UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ____________________
Commission File No. 0-11576
HARRIS & HARRIS GROUP, INC.(R)
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(Exact Name of Registrant as 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)
111 West 57th Street, New York, New York 10019
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 582-0900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
None N/A
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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 if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. |_|Yes |X| No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. |_|Yes |X| No
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. |X|Yes |_| 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|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer.
Large accelerated filer |_| Accelerated filer |X| Non-accelerated Filer |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). |_|Yes |X| No
The aggregate market value of the common stock held by non-affiliates of
Registrant as of June 30, 2005 was $190,859,810 based on the last sale price as
quoted by the Nasdaq National Market on such date (only officers and directors
are considered affiliates for this calculation).
As of March 10, 2006, the registrant had 20,756,345 shares of common
stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE INCORPORATED AT
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Harris & Harris Group, Inc. Proxy Statement for the Part III, Items 10, 11,
2006 Annual Meeting of Shareholders 12 and 14
TABLE OF CONTENTS
Page
PART I
Item 1. Business ................................................ 1
Item 1A. Risk Factors ............................................ 14
Item 1B. Unresolved Staff Comments ............................... 24
Item 2. Properties .............................................. 24
Item 3. Legal Proceedings ....................................... 25
Item 4. Submission of Matters to a Vote of Security Holders ..... 25
PART II
Item 5. Market For Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchase of
Equity Securities .................................. 26
Item 6. Selected Financial Data ................................. 28
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................ 29
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk .............................................. 43
Item 8. Consolidated Financial Statements
and Supplementary Data ............................. 45
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ..................... 81
Item 9A. Controls and Procedures ................................. 81
Item 9B. Other Information ....................................... 82
PART III
Item 10. Directors and Executive Officers of the Registrant ...... 83
Item 11. Executive Compensation .................................. 83
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters ..... 83
Item 13. Certain Relationships and Related Transactions .......... 83
Item 14. Principal Accountant Fees and Services .................. 83
PART IV
Item 15. Exhibits and Financial Statements Schedules ............. 84
Signatures ....................................................... 87
Exhibit Index .................................................... 89
PART I
Item 1. Business
Harris & Harris Group, Inc.(R) (the "Company," "us," "our," and "we"), is
a venture capital company specializing in tiny technology that operates as a
non-diversified business development company ("BDC") under the Investment
Company Act of 1940, which we refer to as the 1940 Act. For tax purposes, we
have elected to be a regulated investment company ("RIC") under Subchapter M of
the Internal Revenue Code of 1986, which we refer to as the Code. Our investment
objective is to achieve long-term capital appreciation, rather than current
income, by making venture capital investments in early-stage companies. Our
investment approach is comprised of a patient examination of available
opportunities, thorough due diligence and close involvement with management. As
a venture capital company, we invest in and provide managerial assistance to our
portfolio companies which, in our opinion, have significant potential for
growth. We are managed by our Board of Directors and officers and have no
investment advisor.
We make initial venture capital investments exclusively in "tiny
technology," which we define as microsystems, microelectromechanical systems
("MEMS") and nanotechnology. We consider a company to be a tiny technology
company if the company employs or intends to employ technology that we consider
to be at the microscale or smaller and if the employment of that technology is
material to its business plan. Our portfolio includes non-tiny technology
investments made prior to 2001, and we may make follow-on investments in either
tiny or non-tiny technology portfolio companies. By making these investments, we
seek to provide our shareholders with an increasingly specific focus on tiny
technology through a portfolio of venture capital investments that address a
variety of markets and products, such as materials, electronics, instruments,
medical devices and biotechnology. This investment policy is not a fundamental
policy and accordingly may be changed without shareholder approval, although we
intend to give shareholders at least 60 days prior notice of any change in our
policy.
Tiny technology is multidisciplinary and widely applicable, and it
incorporates technology that was not previously in widespread use. Microsystems
are measured in micrometers, which are units of measurement in millionths of a
meter. Nanotechnology is measured in nanometers, which are units of measurement
in billionths of a meter. Because it is a new field, tiny technology has
significant scientific, engineering and commercialization risks.
Our website is www.TinyTechVC.com. We make available free of charge
through our website: our annual report on Form 10-K; our quarterly reports on
Form 10-Q; our current reports on Form 8-K; and amendments to those reports as
soon as reasonably practicable after filing or furnishing such materials to the
Securities and Exchange Commission.
Neither our investments, nor an investment in us, is intended to
constitute a balanced investment program. We expect to be risk seeking rather
than risk averse in our investment approach. To such end, we reserve the fullest
possible freedom of action, subject to our certificate of incorporation,
applicable law and regulations, and policy statements contained herein. There is
no assurance that our investment objective will be achieved.
1
We expect to invest a substantial or major portion of our assets in
securities that we consider to be venture capital investments. These venture
capital investments usually do not pay interest or dividends and usually are
subject to legal or contractual restrictions on resale that may adversely affect
the liquidity and marketability of such securities.
We expect to make speculative venture capital investments with limited
marketability and a greater risk of investment loss than less speculative
venture capital issues. Although we currently restrict our initial venture
capital investments to tiny technology, such technology is enabling technology
applicable to a wide range of fields and businesses, and we do not seek to
invest in any particular industries or categories of investments. Our securities
investments may consist of private, public or governmental issuers of any type.
Subject to the diversification requirements applicable to a RIC, we may commit
all of our assets to only a few investments.
Achievement of our investment objectives is basically dependent upon the
judgment of a team of five professional, full-time members of management, four
of whom are designated as Managing Directors, Charles E. Harris, Douglas W.
Jamison, Daniel V. Leff and Alexei A. Andreev, and a Vice President, Daniel B.
Wolfe. Two of our directors are also consultants to us, Kelly S. Kirkpatrick and
Lori D. Pressman. They collectively have expertise in venture capital investing,
intellectual property and nanotechnology. Charles E. Harris is our Chairman and
Chief Executive Officer and a "control" person as defined in the 1940 Act. There
can be no assurance that a suitable replacement could be found for Mr. Harris
upon his retirement, his resignation, his inability to act on our behalf or in
the event of his death. On December 31, 2008, Mr. Harris will be subject to
mandatory retirement pursuant to the Company's mandatory retirement policy for
senior executives. The Board of Directors may extend the mandatory retirement
age for a given senior executive from year to year.
Subject to continuing to meet the tests applicable to BDCs, there are no
limitations on the types of securities or other assets in which we may invest.
Investments may include the following:
o Equity, equity-related securities (including warrants) and debt with
equity features from either private or public issuers.
o Venture capital investments, whether in corporate, partnership or
other form, including development stage or start-up entities.
o Intellectual property or patents or research and development in
technology or product development that may lead to patents or other
marketable technology.
o Debt obligations of all types having varying terms with respect to
security or credit support, subordination, purchase price, interest
payments and maturity.
o Foreign securities.
o Miscellaneous investments.
2
Investments and Strategies
The following is a summary description of the types of assets in which we
may invest, the investment strategies we may utilize and the attendant risks
associated with our investments and strategies.
Equity, Equity-Related Securities and Debt with Equity Features
We may invest in equity, equity-related securities and debt with equity
features. These securities include common stock, preferred stock, debt
instruments convertible into common or preferred stock, limited partnership
interests, other beneficial ownership interests and warrants, options or other
rights to acquire any of the foregoing.
We may make investments in companies with operating histories that are
unprofitable or marginally profitable, that have negative net worth or that are
involved in bankruptcy or reorganization proceedings. These investments would
involve businesses that management believes have turnaround potential through
the infusion of additional capital and management assistance. In addition, we
may make investments in connection with the acquisition or divestiture of
companies or divisions of companies. There is a significantly greater risk of
loss with these types of securities than is the case with traditional investment
securities.
We may also invest in publicly traded securities of whatever nature,
including relatively small, emerging growth companies that management believes
have long-term growth possibilities.
Warrants, options and convertible or exchangeable securities generally
give the investor the right to acquire specified equity securities of an issuer
at a specified price during a specified period or on a specified date. Warrants
and options fluctuate in value in relation to the value of the underlying
security and the remaining life of the warrant or option, while convertible or
exchangeable securities fluctuate in value both in relation to the intrinsic
value of the security without the conversion or exchange feature and in relation
to the value of the conversion or exchange feature, which is like a warrant or
option. When we invest in these securities, we incur the risk that the option
feature will expire worthless, thereby either eliminating or diminishing the
value of our investment.
Investments in equity securities of private companies involve securities
that are restricted as to sale and cannot be sold in the open market without
registration under the Securities Act of 1933 or pursuant to a specific
exemption from these registrations. Opportunities for sale are more limited than
in the case of marketable securities, although these investments may be
purchased at more advantageous prices and may offer attractive investment
opportunities. Even if one of our portfolio companies completes an initial
public offering, we are typically subject to a lock-up agreement for 180 days,
and the stock price may decline substantially before we are free to sell. Even
if we have registration rights to make our investments more marketable, a
considerable amount of time may elapse between a decision to sell or register
the securities for sale and the time when we are able to sell the securities.
The prices obtainable upon sale may be adversely affected by market conditions
or negative conditions affecting the issuer during the intervening time. We may
elect to hold formerly restricted securities after they have become freely
marketable, either because they remain relatively illiquid or because we believe
that they may appreciate in value, during which holding period they may decline
in value and be especially volatile as unseasoned securities. If we need funds
for investment or working capital purposes, we might sell marketable securities
at disadvantageous times or prices.
3
Venture Capital Investments
We define venture capital as the money and resources made available to
start-up firms and small businesses with exceptional growth potential. We expect
our venture capital investments to be largely in development stage or start-up
businesses. Substantially all of our long-term venture capital investments are
in thinly capitalized, unproven, small companies focused on risky technologies.
These businesses also tend to lack management depth, to have limited or no
history of operations and to have not attained profitability. Because of the
speculative nature of these investments, these securities have a significantly
greater risk of loss than traditional investment securities. Some of our venture
capital investments will be complete losses or unprofitable, and some will never
realize their potential.
We may own 100 percent of the securities of a start-up investment for a
period of time and may control the company for a substantial period. Start-up
companies are more vulnerable than better capitalized companies to adverse
business or economic developments. Start-up businesses generally have limited
product lines, markets and/or financial resources. Start-up companies are not
well-known to the investing public and are subject to potential bankruptcy,
general movements in markets and perceptions of potential growth.
In connection with our venture capital investments, we may participate in
providing a variety of services to our portfolio companies, including the
following:
o recruiting management;
o formulating operating strategies;
o formulating intellectual property strategies;
o assisting in financial planning;
o providing management in the initial start-up stages; and
o establishing corporate goals.
We may assist in raising additional capital for these companies from other
potential investors and may subordinate our own investment to that of other
investors. We typically find it necessary or appropriate to provide additional
capital of our own. We may introduce these companies to potential joint venture
partners, suppliers and customers. In addition, we may assist in establishing
relationships with investment bankers and other professionals. We may also
assist with mergers and acquisitions. We do not derive income from these
companies for the performance of any of the above services.
