"Net Realized Income" for a Plan Year shall mean the net realized
income of the Company as reflected in the consolidated statement of operations
of the Company for such Plan Year. For greater clarity, such amount shall
include investment income, fee, service, and other income, realized gains and
losses, and operating expenses (including taxes paid or payable by the Company
for such Plan Year), but shall be calculated without regard to dividends paid
or distributions made to shareholders, payments under this Plan, unrealized
gains or losses, and loss carryovers from other years.
"New Participant" shall mean each Participant who begins
participation in the Plan on or after January 1, 2001. A New Participant may
begin participation in the Plan only as of the first day of a Plan Year.
"New Participant Measuring Date" shall mean, with respect to a New
Participant, the last day of the calendar quarter ending on or immediately
prior to the date such person became an employee of the Company.
"1940 Act" shall mean the Investment Company Act of 1940, as
amended.
"Participant" shall mean each person who is or was designated by
the Committee as a participant in the Plan, including each Full Participant,
Terminating Participant, and New Participant.
"Plan" shall mean the Harris & Harris Group, Inc. Employee Profit
Sharing Plan, as amended from time to time.
"Plan Year" shall mean the calendar year.
"Post-Participation Qualifying Income" for any New Participant for
a Plan Year shall mean the Net Realized Income of the Company for such Plan
Year, less the pre-participation nonqualifying gain, if any. With respect to
a New Participant, pre-participation nonqualifying gain is intended to reduce
Net Realized Income by the portion of net after-tax realized gains
attributable to asset values as of such person's New Participant Measuring
Date, and shall be so interpreted. For each New Participant, the pre-
participation nonqualifying gain shall be the aggregate of, with respect to
each portfolio investment position or portion thereof sold or otherwise
disposed of by the Company during the Plan Year (determined on a first-in,
first-out basis): (1) the Fair Market Value as of the respective New
Participant Measuring Date of any such position or portion, minus (2) the sum
of (a) the tax basis of such position or portion as of such date, plus (b) a
portion of the costs of sale or other disposition equal to the ratio of the
excess of (1) above over (2)(a) above, divided by the gain realized by the
Company on the sale or other disposition of such position or portion (ignoring
sale or disposition costs), plus (c) the amount of taxes payable by the
Company for the Plan Year attributable to the excess of (1) above over the sum
of (2)(a) and (b) above, plus (d) an amount equal to the expenses of the
Company for such Plan Year (other than the amount of taxes attributable to
sales or other dispositions of portfolio investment positions or portions
thereof and expenses of such sales or dispositions) multiplied by a fraction
the numerator of which is the excess of (1) above over (2)(a) above and the
denominator of which is the aggregate gross income of the Company for such
Plan Year before expenses and taxes of any sort.
For purposes of this entire definition, any calculation that would
otherwise yield a negative number as the solution to the calculation shall be
deemed to yield an answer of zero.
Solely for purposes of determining the amount of the pre-participation
nonqualifying gain with respect to any New Participant, if the proceeds
received from any sale or other disposition of a portfolio investment position
or portion thereof are less than the Fair Market Value of such position or
portion as of the relevant New Participant Measuring Date, then the Fair
Market Value of such position or portion as of the New Participant Measuring
Date shall be deemed to equal the amount of such proceeds.
In the event that multiple portfolio investment positions (or portions
thereof) are sold or otherwise disposed of during a Plan Year, some of which
are sold or disposed of at a gain and some of which are sold or disposed of at
a loss, for purposes of calculating the pre-participation nonqualifying gain
the aggregate net realized gain, if any, attributable to such sales or
dispositions shall be allocated between or among the gain positions based on
the relative amounts of the gains realized on the gain positions, consistent
with the purpose of this Plan.