4
We may control, be represented on, or have observer rights on the board of
directors of a portfolio company through one or more of our officers or
directors, who may also serve as officers of the portfolio company. We indemnify
our officers and directors for serving on the boards of directors or as officers
of portfolio companies, which exposes us to additional risks. Particularly
during the early stages of an investment, we may in effect be conducting the
operations of the portfolio company. As a venture capital backed company emerges
from the developmental stage with greater management depth and experience, we
expect that our role in the portfolio company's operations will diminish. Our
goal is to assist each company in establishing its own independent
capitalization, management and board of directors. We expect to be able to
reduce our involvement in those start-up companies that become successful, as
well as in those start-up companies that fail.
Intellectual Property
We believe there is a role for organizations that can assist in technology
transfer. Scientists and institutions that develop and patent intellectual
property perceive the need for and rewards of entrepreneurial commercialization
of their inventions.
Our form of investment may be:
o funding research and development in the development of a technology;
o obtaining licensing rights to intellectual property or patents;
o acquiring intellectual property or patents; or
o forming and funding companies or joint ventures to commercialize
further intellectual property.
Income from our investments in intellectual property or its development
may take the form of participation in licensing or royalty income, fee income,
or some other form of remuneration. In order to satisfy RIC requirements, these
investments will normally be held in an entity taxable as a corporation.
Investment in developmental intellectual property rights involves a high degree
of risk that can result in the loss of our entire investment as well as
additional risks including uncertainties as to the valuation of an investment
and potential difficulty in liquidating an investment. Further, investments in
intellectual property generally require investor patience, as investment return
may be realized only after or over a long period. At some point during the
commercialization of a technology, our investment may be transformed into
ownership of securities of a development stage or start-up company as discussed
under "Venture Capital Investments" above.
Debt Obligations
We may hold debt securities for income and as a reserve pending more
speculative investments. Debt obligations may include U.S. government and
government agency securities, commercial paper, bankers' acceptances,
receivables or other asset-based financing, notes, bonds, debentures, or other
debt obligations of any nature and repurchase agreements related to these
securities. These obligations may have varying terms with respect to security or
credit support, subordination, purchase price, interest payments and maturity
from private, public or governmental issuers of any type located anywhere in the
world. We may invest in debt obligations of companies with operating histories
that are unprofitable or marginally profitable, that have negative net worth or
are involved in bankruptcy or reorganization proceedings, or that are start-up
or development stage entities. In addition, we may participate in the
acquisition or divestiture of companies or divisions of companies through
issuance or receipt of debt obligations.
5
It is likely that our investments in debt obligations will be of varying
quality, including non-rated, highly speculative debt investments with limited
marketability. Investments in lower-rated and non-rated securities, commonly
referred to as "junk bonds," are subject to special risks, including a greater
risk of loss of principal and non-payment of interest. Generally, lower-rated
securities offer a higher return potential than higher-rated securities, but
involve greater volatility of price and greater risk of loss of income and
principal, including the possibility of default or bankruptcy of the issuers of
these securities. Lower-rated securities and comparable non-rated securities
will likely have large uncertainties or major risk exposure to adverse
conditions and are predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms of the
obligation. The occurrence of adverse conditions and uncertainties to issuers of
lower-rated securities would likely reduce the value of lower-rated securities
held by us, with a commensurate effect on the value of our shares.
The markets in which lower-rated securities or comparable non-rated
securities are traded generally are more limited than those in which
higher-rated securities are traded. The existence of limited markets for these
securities may restrict our ability to obtain accurate market quotations for the
purposes of valuing lower-rated or non-rated securities and calculating net
asset value or to sell securities at their fair value. Any economic downturn
could adversely affect the ability of issuers' lower-rated securities to repay
principal and pay interest thereon. The market values of lower-rated and
non-rated securities also tend to be more sensitive to individual corporate
developments and changes in economic conditions than higher-rated securities. In
addition, lower-rated securities and comparable non-rated securities generally
present a higher degree of credit risk. Issuers of lower-rated securities and
comparable non-rated securities are often highly leveraged and may not have more
traditional methods of financing available to them, so that their ability to
service their debt obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of loss owing to
default by these issuers is significantly greater because lower-rated securities
and comparable non-rated securities generally are unsecured and frequently are
subordinated to the prior payment of senior indebtedness. We may incur
additional expenses to the extent that we are required to seek recovery upon a
default in the payment of principal or interest on our portfolio holdings.
The market value of investments in debt securities that carry no equity
participation usually reflects yields generally available on securities of
similar quality and type at the time purchased. When interest rates decline, the
market value of a debt portfolio already invested at higher yields can be
expected to rise if the securities are protected against early call. Similarly,
when interest rates increase, the market value of a debt portfolio already
invested at lower yields can be expected to decline. Deterioration in credit
quality also generally causes a decline in market value of the security, while
an improvement in credit quality generally leads to increased value.
6
Foreign Securities
We may make investments in securities of issuers whose principal
operations are conducted outside the United States, and whose earnings and
securities are stated in foreign currency. In order to maintain our status as a
business development company, our investments in the stocks of companies
organized outside the U.S. would be limited to 30 percent of our assets, because
we must invest at least 70 percent of our assets in "qualifying assets" and
foreign companies are not "qualifying assets." At this time, we do not
anticipate investing a significant portion of our assets in foreign companies.
Compared to otherwise comparable investments in securities of U.S.
issuers, currency exchange risk of securities of foreign issuers is a
significant variable. The value of these investments to us will vary with the
relation of the currency in which they are denominated to the U.S. dollar, as
well as with intrinsic elements of value such as credit risk, interest rates and
performance of the issuer. Investments in foreign securities also involve risks
relating to economic and political developments, including nationalization,
expropriation of assets, currency exchange freezes and local recession.
Securities of many foreign issuers are less liquid and more volatile than those
of comparable U.S. issuers. Interest and dividend income and capital gains on
our foreign securities may be subject to withholding and other taxes that may
not be recoverable by us. We may seek to hedge all or part of the currency risk
of our investments in foreign securities through the use of futures, options and
forward currency purchases or sales.
Borrowing and Margin Transactions
We may from time to time borrow money or obtain credit by any lawful means
from banks, lending institutions, other entities or individuals, in negotiated
transactions. We may issue, publicly or privately, bonds, debentures or notes,
in series or otherwise, with interest rates and other terms and provisions,
including conversion rights, on a secured or unsecured basis, for any purpose,
up to the maximum amounts and percentages permitted for business development
companies under the 1940 Act. The 1940 Act currently prohibits us from borrowing
any money or issuing any other senior securities (other than preferred stock and
other than temporary borrowings of up to five percent of our assets), if in
giving effect to the borrowing or issuance, the value of our total assets would
be less than 200 percent of our total liabilities (other than liabilities not
constituting senior securities). We may pledge assets to secure any borrowings.
We currently have no leverage and have no current intention to issue preferred
stock.
A primary purpose of our borrowing power is for leverage, to increase our
ability to acquire investments both by acquiring larger positions and by
acquiring more positions. Borrowings for leverage accentuate any increase or
decrease in the market value of our investments and thus our net asset value.
Because any decline in the net asset value of our investments will be borne
first by holders of common stock, the effect of leverage in a declining market
would be a greater decrease in net asset value applicable to the common stock
than if we were not leveraged. Any decrease would likely be reflected in a
decline in the market price of our common stock. To the extent the income
derived from assets acquired with borrowed funds exceeds the interest and other
expenses associated with borrowing, our total income will be greater than if
borrowings were not used. Conversely, if the income from assets is not
sufficient to cover the borrowing costs, our total income will be less than if
borrowings were not used. If our current income is not sufficient to meet our
borrowing costs (repayment of principal and interest), we might have to
liquidate some or all of our investments when it may be disadvantageous to do
so. Our borrowings for the purpose of buying most liquid equity securities will
be subject to the margin rules, which require excess liquid collateral marked to
market daily. If we are unable to post sufficient collateral, we will be
required to sell securities to remain in compliance with the margin rules. These
sales might be at disadvantageous times or prices.
7
Repurchase of Shares
Our shareholders do not have the right to compel us to redeem our shares.
We may, however, purchase outstanding shares of our common stock from time to
time, subject to approval of our board of directors and compliance with
applicable corporate and securities laws. The board of directors may authorize
purchases from time to time when they are deemed to be in the best interests of
our shareholders, but could do so only after notification to shareholders. The
board of directors may or may not decide to undertake any purchases of our
common stock.
Our repurchases of our common shares would decrease our total assets and
would therefore likely have the effect of increasing our expense ratio. Subject
to our investment restrictions, we may borrow money to finance the repurchase of
our common stock in the open market pursuant to any tender offer. Interest on
any borrowings to finance share repurchase transactions will reduce our net
assets. If, because of market fluctuations or other reasons, the value of our
assets falls below the required 1940 Act coverage requirements, we may have to
reduce our borrowed debt to the extent necessary to comply with the requirement.
To achieve a reduction, it is possible that we may be required to sell portfolio
securities at inopportune times when it may be disadvantageous to do so. Since
1998, we have repurchased a total of 1,828,740 shares of our common stock at a
total cost of $3,405,531, or $1.86 per share. Because we intend to continue
investing in tiny technology, our board of directors does not currently intend
to authorize the purchase of additional shares of our common stock.
Portfolio Company Turnover
Changes with respect to portfolio companies will be made as our management
considers necessary in seeking to achieve our investment objective. The rate of
portfolio turnover will not be treated as a limiting or relevant factor when
circumstances exist, which are considered by management to make portfolio
changes advisable.
Although we expect that many of our investments will be relatively long
term in nature, we may make changes in our particular portfolio holdings
whenever it is considered that an investment no longer has substantial growth
potential or has reached its anticipated level of performance, or (especially
when cash is not otherwise available) that another investment appears to have a
relatively greater opportunity for capital appreciation. We may also make
general portfolio changes to increase our cash to position us in a defensive
posture. We may make portfolio changes without regard to the length of time we
have held an investment, or whether a sale results in profit or loss, or whether
a purchase results in the reacquisition of an investment which we may have only
recently sold. Our investments in privately held companies are illiquid, which
limits portfolio turnover.
8
The portfolio turnover rate may vary greatly from year to year as well as
during a year and may also be affected by cash requirements.
Competition
Numerous companies and individuals are engaged in the venture capital
business, and such business is intensely competitive. We believe the perpetual
nature of our corporate structure enables us to be a better long-term partner
for our portfolio companies than if we were organized as a traditional private
equity fund, which typically has a limited life. Although we have recently been
one of the more active venture capital firms in making tiny technology
investments, and our investment professionals have scientific and intellectual
property expertise that is relevant to investing in tiny technology, many of our
competitors have significantly greater financial and other resources and
managerial capabilities than we do and are therefore in certain respects in a
better position than we are to obtain access to attractive venture capital
investments, particularly as a lead investor in capital-intensive companies.
There can be no assurance that we will be able to compete against these venture
capital businesses for attractive investments, particularly as a lead investor
in capital-intensive companies.
Regulation
The Small Business Investment Incentive Act of 1980 added the provisions
of the 1940 Act applicable to business development companies ("BDCs"). BDCs are
a special type of investment company. After a company files its election to be
treated as a BDC, it 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 BDCs,
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 making significant managerial
assistance available to companies that 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 Securities Exchange Act of 1934; (iii)
operate for the purpose of investing in the securities of certain types of
portfolio companies, namely, early stage 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; and (v) 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 portfolio company).
9
We may be periodically examined by the SEC for compliance with the 1940
Act.
As with other companies regulated by the 1940 Act, a BDC must adhere to
certain substantive regulatory requirements. A majority of the directors must be
persons who are not interested persons, as that term is defined in the 1940 Act.
Additionally, we are required to provide and maintain a bond issued by a
reputable fidelity insurance company to protect the BDC. Furthermore, as a BDC,
we are prohibited from protecting any director or officer against any liability
to us or our shareholders arising from willful malfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of such
person's office.
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 our assets consist of
qualifying assets. Qualifying assets include: (i) securities of companies that
were eligible portfolio companies at the time we acquired their securities; (ii)
securities of bankrupt or insolvent companies that were eligible portfolio
companies at the time of our 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.
We are permitted by the 1940 Act, under specified conditions, to issue
multiple classes of senior debt and a single class of preferred stock if our
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 our net assets). Under specific conditions, we are also
permitted by the 1940 Act to issue warrants.
Except under certain conditions, we may sell our securities at a price
that is below the prevailing net asset value per share only after a majority of
our disinterested directors have determined that such sale would be in the best
interest of us and our stockholders and upon the approval by the holders of a
majority of our 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 our 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 our 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 us and our portfolio companies.
10
Subchapter M Status
We elected to be treated as a regulated investment company (a "RIC"),
taxable under Subchapter M of the Internal Revenue Code (the "Code"), for
federal income tax purposes. In general, a RIC is not taxable on its income or
gains to the extent it distributes such income or gains to its shareholders. In
order to qualify as a RIC, we must, in general, (1) annually derive at least 90
percent of our gross income from dividends, interest and gains from the sale of
securities and similar sources (the "Income Source Rule"); (2) quarterly meet
certain investment asset diversification requirements; and (3) annually
distribute at least 90 percent of our investment company taxable income as a
dividend (the "Income Distribution Rule"). Any taxable investment company income
not distributed will be subject to corporate level tax. Any taxable investment
company income distributed generally will be taxable to shareholders as dividend
income.
In addition to the requirement that we must annually distribute at least
90 percent of our investment company taxable income, we may either distribute or
retain our realized net capital gains from investments, but any net capital
gains not distributed may be subject to corporate level tax. It is our current
intention not to distribute net capital gains. Any net capital gains distributed
generally will be taxable to shareholders as long-term capital gains.
In lieu of actually distributing our realized net capital gains, we as a
RIC may retain all or part of our net capital gains and elect to be deemed to
have made a distribution of the retained portion to our shareholders under the
"designated undistributed capital gain" rules of the Code. We currently intend
to retain and designate all of our net capital gains. In this case, the "deemed
dividend" generally is taxable to our shareholders as long-term capital gains.
Although we pay tax at the corporate rate on the amount deemed to have been
distributed, our shareholders receive a tax credit equal to their proportionate
share of the tax paid and an increase in the tax basis of their shares by the
amount per share retained by the Company.
To the extent that we declare a deemed dividend, each shareholder will
receive an IRS Form 2439 that will reflect each shareholder's receipt of the
deemed dividend income and a tax credit equal to each shareholder's
proportionate share of the tax paid by us. This tax credit, which is paid at the
corporate rate, is often credited at a higher rate than the actual tax due by a
shareholder on the deemed dividend income. The "residual" credit can be used by
the shareholder to offset other taxes due in that year or to generate a tax
refund to the shareholder. Tax exempt investors may file for a refund. (See Item
7. "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Recent Developments - Subchapter M Status" and "Note 6 of Notes to
Consolidated Financial Statements" contained in Item 8. "Consolidated Financial
Statements and Supplementary Data.")
The following simplified examples illustrate the tax treatment under
Subchapter M of the Code for us and our individual shareholders with regard to
three possible distribution alternatives, assuming a net capital gain of $1.00
per share, consisting entirely of sales of non-real property assets held for
more than 12 months.
11
Under Alternative A: 100 percent of net capital gain declared as a cash
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
federal tax at a rate not in excess of 15 percent* or $.15 per
share, retaining $.85 per share.
3. Non-taxable shareholders that file a federal tax return receive a
$1.00 per share dividend and pay no federal tax, retaining $1.00 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 federal capital gains tax at a rate not in
excess of 15 percent* on 100 percent of the undistributed gain of
$1.00 per share or $.15 per share in tax. Offsetting this tax,
shareholders receive a tax credit equal to 35 percent of the
undistributed gain or $.35 per share.
3. Non-taxable shareholders that file a federal tax return receive a
tax refund equal to $0.35 per share.
*Assumes all capital gains qualify for long-term rates of 15 percent.
Under Alternative C: 100 percent of net capital gain retained by the
Company, with no designated undistributed capital gain or deemed dividend:
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.
Although we may retain income and gains subject to the limitations
described above (including paying corporate level tax on such amounts), we could
be subject to an additional four percent excise tax if we fail to distribute 98
percent of our aggregate annual taxable income.
As noted above, in order to qualify as a RIC, we must meet certain
investment asset diversification requirements each quarter. Because of the
specialized nature of our investment portfolio, we have been able to satisfy the
diversification requirements under Subchapter M of the Code primarily as a
result of receiving certifications from the SEC under the Code with respect to
each taxable year beginning after 1998 that we were "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" for such year.
12
Although we received SEC certifications for 1999-2004, there can be no
assurance that we will receive such certification for 2005 or subsequent years
(to the extent we need additional certifications as a result of changes in our
portfolio). If we require, but fail to obtain, the SEC certification for a
taxable year, we may fail to qualify as a RIC for such year. We will also fail
to qualify as a RIC for a taxable year if we do not satisfy the Income Source
Rule or Income Distribution Rule for such year. In the event we do not qualify
as a RIC for any taxable year, we will be subject to federal tax with respect to
all of our taxable income, whether or not distributed. In addition, all our
distributions to shareholders in that situation generally will be taxable as
ordinary dividends.
Although we generally intend to qualify as a RIC for each taxable year,
under certain circumstances we may choose to take action with respect to one or
more taxable years to ensure that we would be taxed under Subchapter C of the
Code (rather than Subchapter M) for such year or years. We will choose to take
such action only if we determine that the result of the action will benefit us
and our shareholders.
Prior to 1999, we were taxable under Subchapter C of the Code (a "C
Corporation"). Under the Code, a C Corporation that elects to be treated as a
RIC for federal tax purposes is taxable on the effective date of the election to
the extent of any gain built into its assets ("C Corporation Assets") on such
date ("Built-In Gain"). However, a C Corporation may elect alternatively to be
taxable on such Built-In Gain as such gain is realized during the 10-year period
beginning on the effective date of its RIC election (the "Inclusion Period"). We
had Built-In Gains at the time of our qualification as a RIC and elected to be
taxed on any Built-In Gain realized during the Inclusion Period. Prior to 1999,
we carried forward ordinary and capital losses from our operations. After our
election of RIC status, those losses remained available to be carried forward to
subsequent taxable years. Recently issued Internal Revenue Service regulations
confirm that such losses may be used to offset realized Built-In Gains and, to
the extent so used, to eliminate C Corporation taxation of such gains. We have
previously used loss carryforwards to offset Built-In Gains. As of January 1,
2006, the Company had utilized all of its remaining pre-1999 loss carryforwards
and unrealized Built-In Gains.
Subsidiaries
Harris & Harris Enterprises, Inc. ("Enterprises"), is a 100 percent wholly
owned subsidiary of the Company and is consolidated in our financial statements.
Enterprises 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. Currently,
Harris Partners I, L.P., owns our interest in AlphaSimplex Group, LLC. The
partners of Harris Partners I, L.P., are Harris & Harris Enterprises, Inc. (sole
general partner) and the Company (sole limited partner).
13
Employees
We currently employ directly ten full-time employees and one part-time
employee.
Item 1A. Risk Factors
Investing in our shares of common stock involves significant risks
relating to our business and investment objective. You should carefully consider
the risks and uncertainties described below before you purchase any of our
shares of common stock. These risks and uncertainties are not the only ones we
face. Unknown additional risks and uncertainties, or ones that we currently
consider immaterial, may also impair our business. If any of these risks or
uncertainties materialize, our business, financial condition or results of
operations could be materially adversely affected. In this event, the trading
price of our shares of common stock could decline, and you could lose all or
part of your investment.
Risks related to the companies in our portfolio.
Investing in small, private companies involves a high degree of risk and
is highly speculative.
We have invested a substantial portion of our assets in privately held
development stage or start-up companies, the securities of which are inherently
illiquid. These businesses tend to lack management depth, to have limited or no
history of operations and to have not attained profitability. Tiny technology
companies are especially risky, involving scientific, technological and
commercialization risks. Because of the speculative nature of these investments,
these securities have a significantly greater risk of loss than traditional
investment securities. Some of our venture capital investments are likely to be
complete losses or unprofitable, and some will never realize their potential. We
have been, and will continue to be, risk seeking rather than risk averse in our
approach to venture capital and other investments. Neither our investments nor
an investment in our shares of common stock are intended to constitute a
balanced investment program.
We may invest in companies working with technologies or intellectual
property that currently have few or no proven commercial applications.
Nanotechnology, in particular, is a developing area of technology, of
which much of the future commercial value is unknown, difficult to estimate and
subject to widely varying interpretations. There are as of yet relatively few
nanotechnology products commercially available. The timing of additional future
commercially available nanotechnology products is highly uncertain.
Our portfolio companies may not successfully develop their products.
The technology of our portfolio companies is new and in many cases
unproven. Their potential products require significant and lengthy product
development, manufacturing and marketing efforts. To date, many of our portfolio
companies have not developed any commercially available products. In addition,
our portfolio companies may not be able to manufacture successfully or to market
their products in order to achieve commercial success. Further, the products may
never gain commercial acceptance. If our portfolio companies are not able to
develop, manufacture or market successful tiny technology-enabled products, they
will be unable to generate product revenue or build sustainable or profitable
businesses.
14
Our portfolio companies working with tiny technology may be particularly
susceptible to intellectual property litigation.
Research and commercialization efforts in tiny technology are being
undertaken by a wide variety of government, academic and private corporate
entities. As additional commercially viable applications of tiny technology
begin to emerge, ownership of intellectual property on which these products are
based may be contested. Any litigation over the ownership of, or rights to, any
of our portfolio companies' technologies or products would have a material
adverse effect on those companies' values.
Unfavorable economic conditions could result in the inability of our
portfolio companies to access additional capital, leading to financial losses in
our portfolio.
Most of the companies in which we have made, or will make, investments are
susceptible to economic slowdowns or recessions. An economic slowdown or adverse
capital or credit market conditions may affect the ability of a company in our
portfolio to raise additional capital from venture capital or other sources or
to engage in a liquidity event such as an initial public offering or merger.
Adverse economic, capital or credit market conditions may lead to financial
losses in our portfolio.
The value of our portfolio could be adversely affected if the technologies
utilized by our portfolio companies are found to cause health or environmental
risks.
Our portfolio companies work with new technologies, which could have
potential environmental and health impacts. Tiny technology in general and
nanotechnology in particular are currently the subject of health and
environmental impact research. If health or environmental concerns about tiny
technology or nanotechnology were to arise, whether or not they had any basis in
fact, our portfolio companies might incur additional research, legal and
regulatory expenses, and might have difficulty raising capital or marketing
their products.