"Qualifying Income" shall mean the Net Realized Income of the Company
for such Plan Year, less the nonqualifying gain, if any. Nonqualifying gain
is intended to reduce Net Realized Income by the portion of net after-tax
realized gains attributable to asset values as of September 30, 1997, and
shall be so interpreted. The nonqualifying gain shall be the aggregate of,
with respect to each portfolio investment position or portion thereof sold or
otherwise disposed of by the Company during the Plan Year (determined on a
first-in, first-out basis) and held by the Company on September 30, 1997: (1)
the Fair Market Value as of September 30, 1997 of such position or portion,
minus (2) the sum of (a) the tax basis of such position or portion as of
September 30, 1997, plus (b) a portion of the costs of sale or disposition
equal to the ratio of the excess of (1) over (2)(a) above, divided by the gain
realized by the Company on the sale or other disposition of such position or
portion (ignoring sale or disposition costs), plus (c) the amount of taxes
payable by the Company for the Plan Year attributable to the excess of (1)
above over the sum of (2)(a) and (b) above, plus (d) an amount equal to the
expenses of the Company for such Plan Year (other than the amount of taxes
attributable to sales or other dispositions of portfolio investment positions
or portions thereof and expenses of such sales or dispositions) multiplied by
a fraction the numerator of which is the excess of (1) above over (2)(a) above
and the denominator of which is the aggregate gross income of the Company for
such Plan Year before expenses and taxes of any sort.
For purposes of this entire definition, any calculation (or part
thereof) that would otherwise yield a negative number as the solution to the
calculation (or part) shall be deemed to yield an answer of zero.
For purposes of determining the amount of the nonqualifying gain, if the
proceeds received from any sale or other disposition of a portfolio investment
position or portion thereof are less than the Fair Market Value of such
position or portion as of September 30, 1997, then the Fair Market Value of
such position or portion as of September 30, 1997 shall be deemed to equal
such proceeds.
In the event that multiple portfolio investment positions (or portions
thereof) are sold or otherwise disposed of during a Plan Year, some of which
are sold or disposed of at a gain and some of which are sold or disposed of at
a loss, for purposes of calculating the nonqualifying gain the aggregate net
realized gain, if any, attributable to such sales or dispositions shall be
allocated between or among the gain positions based on the relative amounts of
the gains realized on the gain positions, consistent with the purpose of this
Plan.
"Terminating Participant" shall mean a person whose full
participation in Qualifying Income has been terminated pursuant to this Plan.
Following the action or event in a Plan Year that results in a Participant
becoming a Terminating Participant, the person shall remain a Participant for
that Plan Year and for succeeding Plan Years for purposes of such
Participant's rights to Terminating Qualifying Income. A Terminating
Participant shall cease to be a Participant when all portfolio investments
held by the Company at the time such person became a Terminating Participant
are sold or otherwise disposed of by the Company (determined on a first-in,
first-out basis).
"Terminating Qualifying Income" for any Terminating Participant
for a Plan Year shall mean the Net Realized Income of the Company for such
Plan Year, less the terminating nonqualifying gain, if any. With respect to
any Terminating Participant, terminating nonqualifying gain is intended to
reduce Net Realized Income by the portion of net after-tax realized gains
attributable to increases in asset values after the time such person becomes a
Terminating Participant, as well as by the amount of nonqualifying gain (as
defined in "Qualifying Income"), and shall be so interpreted. For each
Terminating Participant, the terminating nonqualifying gain shall be the
aggregate of:
(1) with respect to all or any portion of any portfolio investment
position sold or otherwise disposed of by the Company during the Plan Year
(determined on a first-in, first-out basis) and held by the Company on
September 30, 1997, (a) (i) the gain realized on such sale or other
disposition (ignoring sale or disposition costs), plus (ii) the excess of the
Fair Market Value of such position or portion as of September 30, 1997 over
the tax basis of such position or portion as of September 30, 1997, minus
(iii) the excess of the Fair Market Value of such position or portion as of
the last day of the quarter ending on or immediately prior to the date such
person became a Terminating Participant over the tax basis of such position or
portion thereof as of such date, minus (b) the sum of (i) a portion of the
costs of sale or other disposition equal to the ratio of (a) above divided by
the gain realized by the Company on the sale or other disposition of such