Public perception of ethical and social issues regarding nanotechnology
may limit or discourage the use of nanotechnology-enabled products, which could
reduce our portfolio companies' revenues and harm our business.
Nanotechnology has received both positive and negative publicity and is
the subject increasingly of public discussion and debate. Government authorities
could, for social or other purposes, prohibit or regulate the use of
nanotechnology. Ethical and emotional concerns about nanotechnology could
adversely affect acceptance of the potential products of our portfolio companies
or lead to new government regulation of nanotechnology-enabled products. For
example, debate regarding the production of materials that could cause harm to
the environment or the health of individuals could raise concerns in the
public's perception of nanotechnology, not all of which may be rational or
scientifically based.
15
Risks related to the illiquidity of our investments.
We invest in illiquid securities and may not be able to dispose of them
when it is advantageous to do so, or ever.
Most of our investments are or will be equity or equity-linked securities
acquired directly from small companies. These equity securities are generally
subject to restrictions on resale or otherwise have no established trading
market. The illiquidity of most of our portfolio of equity securities may
adversely affect our ability to dispose of these securities at times when it may
be advantageous for us to liquidate these investments. We may never be able to
dispose of these securities.
Unfavorable economic conditions and regulatory changes could impair our
ability to engage in liquidity events.
Our business of making private equity investments and positioning our
portfolio companies for liquidity events may be adversely affected by current
and future capital markets and economic conditions. The public equity markets
currently provide less opportunity for liquidity events than at times in the
past when there was more robust demand for initial public offerings, even for
more mature technology companies than those in which we typically invest. The
potential for public market liquidity could further decrease and could lead to
an inability to realize potential gains or could lead to financial losses in our
portfolio and a decrease in our revenues, net income and assets. Recent
government reforms affecting publicly traded companies, stock markets,
investment banks and securities research practices have made it more difficult
for privately held companies to complete successful initial public offerings of
their equity securities, and such reforms have increased the expense and legal
exposure of being a public company. Slowdowns in initial public offerings may
also have an adverse effect on the frequency and prices of acquisitions of
privately held companies. A lack of merger and/or acquisition opportunities for
privately held companies may also have an adverse effect on the ability of these
companies to raise capital from private sources. Public equity market response
to company offerings of nanotechnology-enabled products is uncertain. An
inability to engage in liquidity events could negatively affect our liquidity,
our reinvestment rate in new and follow-on investments and the value of our
portfolio.
Even if our portfolio companies complete initial public offerings, the
returns on our investments may be uncertain.
When companies in which we have invested as private entities complete
initial public offerings of their securities, these newly issued securities are
by definition unseasoned issues. Unseasoned issues tend to be highly volatile
and have uncertain liquidity, which may negatively affect their price. In
addition, we are typically subject to lock-up provisions that prohibit us from
selling our investments into the public market for specified periods of time
after initial public offerings. The market price of securities that we hold may
decline substantially before we are able to sell these securities. Most initial
public offerings of technology companies are listed on the Nasdaq National
Market. Recent government reforms of the Nasdaq National Market have made market
making by broker-dealers less profitable, which has caused broker-dealers to
reduce their market making activities, thereby making the market for unseasoned
stocks less liquid.
16
Risks related to our Company.
Because there is generally no established market in which to value our
investments, our Valuation Committee's value determinations may differ
materially from the values that a ready market or third party would attribute to
these investments.
There is generally no public market for the equity securities in which we
invest. Pursuant to the requirements of the 1940 Act, we value all of the
private equity securities in our portfolio at fair value as determined in good
faith by a committee of independent members of our Board of Directors, which we
call the Valuation Committee, pursuant to Valuation Procedures established by
the Board of Directors. As a result, determining fair value requires that
judgment be applied to the specific facts and circumstances of each portfolio
investment pursuant to specified valuation principles and processes. We are
required by the 1940 Act to value specifically each individual investment on a
quarterly basis and record unrealized depreciation for an investment that we
believe has become impaired. Conversely, we must record unrealized appreciation
if we believe that our securities have appreciated in value. Without a readily
ascertainable market value and because of the inherent uncertainty of valuation,
the fair value that we assign to our investments may differ from the values that
would have been used had an efficient market existed for the investments, and
the difference could be material. Any changes in fair value are recorded in our
consolidated statements of operations as a change in the "Net (decrease)
increase in unrealized appreciation on investments."
In the venture capital industry, even when a portfolio of early stage,
high-technology venture capital investments proves to be profitable over the
portfolio's lifetime, it is common for the portfolio's value to undergo a
so-called "J-curve" valuation pattern. This means that when reflected on a
graph, the portfolio's valuation would appear in the shape of the letter "J,"
declining from the initial valuation prior to increasing in valuation. This
J-curve valuation pattern results from write-downs and write-offs of portfolio
investments that appear to be unsuccessful, prior to write-ups for portfolio
investments that prove to be successful. Because early stage companies typically
have negative cash flow and are by their nature inherently fragile, it is easier
in a valuation process to substantiate a loss of value than an increase in
value, absent a substantial investment at a higher valuation by a third party,
knowledgeable, non-strategic investor. Even if our venture capital investments
prove to be profitable in the long run, such J-curve valuation patterns could
have a significant adverse effect on the value of our shares of common stock in
the interim. As we continue to make additional tiny technology investments, this
J-curve pattern may not be relevant for the portfolio as a whole because the
individual J-curves for each investment, or series of investments, may overlap
with previous investments at different stages of their J-curves.
17
Because we are a non-diversified company with a relatively concentrated
portfolio, the value of our business is subject to greater volatility than the
value of companies with more broadly diversified investments.
As a result of our assets being invested in the securities of a small
number of issuers, we are classified as a non-diversified company. We may be
more vulnerable to events affecting a single issuer or industry and therefore
subject to greater volatility than a company whose investments are more broadly
diversified. Accordingly, an investment in our shares of common stock may
present greater risk to you than an investment in a diversified company.
We may be obligated to pay substantial amounts under our profit-sharing
plan.
Our employee profit-sharing plan requires us to distribute to our officers
and employees 20 percent of any net after-tax realized income as reflected on
our consolidated statements of operations for that year, less any non-qualifying
gain. Payments may be made under our profit-sharing plan in a particular year,
even if we have incurred losses in previous years. These distributions reduce
funds available for investment and may have a significant effect on the amount
of direct distributions in the form of cash dividends, or indirect distributions
in the form of tax credits, if any, made to our shareholders.
We are dependent upon key management personnel for future success and may
not be able to retain them.
We are dependent upon the diligence and skill of our senior management and
other key advisers for the selection, structuring, closing and monitoring of our
investments. We utilize lawyers and outside consultants, including two of our
directors, Dr. Kelly S. Kirkpatrick and Lori D. Pressman, to assist us in
conducting due diligence when evaluating potential investments. There is
generally no publicly available information about the companies in which we
invest, and we rely significantly on the diligence of our employees and advisers
to obtain information in connection with our investment decisions. Our future
success to a significant extent depends on the continued service and
coordination of our senior management team, and particularly on our Chairman and
Chief Executive Officer, Charles E. Harris. The departure of any of our
executive officers, key employees or advisers could materially adversely affect
our ability to implement our business strategy. We do not maintain for our
benefit any key man life insurance on any of our officers or employees.
We will need to hire additional employees as the size of our portfolio
increases.
We anticipate that it will be necessary for us to add investment
professionals with expertise in venture capital and/or tiny technology and
administrative and support staff to accommodate the increasing size of our
portfolio. We may need to provide additional scientific, business, accounting,
legal or investment training for our hires. There is competition for highly
qualified personnel, and we may not be successful in our efforts to recruit and
retain highly qualified personnel.
18
The market for venture capital investments, including tiny technology
investments, is highly competitive.
We face substantial competition in our investing activities from many
competitors, including but not limited to: private venture capital funds;
investment affiliates of large industrial, technology, service and financial
companies; small business investment companies; wealthy individuals; and foreign
investors. Our most significant competitors typically have significantly greater
financial resources than we do. Greater financial resources are particularly
advantageous in securing lead investor roles in venture capital syndicates. Lead
investors negotiate the terms and conditions of such financings. Many sources of
funding compete for a small number of attractive investment opportunities.
Hence, we face substantial competition in sourcing good investment opportunities
on terms of investment that are commercially attractive.
In addition to the difficulty of finding attractive investment
opportunities, our status as a regulated business development company may hinder
our ability to participate in investment opportunities or to protect the value
of existing investments.
We are required to disclose on a quarterly basis the names and business
descriptions of our portfolio companies and the value of any portfolio
securities. Most of our competitors are not subject to these disclosure
requirements. Our obligation to disclose this information could hinder our
ability to invest in some portfolio companies. Additionally, other current and
future regulations may make us less attractive as a potential investor than a
competitor not subject to the same regulations.
Our failure to make follow-on investments in our portfolio companies could
impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make
additional investments in that portfolio company as "follow-on" investments, in
order to: (1) increase or maintain in whole or in part our ownership percentage;
(2) exercise warrants, options or convertible securities that were acquired in
the original or subsequent financing; or (3) attempt to preserve or enhance the
value of our investment. "Pay to play" provisions have become common in venture
capital transactions. These provisions require proportionate investment in
subsequent rounds of financing in order to preserve preferred rights such as
anti-dilution protection or even to prevent preferred shares from being
converted to common shares.
We may elect not to make follow-on investments or otherwise lack
sufficient funds to make such investments. We have the discretion to make any
follow-on investments, subject to the availability of capital resources. The
failure to make a follow-on investment may, in some circumstances, jeopardize
the continued viability of a portfolio company and our initial investment, or
may result in a missed opportunity for us to increase our participation in a
successful operation, or may cause us to lose some or all preferred rights or
even substantially all of our equity ownership in it pursuant to "pay to play"
provisions. Even if we have sufficient capital to make a desired follow-on
investment, we may elect not to make a follow-on investment because we may not
want to increase our concentration of risk, because we prefer other
opportunities or because we are inhibited by compliance with business
development company requirements or the desire to maintain our tax status.
19
Bank borrowing or the issuance of debt securities or preferred stock by us
to fund investments in portfolio companies or to fund our operating expenses
would make our total return to common shareholders more volatile.
Use of debt or preferred stock as a source of capital entails two primary
risks. The first is the risk of leverage, which is the use of debt to increase
the pool of capital available for investment purposes. The use of debt leverages
our available common equity capital, magnifying the impact on net asset value of
changes in the value of our investment portfolio. For example, a business
development company that uses 33 percent leverage (that is, $50 of leverage per
$100 of common equity) will show a 1.5 percent increase or decline in net asset
value for each 1 percent increase or decline in the value of its total assets.
The second risk is that the cost of debt or preferred stock financing may exceed
the return on the assets the proceeds are used to acquire, thereby diminishing
rather than enhancing the return to common shareholders. If we issue preferred
shares, the common shareholders would bear the cost of this leverage. To the
extent that we utilize debt or preferred stock financing for any purpose, these
two risks would likely make our total return to common shareholders more
volatile. In addition, we might be required to sell investments, in order to
meet dividend, interest or principal payments, when it may be disadvantageous
for us to do so.
As provided in the 1940 Act and subject to some exceptions, we can issue
debt or preferred stock so long as our total assets immediately after the
issuance, less some ordinary course liabilities, exceed 200 percent of the sum
of the debt and any preferred stock outstanding. The debt or preferred stock may
be convertible in accordance with SEC guidelines, which may permit us to obtain
leverage at more attractive rates. The requirement under the 1940 Act to pay, in
full, dividends on preferred shares or interest on debt before any dividends may
be paid on our shares of common stock means that dividends on our shares of
common stock from earnings may be reduced or eliminated. An inability to pay
dividends on our shares of common stock could conceivably result in our ceasing
to qualify as a regulated investment company, or RIC, under the Code, which
would in most circumstances be materially adverse to the holders of our shares
of common stock. As of the date hereof, we do not have any debt or preferred
stock outstanding.
We are authorized to issue preferred stock, which would convey special
rights and privileges to its owners senior to those of common stock
shareholders.
We are currently authorized to issue up to 2,000,000 shares of preferred
stock, under terms and conditions determined by our Board of Directors. These
shares would have a preference over our common stock with respect to dividends
and liquidation. The statutory class voting rights of any preferred shares we
would issue could make it more difficult for us to take some actions that may,
in the future, be proposed by the Board and/or holders of common stock, such as
a merger, exchange of securities, liquidation or alteration of the rights of a
class of our securities if these actions were perceived by the holders of the
preferred shares as not in their best interests. The issuance of preferred
shares convertible into shares of common stock might also reduce the net income
and net asset value per share of our common stock upon conversion.
20
Loss of status as a RIC would reduce our net asset value and distributable
income.
We qualify as a RIC for 2004 under the tax Code. As a RIC, we do not have
to pay federal income taxes on our income (including realized gains) that is
distributed to our shareholders. Accordingly, we are not permitted under
accounting rules to establish reserves for taxes on our unrealized capital
gains. If we failed to qualify for RIC status in 2005 or beyond, to the extent
that we had unrealized gains, we would have to establish reserves for taxes,
which would reduce our net asset value, net of a reduction in the reserve for
employee profit sharing, accordingly. In addition, if we, as a RIC, were to
decide to make a deemed distribution of net realized capital gains and retain
the net realized capital gains, we would have to establish appropriate reserves
for taxes. It is possible that establishing reserves for taxes could have a
material adverse effect on the value of our common stock.
We operate in a heavily regulated environment and changes to or
non-compliance with regulations and laws could harm our business.
We are subject to substantive SEC regulations as a business development
company. Securities and tax laws and regulations governing our activities may
change in ways adverse to our and our shareholders' interests, and
interpretations of these laws and regulations may change with unpredictable
consequences. Any change in the laws or regulations that govern our business
could have an adverse impact on us or on our operations. Changing laws,
regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
Nasdaq National Market rules, are creating additional expense and uncertainty
for publicly held companies in general, and for business development companies
in particular. These new or changed laws, regulations and standards are subject
to varying interpretations in many cases because of their lack of specificity,
and as a result, their application in practice may evolve over time, which may
well result in continuing uncertainty regarding compliance matters and higher
costs necessitated by ongoing revisions to disclosure and governance practices.
We are committed to maintaining high standards of corporate governance and
public disclosure. As a result, our efforts to comply with evolving laws,
regulations and standards have and will continue to result in increased general
and administrative expenses and a diversion of management time and attention
from revenue-generating activities to compliance activities. In particular, our
efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the
related regulations regarding our required assessment of our internal controls
over financial reporting and our external auditors' audit of that assessment has
required the commitment of significant financial and managerial resources. We
will continue to evaluate the effectiveness of internal controls and procedures
on an ongoing basis. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all controls issues within the Company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented. Because of the inherent limitations
in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected. We may identify material weaknesses or significant
deficiencies in our internal controls. If so, our ability to report our
financial results on a timely and accurate basis may be adversely affected.
21
Moreover, even though BDCs are not mutual funds, they must comply with
several of the new regulations applicable to mutual funds, such as the
requirement for the implementation of a comprehensive compliance program and the
appointment of a Chief Compliance Officer. Further, our Board members, Chief
Executive Officer and Chief Financial Officer could face an increased risk of
personal liability in connection with the performance of their duties. As a
result, we may have difficulty attracting and retaining qualified Board members
and executive officers, which could harm our business, and we have significantly
increased both our coverage under, and the related expense, for directors' and
officers' liability insurance. If our efforts to comply with new or changed
laws, regulations and standards differ from the activities intended by
regulatory or governing bodies, our reputation may be harmed. Also, as business
and financial practices continue to evolve, they may render the regulations
under which we operate less appropriate and more burdensome than they were when
originally imposed. This increased regulatory burden is causing us to incur
significant additional expenses and is time consuming for our management, which
could have a material adverse effect on our financial performance.
We expect that the market price of our common stock will be volatile.
The price of the shares of our common stock may be higher or lower than
the price you pay for your shares, depending on many factors, some of which are
beyond our control and may not be directly related to our operating performance.
These factors include the following:
o announcements regarding any of our portfolio companies;
o announcements regarding developments in the nanotechnology field in
general;
o environmental concerns regarding nanotechnology, whether real or
perceptual;
o announcements regarding government funding and initiatives related
to the development of nanotechnology;
o general economic conditions and trends; and/or
o departures of key personnel.
We will not have control over many of these factors but expect that our
stock price may be influenced by them. As a result, our stock price may be
volatile and you may lose all or part of your investment.
22
Quarterly results fluctuate and are not indicative of future quarterly
performance.
Our quarterly operating results fluctuate as a result of a number of
factors. These factors include, among others, variations in and the timing of
the recognition of realized and unrealized gains or losses, the degree to which
we and our portfolio companies encounter competition in our markets and general
economic and capital markets 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.
To the extent that we do not realize income or retain after-tax realized
capital gains, we may have a greater need for additional capital to fund our
investments and operating expenses.
As a RIC, we must annually distribute at least 90 percent of our
investment company taxable income as a dividend and may either distribute or
retain our realized net capital gains from investments. As a result, these
earnings may not be available to fund investments. If we fail to generate net
realized capital gains or to obtain funds from outside sources, it would have a
material adverse effect on our financial condition and results of operations as
well as our ability to make follow-on and new investments. Because of the
structure and objectives of our business, we generally expect to experience net
operating losses and rely on proceeds from sales of investments, rather than on
investment income, to defray a significant portion of our operating expenses.
These sales are unpredictable and may not occur. In addition, as a business
development company, we are generally required to maintain a ratio of at least
200 percent of total assets to total borrowings, which may restrict our ability
to borrow to fund these requirements. Lack of capital could curtail our
investment activities or impair our working capital.
Investment in foreign securities could result in additional risks.
The Company may invest in foreign securities, although, as of December 31,
2005, we had no investments in foreign securities. If we invest in securities of
foreign issuers, we may be subject to risks not usually associated with owning
securities of U.S. issuers. These risks can include fluctuations in foreign
currencies, foreign currency exchange controls, social, political and economic
instability, differences in securities regulation and trading, expropriation or
nationalization of assets, and foreign taxation issues. In addition, changes in
government administrations or economic or monetary policies in the United States
or abroad could result in appreciation or depreciation of our securities and
could favorably or unfavorably affect our operations. It may also be more
difficult to obtain and enforce a judgment against a foreign issuer. Any foreign
investments made by us must be made in compliance with U.S. and foreign currency
restrictions and tax laws restricting the amounts and types of foreign
investments.
23
Investing in our stock is highly speculative and an investor could lose
some or all of the amount invested.
Our investment objective and strategies result in a high degree of risk in
our investments and may result in losses in the value of our investment
portfolio. Our investments in portfolio companies are highly speculative and,
therefore, an investor in our common stock may lose his or her entire
investment. The value of the shares of our common stock may decline and may be
affected by numerous market conditions, which could result in the loss of some
or all of the amount invested in our common stock. The securities markets
frequently experience extreme price and volume fluctuations which affect market
prices for securities of companies generally, and technology and very small
capitalization companies in particular. Because of our focus on the technology
and very small capitalization sectors, and because we are a small capitalization
company ourselves, our stock price is especially likely to be affected by these
market conditions. General economic conditions, and general conditions in the
Internet and information technology, life sciences, nanotechnology, tiny
technology, materials science and other high technology industries, may also
affect the price of the shares of our common stock.
Our shares might trade at discounts from net asset value, or at premiums
that are unsustainable over the long term.
Shares of business development companies like us may, during some periods,
trade at prices higher than their net asset value and during other periods, as
frequently occurs with closed-end investment companies, trade at prices lower
than their net asset value. The possibility that our shares will trade at
discounts from net asset value or at premiums that are unsustainable over the
long term are risks separate and distinct from the risk that our net asset value
will decrease. The risk of purchasing shares of a business development company
that might trade at a discount or unsustainable premium is more pronounced for
investors who wish to sell their shares in a relatively short period of time
because, for those investors, realization of a gain or loss on their investments
is likely to be more dependent upon the existence of a premium or discount than
upon portfolio performance. Our shares of common stock may or may not trade at a
price higher than or equal to net asset value. On December 31, 2005, our stock
closed at $13.90 per share, a premium of $8.22 over our net asset value per
share of $5.68 as of December 31, 2005.
You have no right to require us to repurchase your shares.
You do not have the right to require us to repurchase your shares of
common stock.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Company maintains its offices at 111 West 57th Street, New York, New
York 10019, where it leases approximately 3,540 square feet of office space
pursuant to lease agreements expiring in 2010. (See "Note 7 of Notes to
Consolidated Financial Statements and Schedules" contained in Item 8.
"Consolidated Financial Statements and Supplementary Data.")
24
Item 3. Legal Proceedings
The Company is not a party to any legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
None.
25
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchase of Equity Securities
Stock Transfer Agent
The Bank of New York, 101 Barclay Street, Suite 12W, New York, New York
10286 (Telephone 800-524-4458, Attention: Mr. Ernie Zavala) serves as transfer
agent for our common stock. Certificates to be transferred should be mailed
directly to the transfer agent, preferably by registered mail.
Market Prices
Our common stock is traded on the Nasdaq National Market under the symbol
"TINY." 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 Nasdaq National Market. The quarterly stock prices quoted represent
interdealer quotations and do not include markups, markdowns or commissions.
2005 Quarter Ending Low High
March 31 $11.30 $16.80
June 30 $10.01 $13.38
September 30 $10.70 $13.85
December 31 $10.15 $14.95
2004 Quarter Ending Low High
March 31 $11.47 $20.70
June 30 $10.77 $23.60
September 30 $ 7.07 $13.90
December 31 $10.29 $16.70
Dividends
We did not pay a cash dividend or declare a deemed dividend for 2002, 2003
and 2004. On December 20, 2005, we declared a deemed dividend of $1.11805631 per
share for 2005 for a total of $23,206,763, and in January 2006 we paid federal
income taxes on behalf of shareholders of $0.39131971 per share for a total of
$8,122,367. We paid the tax at the corporate rate on the distribution, and the
shareholders received a tax credit equal to their proportionate share of the tax
paid.
26
Recent Sales of Unregistered Securities
The Company did not sell any equity securities during 2005 that were not
registered under the Securities Act of 1933.