position or portion (ignoring sale or disposition costs), plus (ii) the amount
of taxes payable by the Company for the Plan Year attributable to the excess
of (a) over (b)(i) above, plus
(2) with respect to all or any portion of any portfolio investment
position sold or otherwise disposed of by the Company during the Plan Year
(determined on a first-in, first-out basis), acquired by the Company after
September 30, 1997, and held by the Company on the date such person became a
Terminating Participant, (a) the gain realized on such sale or other
disposition (ignoring sale or disposition costs), minus the excess of the Fair
Market Value of such position or portion as of the last day of the quarter
ending on or immediately prior to the date such person became a Terminating
Participant over the tax basis of such position or portion as of such date,
minus (b) the sum of (i) a portion of the costs of sale or other disposition
equal to the ratio of (a) above divided by the gain realized by the Company on
the sale or other disposition of such position or portion thereof (ignoring
sale or disposition costs), plus (ii) the amount of taxes payable by the
Company for the Plan Year attributable to the excess of (a) over (b)(i) above,
plus
(3) with respect to all or any portion of any portfolio investment
position sold or otherwise disposed of by the Company during the Plan Year
(determined on a first-in, first-out basis) and acquired by the Company after
the date such person became a Terminating Participant, (a) the gain realized
on such sale or other disposition (ignoring sale or disposition costs), minus
(b) the sum of (i) the costs of sale or other disposition, plus (ii) the
amount of taxes payable by the Company for the Plan Year attributable to such
sale or other disposition, minus
(4) an amount equal to the expenses of the Company for such Plan
Year (other than the amount of taxes attributable to sales or other
dispositions of portfolio investment positions or portions thereof and
expenses of such sales or dispositions) multiplied by a fraction the numerator
of which is the excess of (a) the aggregate net realized gain from the sale or
other disposition of portfolio investment positions or portions thereof
(ignoring sale or disposition costs) over (b) the sum of (1)(a) above, (2)(a)
above, and (3)(a) above and the denominator of which is the aggregate gross
income of the Company for such Plan Year before expenses and taxes of any
sort.
For purposes of this entire definition, any calculation that would
otherwise yield a negative number as the solution to the calculation shall be
deemed to yield an answer of zero.
Solely for purposes of determining the amount of the terminating
nonqualifying gain with respect to any Terminating Participant, (i) if the
proceeds received from any sale or other disposition of a portfolio investment
position or portion thereof are less than the Fair Market Value of such
position or portion as of September 30, 1997, then the Fair Market Value of
such position or portion as of September 30, 1997 shall be deemed to equal the
amount of such proceeds, and (ii) if the proceeds received from any sale or
other disposition of a portfolio investment position or portion thereof are
less than the Fair Market Value of such position or portion as of the last day
of the quarter ending on or immediately prior to the date such person became a
Terminating Participant, then the Fair Market Value of such position or
portion as of the last day of the quarter ending on or immediately prior to
the date such person became a Terminating Participant shall be deemed to equal
the amount of such proceeds.
For purposes of (2) above, in the event the relevant portfolio
investment position or portion thereof was acquired after the last day of the
quarter ending on or immediately prior to the date a person became a
Terminating Participant, the Fair Market Value of such position as of the end
of such quarter shall be the acquisition cost.
In the event that multiple portfolio investment positions (or portions
thereof) are sold or otherwise disposed of during a Plan Year, some of which
are sold or disposed of at a gain and some of which are sold or disposed of at
a loss, for purposes of calculating the terminating nonqualifying gain the
aggregate net realized gain, if any, attributable to such sales or
dispositions shall be allocated between or among the gain positions based on
the relative amounts of the gains realized on the gain positions, consistent
with the purpose of this Plan.
SECTION 2.
Amount of Award; Payment of Award
As soon as practicable following the end of each Plan Year, the
Committee shall determine whether, and if so, how much, Qualifying Income
exists with respect to such Plan Year and whether, and if so, how much,
Terminating Qualifying Income or Post-Participation Qualifying Income exists
with respect to any Terminating Participant or New Participant. The Committee
shall make a provisional determination, based on accruals provided by
management, within 45 days after the end of each Plan Year.
Not later than 60 days after the end of each Plan Year the Company shall
pay (1) to each Full Participant an Award in an amount equal to the product of
(a) 90% of the estimated Qualifying Income for such Plan Year, multiplied by
(b) such Full Participant's Award Percentage, (2) to each Terminating
Participant an Award in an amount equal to the product of (a) 90% of the
estimated Terminating Qualifying Income for such Terminating Participant for
such Plan Year, multiplied by (b) such Terminating Participant's Award
Percentage, and (3) to each New Participant an Award in an amount equal to the
product of (a) 90% of the estimated Post-Participation Qualifying Income for
such New Participant for such Plan Year, multiplied by (b) such New
Participant's Award Percentage. Not later than 45 days after the filing of
the Company's federal income tax return, the Committee shall finalize the
foregoing determinations and pay to the Participants any remaining Award
amounts owed to the Participants, determined under principles consistent with
the preceding sentence. In the event that any portion of the maximum amount
payable under this Plan for a Plan Year is not required to be paid pursuant to
the foregoing provisions (because a Participant has become a Terminating
Participant or has been terminated for Cause or because of the participation
in the Plan of New Participants), the remaining portion of such maximum amount
shall be paid to the eligible Participants (other than (1) any Terminating
Participants or (2) any New Participants who have participated in the Plan for
less than three years) based on their relative Award Percentages, provided,
however, that the aggregate amount payable to all Participants for a Plan Year
shall not exceed 20% of the Qualifying Income for the Plan Year. In the event
that the aggregate amount of all Awards payable for any Plan Year shall be
greater than 20% of the Qualifying Income for such Plan Year (a "Plan
prohibited payment"), each Participant's Award for such Plan Year shall be
reduced, pro-rata, by the minimum amount necessary to allow the aggregate
Awards for such Plan Year not to constitute a Plan prohibited payment. If
such a reduction is necessary, each Participant shall unconditionally forfeit
the amount of any reduction made pursuant to this paragraph.
Upon the termination of employment of any Full Participant or New
Participant for any reason other than termination by the Company for Cause,
such Full Participant or New Participant shall become a Terminating
Participant. In the event a New Participant becomes a Terminating
Participant, the definition of Terminating Qualifying Income shall be modified
by substituting such Participant's New Participant Measuring Date for
September 30, 1997, wherever the latter date appears in such definition. That
substitution is intended to ensure that such a Terminating Participant does
not share in any net after-tax realized gains attributable to asset values as
of such person's New Participant Measuring Date, and the provisions of this
Plan shall be so interpreted. If the employment of any Participant is
terminated for Cause, such former employee shall cease to be a Participant and
any Awards not yet paid to or earned by such person shall automatically be
forfeited.
Notwithstanding any other provision of the Plan, in no event shall the
aggregate amount of all Awards payable for any Plan Year during which the
Company remains a "business development company" within the meaning of the
1940 Act be greater than the maximum percentage of the Company's "net income
after taxes" (within the meaning of Section 57(n)(1)(B) of the 1940 Act or any
successor provision thereto) permitted to be paid as profit sharing under the
1940 Act or other applicable law. In the event that any portion of any Award
may not be paid pursuant to the limitation set forth in the preceding sentence
(a "1940 Act prohibited payment"), each Participant's Award for such Plan Year
shall be reduced, pro-rata, by the minimum amount necessary to allow the
aggregate Awards for such Plan Year not to constitute a 1940 Act prohibited
payment. If such a reduction is necessary, each Participant shall
unconditionally forfeit the amount of any reduction made pursuant to this
paragraph.
Further, notwithstanding any provision of this Plan to the contrary, in
the case of any Participant for any Plan Year, no Award of more than the
excess of $1,000,000 over the amount of other compensation paid by the Company
to such Participant for such Plan Year (after any Award reduction described in
this Section 2) shall be paid unless and until the shareholders of the Company
have approved the making of such Awards pursuant to the requirements of
Section 162(m) of the Internal Revenue Code of 1986, as amended.