Shareholders
As of March 1, 2006, there were approximately 131 holders of record of the
Company's common stock which, the Company has been informed, hold the Company's
common stock for approximately 18,000 beneficial owners.
27
Item 6. Selected Financial Data
The information below was derived from the audited Consolidated Financial
Statements included in this report and in previous annual reports filed with the
SEC. For 2001, we have included the taxes paid on behalf of shareholders on the
deemed dividend of $271,467 as a component of "net realized income (loss) from
investments" to conform to current year presentation. This revision has no
impact on net assets or net asset value per outstanding share as previously
reported. This information should be read in conjunction with those Consolidated
Financial Statements and Supplementary Data and the notes thereto. These
historical results are not necessarily indicative of the results to be expected
in the future.
Financial Position as of December 31:
2005 2004 2003 2002 2001
Total assets $132,947,623 $ 79,361,451 $ 44,115,128 $ 35,951,969 $ 39,682,367
Total liabilities $ 14,959,881 $ 4,616,652 $ 3,432,390 $ 8,695,923 $ 15,347,597
Net assets $117,987,742 $ 74,744,799 $ 40,682,738 $ 27,256,046 $ 24,334,770
Net asset value per outstanding share $ 5.68 $ 4.33 $ 2.95 $ 2.37 $ 2.75
Cash dividends paid $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
Cash dividends paid per outstanding share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
Shares outstanding, end of year 20,756,345 17,248,845 13,798,845 11,498,845 8,864,231
December 31:
Operating Data for year ended
2005 2004 2003 2002 2001
Total investment income $ 1,540,862 $ 637,562 $ 167,785 $ 253,461 $ 510,661
Total expenses(1) $ 7,006,623 $ 4,046,341 $ 2,731,527 $ 2,124,549 $ 1,035,221
Net operating (loss) income $ (5,465,761) $ (3,408,779) $ (2,563,742) $ (1,871,088) $ (524,560)
Total tax expense(2) (benefit) $ 8,288,778 $ 650,617 $ 13,761 $ 199,309 $ 299,418
Net realized income (loss) from
investments $ 14,208,789 $ 858,503 $ (984,925) $ 2,390,302 $ 1,004,899
Net realized (loss) income $ 8,743,028 $ (2,550,276) $ (3,548,667) $ 519,214 $ 480,339
Net decrease (increase) in unrealized
depreciation on investments $ (2,026,652) $ 484,162 $ 343,397 $ (3,241,408) $ (7,641,044)
Net increase (decrease) in net assets
resulting from operations $ 6,716,376 $ (2,066,114) $ (3,205,270) $ (2,722,194) $ (7,160,705)
Increase (Decrease) in net assets
resulting from operations per
average outstanding share $ 0.36 $ (0.13) $ (0.28) $ (0.27) $ (0.80)
(1) Included in total expenses are the following profit-sharing
expenses/(reversals): $1,796,264 in 2005; $311,594 in 2004; ($163,049) in
2002; and ($984,021) in 2001.
(2) Included in total tax expense are the following taxes paid by the Company
on behalf of shareholders: $8,122,367 in 2005, $0 in each of 2004, 2003,
2002, and $271,467 in 2001.
28
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 the Company's 2005 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 our control. Although we believe 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 us or any other person
that our plans will be achieved.
Background and Overview
We incorporated under the laws of the state of New York in August 1981. In
1983, we completed an initial public offering and invested $406,936 in Otisville
BioTech, Inc., which also completed an initial public offering later that year.
In 1984, Charles E. Harris purchased a controlling interest in us and became the
control person in Otisville. We then divested our other assets and became a
financial services company, with the investment in Otisville as the initial
focus of our business activity. We hired new management for Otisville, and
Otisville acquired new technology targeting the development of a human blood
substitute.
By 1988, we operated two insurance brokerages and a trust company as
wholly-owned subsidiaries. In 1989, Otisville changed its name to Alliance
Pharmaceutical Corporation, and by 1990, we had completed selling our $406,936
investment in Alliance for total proceeds of $3,923,559.
In 1992, we sold our insurance brokerage and trust company subsidiaries to
their respective managements and registered as an investment company under the
1940 Act, commencing operations as a closed-end, non-diversified investment
company. In 1995, we elected to become a business development company subject to
the provisions of Sections 55 through 65 of the 1940 Act. Throughout our
corporate history, we have made early stage venture capital investments in a
variety of industries. We define venture capital investments as investments in
start-up firms and small businesses with exceptional growth potential. In 1994,
we made our first tiny technology investment. From August 2001 through December
31, 2005, all 25 of our initial investments have been exclusively in tiny
technology.
29
Since our investment in Otisville in 1983 through December 31, 2005, we
have made a total of 67 venture capital investments, including four private
placement investments in securities of publicly traded companies. We have sold
44 of these 67 investments, realizing total proceeds of $143,593,693 on our
invested capital of $51,144,319. Eighteen of these 44 investments were
profitable. As measured from first dollar in to last dollar out, the average and
median holding periods for these 44 investments were 3.63 years and 3.18 years,
respectively. As measured by the 149 separate rounds of investment within these
44 investments, the average and median holding periods for the 149 separate
rounds of investment were 2.85 years and 2.53 years, respectively. At December
31, 2005, we valued the 23 venture capital investments remaining in our
portfolio at $33,187,333, or 28.1 percent of our net assets, including net
unrealized depreciation of $4,519,009. At December 31, 2005, from first dollar
in, the average and median holding periods for these 23 venture capital
investments were 2.9 years and 1.75 years, respectively. As measured by the 56
separate rounds of investment within these 23 investments, the average and
median holding periods for the 56 separate rounds of investment were 2.4 years
and 1.6 years, respectively.
We have invested a substantial portion of our assets in venture capital
investments of private, development stage or start-up companies. These private
businesses tend to be thinly capitalized, unproven, small companies that lack
management depth, have little or no history of operations and are developing
unproven technologies. At December 31, 2005, $33,187,333, or 28.1 percent, of
our net assets at fair value consisted of private venture capital investments,
net of unrealized depreciation of $4,519,009. At December 31, 2004, $18,508,138,
or 24.8 percent, of our net assets at fair value consisted of private venture
capital investments, net of unrealized depreciation of $9,577,094. At December
31, 2003, $15,106,576, or 37.1 percent, of our net assets at fair value
consisted of private venture capital investments, net of unrealized depreciation
of $2,375,303.
We value our private venture capital investments each quarter as
determined in good faith by our Valuation Committee, a committee of independent
directors, within guidelines established by our Board of Directors in accordance
with the 1940 Act. (See "Footnote to Consolidated Schedule of Investments"
contained in "Consolidated Financial Statements.")
We have discretion in the investment of our capital. However, we invest
primarily in illiquid equity securities of private companies. Generally, these
investments take the form of preferred stock, are subject to restrictions on
resale and have no established trading market. Our principal objective is to
achieve long-term capital appreciation. Therefore, a significant portion of our
investment portfolio provides little or no income in the form of dividends or
interest. We earn interest income from fixed-income securities, including U.S.
government and government agency securities. The amount of interest income we
earn varies with the average balance of our fixed-income portfolio and the
average yield on this portfolio. Interest income is secondary to capital gains
and losses in our results of operations.
30
We present the financial results of our operations utilizing accounting
principles generally accepted in the United States for investment companies. On
this basis, the principal measure of our financial performance during any period
is the net increase/(decrease) in our net assets resulting from our operating
activities, which is the sum of the following three elements:
Net Operating Income / (Loss) - the difference between our income from
interest, dividends, and fees and our operating expenses.
Net Realized Income / (Loss) on Investments - the difference between the
net proceeds of sales of portfolio securities and their stated cost, plus income
from interests in limited liability companies.
Net Increase / (Decrease) in Unrealized Appreciation or Depreciation on
Investments - the net unrealized change in the value of our investment
portfolio.
Owing to the structure and objectives of our business, we generally expect
to experience net operating losses and seek to generate increases in our net
assets from operations through the long term appreciation of our venture capital
investments. We have relied, and continue to rely, on proceeds from sales of
investments, rather than on investment income, to defray a significant portion
of our operating expenses. Because such sales are unpredictable, we attempt to
maintain adequate working capital to provide for fiscal periods when there are
no such sales.
Results of Operations
Years Ended December 31, 2005, 2004, and 2003
During the three years ended December 31, 2005, 2004, and 2003, we had net
increases (decreases) in net assets resulting from operations of $6,716,376,
($2,066,114), and ($3,205,270), respectively.
Investment Income and Expenses:
During the three years ended December 31, 2005, 2004, and 2003, we had net
operating losses of $5,465,761, $3,408,779, and $2,563,742, respectively. The
variation in these results is primarily owing to the changes in investment
income and operating expenses. During the three years ended December 31, 2005,
2004 and 2003, total investment income was $1,540,862, $637,562 and $167,785,
respectively. During the three years ended December 31, 2005, 2004, and 2003,
operating expenses were $7,006,623, $4,046,341, and $2,731,527, respectively.
During 2005, investment income increased owing to an increase in our
income on U.S. Government and Government Agency Securities, as our holdings
increased from $44,622,722 at December 31, 2004 to $96,250,864 at December 31,
2005 and as a result of an increase in interest rates during the year. During
2004, investment income increased by $469,777 primarily owing to an increase in
our holdings in U.S. Government and Government Agency Securities from
$27,120,486 at December 31, 2003 to $44,622,722 at December 31, 2004.
31
The increase in operating expenses during 2005 was primarily owing to
increases in the profit-sharing provision, salaries and benefits, professional
fees administration and operations, rent expense and Directors' fees and
expenses. Profit sharing expense for 2005 was $1,796,264, an increase of
$1,484,670 as compared to 2004. Profit sharing expense increased primarily as a
result of the gains realized on the sale of NeuroMetrix, Inc., offset by the
taxes payable by the Company on the deemed dividend and taxes payable on
Built-In Gains. The profit sharing expense is also impacted by the Company's
decision to retain its net realized long-term capital gains for reinvestment for
growth, rather than distribute them as a cash dividend. When the Company chooses
to retain its net realized long-term capital gains, it declares a deemed
dividend and pays taxes on behalf of shareholders. Conversely, when the Company
distributes its net realized long-term capital gains as a cash dividend, the
shareholders pay all of the taxes. The taxes payable by the Company on behalf of
shareholders reduce the amount of profit against which the profit sharing
payable to employees is calculated. Had the Company chosen to distribute its net
realized long-term capital gains as a cash dividend, the provision for employee
profit sharing would have been $3,420,737 for 2005, rather than the actual
provision for employee profit sharing of $1,796,264 for 2005.
Salaries and benefits increased by $530,945, or 27.5 percent, primarily as
a result of the addition of three employees. Professional fees increased by
$162,751, or 24.4 percent, reflecting in part the expenses associated with
ongoing compliance with the Sarbanes-Oxley Act of 2002. Administration and
operations increased by $600,824, or 83.6 percent, primarily as the result of
increases in travel expenses associated with additional investments in portfolio
companies, increases in expenses related to the preparation and distribution of
the annual and quarterly reports and proxy statement owing to the increased
number of shareholders, and an increase in the premium expense for director and
officer liability insurance. The premium expense for director and officer
liability insurance increased by $339,810 to $512,038 in 2005, and the premium
expense for 2006 is estimated to be $514,650. Rent expense increased by $60,148
or 39.7 percent due to the leasing of additional office space in California and
New York. Directors' fees and expenses increased by $99,664 or 47.6 percent as a
result of an increase in the fees paid to the directors for monthly retainer and
meeting attendance in 2005.