SECTION 3.
Administration
The Plan shall be administered by the Committee with decisions taken in
accordance with its normal procedures. Members of the Committee shall not be
liable for any acts or omissions to act in the administration of the Plan.
A secretary selected by the Committee shall keep full and accurate
minutes of all meetings and records of the actions of the Committee, and these
minutes and records shall be at all times open to inspection by the members of
the Board. The secretary shall periodically transmit to the Board certified
copies of any statements or schedules prepared in connection with the
administration of the Plan.
SECTION 4.
Amendment, Termination or Modification of the Plan
The Plan at any time and for any reason may be modified, amended, or
terminated by the Committee (subject to the approval of the Board); provided,
however, that no such amendment, modification, or termination of the Plan
shall adversely affect the Award rights of any Participant for or during such
Plan Year (or any subsequent Plan Year) unless such Participant has consented
in writing to such action. Nothing in this Plan shall preclude the Committee
from, for any Plan Year subsequent to the current Plan Year, naming additional
Participants in the Plan or changing the Award Percentage of any Full
Participant or New Participant (subject to the overall percentage limitations
contained herein).
SECTION 5.
General Provisions
Compliance with Legal Requirements. The Plan and the granting and
payment of Awards, and the other obligations of the Company under the Plan
shall be subject to all applicable federal and state laws, rules, and
regulations, and to such approvals by any regulatory or governmental agency as
may be required.
Nontransferability. Awards not yet earned shall not be transferable or
subject to assignment or alienation under any circumstances. Awards earned
but not yet paid shall not be transferable by a Participant except by will or
the laws of descent and distribution.
No Right to Continued Employment. Nothing in the Plan or in any Award
granted or other agreement entered into pursuant hereto shall confer upon any
Participant the right to continue in the employ of the Company or to be
entitled to any remuneration or benefits not set forth in the Plan or other
agreement or to interfere with or limit in any way the right of the Company to
terminate such Participant's employment.
Withholding Taxes. Where a Participant or other person is entitled to
receive a cash payment pursuant to an Award hereunder, the Company shall have
the right to withhold any taxes or to require the Participant or such other
person to pay to the Company the amount of any taxes that the Company may be
required to withhold before delivery to such Participant or other person of
such payment.
Unfunded Status of Awards. The Plan is intended to constitute an
"unfunded" plan for incentive and deferred compensation. With respect to any
payments not yet made to a Participant pursuant to an Award, nothing contained
in the Plan or any Award shall give any such Participant any rights that are
greater than those of a general creditor of the Company.
Governing Law. The Plan and all determinations made and actions taken
pursuant hereto to the extent not governed by federal law shall be governed by
the laws of the State of New York without giving effect to the conflict of
laws principles thereof.
Effective Date. The Plan shall be effective as of January 1, 2000.
Beneficiary. A Participant may file with the Committee a written
designation of a beneficiary on such form as may be prescribed by the
Committee and may, from time to time, amend or revoke such designation. If no
designated beneficiary survives the Participant, the executor or administrator
of the Participant's estate shall be deemed to be the Participant's
beneficiary.
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to use of our
report dated March 20, 2000 included in this Form 10-K. It should be noted
that we have not audited any financial statements of the company subsequent
to December 31, 1999 or performed any audit procedures subsequent to the
date of our report.
/s/Arthur Andersen LLP
----------------------
New York, New York
March 20, 1999
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
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<S> <C>
<PERIOD TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<INVESTMENTS-AT-COST> 16,653,130
<INVESTMENTS-AT-VALUE> 63,535,651
<RECEIVABLES> 76,852
<ASSETS-OTHER> 1,575,009
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<REALIZED-GAINS-CURRENT> 10,976,714
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<NET-CHANGE-FROM-OPS> 37,081,381
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<NET-CHANGE-IN-ASSETS> 31,078,096
<ACCUMULATED-NII-PRIOR> 0
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<AVERAGE-NET-ASSETS> 38,095,757
<PER-SHARE-NAV-BEGIN> 2.13
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