The increase in operating expenses during 2004 was primarily owing to
increases in the profit sharing provision, salaries and benefits, professional
fees and administration and operations. The profit-sharing provision increased
by $311,594, or 100 percent. The increase in the profit-sharing provision is
primarily a result of the increase in the value of our investment in
NeuroMetrix, Inc., which completed its IPO on July 22, 2004. Salaries and
benefits increased by $387,396, or 25.1 percent, primarily as a result of the
addition of four employees, partially offset by a decrease in mandatory
retirement plan pension expense that is being amortized through December 31,
2004. Administration and operations increased by $272,345, or 61.0 percent,
primarily as the result of an increase in travel expenses associated with
additional investments in portfolio companies, an increase in expenses related
to the preparation and distribution of the annual and quarterly reports and
proxy statement owing to the increased number of shareholders, and an increase
in expense and the amount of director and officer liability insurance. The
premium expense for director and officer liability insurance increased by
$94,258 to $172,229 in 2004. Professional fees increased by $363,516, or 119.7
percent, reflecting in part the expenses associated with implementation of the
Sarbanes-Oxley Act of 2002 and Rule 38a-1 under the 1940 Act. We estimated that
our total incremental direct and indirect expenses in 2004 associated with the
Sarbanes-Oxley Act of 2002 and Rule 38a-1 under the 1940 Act totaled $316,000.
32
Realized Income and Losses from Investments:
During the years ended December 31, 2005, 2004 and 2003, we had net
realized income (losses) from investments of $14,208,789, $858,503 and
($984,925), respectively. The variation in these results is primarily owing to
variations in gross realized income (loss) from investments and income taxes in
each of the three years. For the years ended December 31, 2005, 2004, and 2003,
realized income (loss) from investments, before taxes, was $23,862,037, $813,994
and ($971,164), respectively. Income tax expense (benefit) for the years ended
December 31, 2005, 2004 and 2003 was $9,653,248, ($44,509) and $13,761.
During 2005, our realized income from investments before taxes of
$23,862,037 consisted primarily of a realized gain of $30,179,762 from the sale
of our investment in NeuroMetrix, Inc., offset by realized losses of $1,358,286,
$2,093,968, $1,091,209, and $1,619,245, from the sale of our shares in Agile
Materials & Technologies, Inc., Experion Systems, Inc., Nanotechnologies, Inc.,
and Optiva, Inc., respectively. Realized losses on U.S. Government and U.S.
Government Agency Securities totaled $422,383 for 2005. For the year ended
December 31, 2005, our income tax expense on realized gains was $9,653,248,
which includes $8,122,367 of taxes payable by the Company on behalf of
shareholders in connection with the deemed dividend and $1,364,470 of taxes on
Built-In Gains.
During 2004, our realized income from investments before taxes of $813,994
consisted primarily of a realized gain of $1,681,259 from the sale of our
investment in NanoGram Devices Corporation, offset by a realized loss of
$915,108 from the sale of our shares of Series D Convertible Preferred Stock in
NeoPhotonics Corporation. For the year ended December 31, 2004, our income tax
benefit on realized gains and losses was $44,509 which related primarily to
taxes owed to Harris & Harris Enterprises.
During 2003, our realized loss from investments before taxes of $971,164
consisted primarily of a realized loss of $1,000,001 from the write-off of
Kriton Medical, Inc., offset by realized gains on U.S. Government and Agency
Securities. For the year ended December 31, 2003, our income tax expense on
realized gains and losses was $13,761 which related primarily to taxes on gains
generated by Harris & Harris Enterprises, Inc.
Net Unrealized Appreciation and Depreciation of Portfolio Securities:
During the year ended December 31, 2005, net unrealized depreciation on
investments increased by $2,026,652. During the year ended December 31, 2004,
net unrealized depreciation decreased by $484,162. During the year ended
December 31, 2003, net unrealized depreciation decreased by $343,397.
33
The net increase in unrealized depreciation on investments in 2005 is the
result of the appreciation in value of $19,790,298 on investments held, offset
by depreciation of $23,181,420 related to investments sold. The change in
unrealized depreciation on investments held is owing to appreciation in our
investment in NeuroMetrix, Inc. prior to the sale of our interest in it as well
as increases in the valuations of NanoGram Corporation, Nanosys, Inc. and
Nantero, Inc. of $313,534, $870,113 and $813,771, respectively. These were
offset by decreases in the valuations of AlphaSimplex Group LLC, CSwitch, Inc.,
Mersana Therapeutics, Inc., NanoOpto, Inc., Polatis, Inc., and Zia Laser, Inc.
of $109,464, $500,000, $563,097, $529,997, $169,827, and $1,312,500
respectively. The change in unrealized depreciation on investments sold is owing
to the realization of the gain on our investment in NeuroMetrix, Inc. offset by
the realization of losses on our investments in Agile Materials and
Technologies, Inc., Experion Systems, Inc., Nanotechnologies, Inc., and Optiva,
Inc.
The net decrease in unrealized depreciation on investments in 2004 was the
result of the appreciation in value of $264,170 on investments held and
appreciation of $915,118 related to investments sold. The change in unrealized
depreciation on investments held is primarily owing to an increase in the
valuation of our investment in Neurometrix, Inc. of $6,288,405 offset by
decreases in the valuations of our investments in Agile Materials and
Technologies, Inc., of $614,081, Experion Systems, Inc., of $630,497,
Nanotechnologies, Inc., of $1,275,373, Optiva, Inc., of $2,000,000, and Polatis,
Inc., of $1,162,208. The decrease in unrealized depreciation on investments sold
was owing to the realization of the loss of $915,108 on the sale of our shares
of Series D Convertible Preferred Stock in NeoPhotonics Corporation. During
2004, unrealized depreciation on U.S. Government and U.S. Government Agency
Securities increased by $321,370. In 2004, we incurred $695,126 of income tax
expense on Built-In Gains on NeuroMetrix, Inc.
The net decrease in unrealized depreciation on investments in 2003 was the
result of the depreciation in value of $656,604 on investments held and
appreciation of $1,000,0001 related to investments sold. The change in
unrealized depreciation on investments held is primarily owing to an increase in
unrealized depreciation of Agile Material and Technologies, Inc., of $750,000,
Experion Systems, Inc., of $325,662 and NeoPhotonics Corporation of $345,558,
offset by a decrease in unrealized depreciation of Polatis, Inc., of $226,046
and an increase in unrealized appreciation in Nanotechnologies, Inc., of
$357,963. Unrealized appreciation on investments sold increased by $1,000,001 as
a result of the loss realized in 2003 on the write-off of Kriton Medical, Inc.,
which had previously been written off for book purposes.
Financial Condition
Year ended December 31, 2005
At December 31, 2005, our total assets and net assets were $132,947,623
and $117,987,742, respectively. Our net asset value per share ("NAV") at that
date was $5.68, and our shares outstanding increased to 20,756,345 versus
17,248,845 at December 31, 2004.
34
During the 12 months ended December 31, 2005, significant financial
developments included the receipt of proceeds from our public offering of common
stock and the sale of our investment in NeuroMetrix, Inc. Gross proceeds from
the issuance of 3,507,500 new shares of our common stock totaled $37,091,813,
less costs of $565,246, for net proceeds of $36,526,567. The Company received
proceeds of $34,591,136 from the sale of its 1,137,570 shares of NeuroMetrix. In
addition, the value of our venture capital investments increased by $1,565,373
to $33,187,333.
During the 12 months ended December 31, 2005, the value of our venture
capital investments increased from $31,621,960 at December 31, 2004 to
$33,187,333 at December 31, 2005. This increase included $16,251,339 from four
new and eleven follow-on venture capital investments and increases in the
valuations of NanoGram Corporation, Nanosys, Inc. and Nantero, Inc. of $313,534,
$870,113 and $813,771, respectively, offset by the sale of our interests in
Agile Materials & Technologies, Inc., Experion Systems, Inc., Nanotechnologies,
Inc., NeuroMetrix, Inc., and Optiva, Inc. and by decreases in the valuation of
our investments in AlphaSimplex Group LLC, CSwitch Corporation, Mersana
Therapeutics, Inc., NanoOpto Corporation, Polatis, Inc., and Zia Laser, Inc., of
$109,464, $500,000, $563,097, $529,997, $169,827, and $1,312,500, respectively.
The increase in the value of our investment in U.S. government and agency
obligations, from $44,622,722 at December 31, 2004, to $96,250,864 at December
31, 2005, resulted primarily from the receipt of net proceeds of $36,526,567
pursuant to the issuance of 3,507,500 new shares of our common stock and
proceeds from the sale of NeuroMetrix of $34,591,136. These increases were
partially offset by four new venture capital investments and eleven follow-on
investments totaling $16,251,339, as well as by operating expenses.
The Company's liabilities increased from $4,616,652 at December 31, 2004
to $14,959,881 at December 31, 2005. The increases were attributable to an
increase of $1,796,264 in the profit sharing accrual, the provision of
$8,122,367 for taxes payable by the Company on behalf of shareholders on the
deemed dividend, and current taxes payable of $1,524,470.
The following table is a summary of additions to our portfolio of venture
capital investments during the 12 months ended December 31, 2005:
New Investment AMOUNT
-------------- -----------
eLite Optoelectronics, Inc. $ 1,000,000
Kereos, Inc. $ 800,000
Kovio, Inc. $ 3,000,000
Zia Laser, Inc. $ 1,500,000
35
Follow-on Investments
---------------------
Cambrios Technologies Corporation $ 511,006
Chlorogen, Inc. $ 364,261
Kereos, Inc. $ 160,000
Molecular Imprints, Inc. $ 2,500,000
Nanomix, Inc. $ 250,000
NanoOpto Corporation $ 411,741
Mersana Therapeutics, Inc. $ 683,000
Nanosys, Inc. $ 3,000,003
Nantero, Inc. $ 571,329
NeoPhotonics Corporation $ 999,999
Starfire Systems, Inc. $ 500,000
-----------
Total $16,251,339
===========
The following tables summarize the fair values of our portfolios of
venture capital investments and U.S. government and agency obligations, as
compared with their cost, at December 31, 2005, and December 31, 2004:
December 31,
---------------------------
2005 2004
----------- -----------
Venture capital investments,
at cost $37,706,342 $32,496,605
Net unrealized depreciation(1) 4,519,009 874,645
----------- -----------
Venture capital investments,
at fair value $33,187,333 $31,621,960
=========== ===========
December 31,
---------------------------
2005 2004
----------- -----------
U.S. government and agency
obligations, at cost $96,320,405 $44,945,505
Net unrealized depreciation(1) 69,541 322,783
----------- -----------
U.S. government and agency
obligations, at fair value $96,250,864 $44,622,722
=========== ===========
(1) At December 31, 2005 and December 31, 2004, the net accumulated unrealized
depreciation on investments, including deferred taxes, was $4,764,125 and
$2,737,473, respectively.
36
The following table summarizes the fair value composition of our venture
capital investment portfolio at December 31, 2005, and December 31, 2004.
NeuroMetrix, Inc., which was sold during 2005, accounted for 97.6 percent of the
"Other Venture Capital Investments," at December 31, 2004.
December 31,
-----------------
Category 2005 2004
------ ------
Tiny Technology 99.9% 57.5%
Other Venture Capital Investments 0.1% 42.5%
------ ------
Total Venture Capital Investments 100.0% 100.0%
====== ======
The following table summarizes the fair value composition of our venture
capital investment portfolio that was still privately held at December 31, 2005,
and December 31, 2004. NeuroMetrix, Inc., was a publicly held company at
December 31, 2004.
December 31,
-----------------
Category 2005 2004
------ ------
Tiny Technology 99.9% 98.2%
Other Privately Held Venture
Capital Investments 0.1% 1.8%
------ ------
Total Venture Capital Investments 100.0% 100.0%
====== ======
Year ended December 31, 2004
At December 31, 2004, our total assets and net assets were $79,361,451 and
$74,744,799, respectively. Our net asset value per share ("NAV") at that date
was $4.33, and our shares outstanding increased to 17,248,845 versus 13,798,845
at December 31, 2003.
During the 12 months ended December 31, 2004, significant financial
developments included the receipt of net proceeds of $36,501,000, less costs of
$372,825, for a total of $36,128,175, pursuant to the issuance of 3,450,000 new
shares of our common stock. In addition, the value of our venture capital
investments increased by $16,515,384 to $31,621,960.
During the twelve months ended December 31, 2004, the value of our venture
capital investments increased from $15,106,576 at December 31, 2003 to
$31,621,960 at December 31, 2004. This increase included $16,709,107 from nine
new venture capital investments and 10 follow-on investments, the sale of
NanoGram Devices and the net increase in the valuation of our venture capital
investments. Our investment in NeuroMetrix, Inc., also increased in value by
$6,288,405, partially offset by the sale of our interest in NanoGram Devices
Corporation and our Series D stock in NeoPhotonics Corporation and decreases in
the valuation of our investments in Agile Materials & Technologies, Inc.,
Experion Systems, Inc., Nanotechnologies, Inc., Optiva, Inc., and Polatis, Inc.,
of $614,081, $630,497, $1,275,373, $2,000,000, and $1,162,208, respectively.
37
On July 27, 2004, NeuroMetrix, Inc., completed its IPO. Our preferred
stock was converted into 1,137,570 shares of common stock that were subject to a
180-day lock-up period that expired on January 18, 2005. The valuation of our
investment in NeuroMetrix, Inc., at December 31, 2004, reflected a 1.9 percent
discount to the market price. This discount reflected the remaining lock-up
period.
The increase in the value of our investment in U.S. government and agency
obligations, from $27,120,486 at December 31, 2003, to $44,622,722 at December
31, 2004, resulted primarily from the receipt of net proceeds of $36,128,175
pursuant to the issuance of 3,450,000 new shares of our common stock, partially
offset by nine new venture capital investments and ten follow-on investments
totaling $16,709,107, as well as by operating expenses.
The following table is a summary of additions to our portfolio of venture
capital investments during the 12 months ended December 31, 2004:
New Investment Amount
-------------- -----------
Cambrios Technologies Corporation $ 783,019
Crystal IS, Inc. $ 199,983
CSwitch, Inc. $ 1,000,000
Molecular Imprints, Inc. $ 2,000,000
Nanomix, Inc. $ 2,250,000
NeoPhotonics Corporation $ 1,925,000
Nextreme Thermal Solutions, Inc. $ 500,000
Solazyme, Inc. $ 310,000
Starfire Systems, Inc. $ 250,000
Follow-on Investment
--------------------
Agile Materials & Technologies, Inc. $ 376,008
Polatis, Inc. $ 839,000
Experion Systems, Inc. $ 121,262
NanoGram Corporation $ 1,000,000
NanoOpto Corporation $ 1,921,252
Mersana Therapeutics, Inc. $ 550,000
Nanotechnologies, Inc. $ 171,492
NeoPhotonics Corporation $ 12,092
NeuroMetrix, Inc. $ 1,749,999
Optiva, Inc. $ 750,000
-----------
Total $16,709,107
===========
38
Cash Flow
Year Ended December 31, 2005
Net cash used in operating activities for the year ended December 31,
2005, was $2,914,285, primarily owing to an increase in our operating expenses.
Cash used in investing activities for the year ended December 31, 2005,
was $33,049,325, primarily reflecting a net increase in our investment in U.S.
government obligations of $52,144,482 and investments in private placements of
$16,251,339, less proceeds from the sale of venture capital investments of
$35,392,200.
Cash provided by financing activities for the year ended December 31,
2005, was $36,526,567, reflecting net proceeds from the issuance of 3,507,500
new shares of our common stock on September 14, 2005, in an underwritten
follow-on offering. Although we will make initial investments exclusively in
tiny technology, we can make follow-on investments in non-tiny technology
companies currently in our portfolio. Further, while considering venture capital
investments, we may invest the proceeds in U.S. government and agency
obligations, which are likely to yield less than our operating expense ratio. We
expect to invest or reserve for potential follow-on investment the net proceeds
within two years of the offering. We may also use the proceeds of this offering
for operating expenses, including due diligence expenses on potential
investments. For the purpose of allocating the proceeds of the offering,
reserves for follow-on investments in any particular portfolio holding may be no
more than the greater of twice the investment to date in that portfolio holding
or five times the initial investment in the case of seed-stage investments.
Year Ended December 31, 2004
Net cash used in operating activities for the year ended December 31,
2004, was $3,809,805, primarily owing to an increase in our operating expenses.
Cash used in investing activities for the year ended December 31, 2004,
was $32,093,612, primarily reflecting an increase in our investment in U.S.
government obligations of $17,823,606 and investments in private placements of
$16,731,216.
Cash provided by financing activities for the year ended December 31,
2004, was $36,128,175, reflecting net proceeds from the issuance of 3,450,000
new shares of our common stock on July 7, 2004, in an underwritten follow-on
offering. Although we will make initial investments exclusively in tiny
technology, we can make follow-on investments in non-tiny technology companies
currently in our portfolio. Further, while considering venture capital
investments, we may invest the proceeds in U.S. government and agency
obligations, which are likely to yield less than our operating expense ratio. We
expect to invest or reserve for potential follow-on investment the net proceeds
within two years of the offering. We may also use the proceeds of this offering
for operating expenses, including due diligence expenses on potential
investments. For the purpose of allocating the proceeds of the offering,
reserves for follow-on investments in any particular portfolio holding may be no
more than the greater of twice the investment to date in that portfolio holding
or five times the initial investment in the case of seed-stage investments.
39
Year Ended December 31, 2003
Cash flow used in operating activities for the year ended December 31,
2003, was $6,592,321, primarily reflecting the following changes from December
31, 2002, to December 31, 2003: an increase to restricted funds of $455,134; a
payment of a payable to a broker for an unsettled trade of $5,696,725; and a
decrease to current income tax liability of $857,656. In addition, net realized
and unrealized loss on investments was $627,767, and the net decrease in net
assets resulting from operations was $3,205,270.
Cash used in investing activities for the year ended December 31, 2003,
was $15,582,923, primarily reflecting an increase in our investment in U.S.
government and agency obligations of $11,669,430 and investments in private
placements of $3,727,718.
Cash provided by financing activities for the year ended December 31,
2003, was $16,633,462, primarily reflecting net proceeds of $16,631,962 from the
issuance of 2,300,000 new shares of our common stock in an underwritten
follow-on offering. Within 12 months, we invested and used for operating
expenses all of the net proceeds from this issuance.
Liquidity and Capital Resources
Our primary sources of liquidity are cash, receivables and freely
marketable securities, net of short-term indebtedness. Our secondary sources of
liquidity are restricted securities of companies that are publicly traded.
Year Ended December 31, 2005
At December 31, 2005, and December 31, 2004, our total net primary
liquidity was $97,797,219 and $45,353,691, respectively, and our secondary
liquidity was $0 and $13,113,822, respectively.
Our net primary sources of liquidity are more than adequate to cover our
gross cash operating expenses over the next 12 months. Our gross cash operating
expenses for 2005 and 2004 totaled $5,021,066 and $3,878,610, respectively.
The increase in our primary source of liquidity from December 31, 2004, to
December 31, 2005, is primarily owing to the receipt of the net proceeds from
the issuance of 3,507,500 new shares of our common stock and the net proceeds
from the sale of our investment in NeuroMetrix, Inc. These receipts were
partially offset by our investments in Cambrios, Inc., Chlorogen, Inc., eLite
Optoelectronics, Inc., Kereos, Inc., Kovio, Inc., Mersana Therapeutics, Inc.,
Molecular Imprints, Inc., Nanomix, Inc., NanoOpto Corporation, Nanosys, Inc.,
Nantero, Inc., NeoPhotonics Corporation, Starfire Systems, Inc., and Zia Laser,
Inc., and the use of funds for net operating expenses.
40
On November 19, 2001, we established an asset account line of credit. The
asset account line of credit was secured by government and government agency
securities. Under the asset account line of credit, we were able to borrow up to
$8,000,000. The asset account line of credit could be increased to up to 95
percent of the current value of the U.S. government agency obligations with
which we secure the line. The asset account line of credit carried interest at a
rate of the Broker Call Rate plus 50 basis points. Our outstanding balance under
the asset account line of credit at December 31, 2004 was $0. The Company
terminated this line of credit on November 1, 2005.
Year Ended December 31, 2004
At December 31, 2004, and December 31, 2003, our total net primary
liquidity was $45,353,691 and $27,563,886, respectively, and our secondary
liquidity was $13,113,822 and $0, respectively. At December 31, 2004, we had
contractually restricted common shares of NeuroMetrix, Inc., that were publicly
traded. These shares became freely marketable on January 18, 2005.
Our net primary sources of liquidity were more than adequate to cover our
gross cash operating expenses over the next 12 months. Our gross cash operating
expenses totaled $3,878,610 and $2,455,454 in 2004 and 2003, respectively.
The increase in our primary source of liquidity from December 31, 2003, to
December 31, 2004, was primarily owing to the receipt of the net proceeds from
the issuance of 3,450,000 new shares of our common stock and the net proceeds
from the sale of our investment in NanoGram Devices Corporation, partially
offset by our investments in Agile Materials & Technologies, Inc., Cambrios
Technologies Corporation, Crystal IS, Inc., CSwitch, Inc., Experion Systems,
Inc., Mersana Therapeutics, Inc., Molecular Imprints, Inc., NanoGram
Corporation, Nanomix, Inc., NanoOpto Corporation, NeoPhotonics Corporation,
NeuroMetrix, Inc., Nextreme Thermal Solutions, Inc., Optiva, Inc., Polatis,
Inc., Solazyme, Inc., and Starfire Systems, Inc., and the use of funds for net
operating expenses. The increase in our secondary source of liquidity from
December 31, 2003, to December 31, 2004, is owing to the completion of the
public offering of NeuroMetrix, Inc.
Critical Accounting Policies
The Company's significant accounting policies are described in Note 2 to
the Consolidated Financial Statements and in the Footnote to the Consolidated
Schedule of Investments. Critical accounting policies are those that are both
important to the presentation of our financial condition and results of
operations and those that require management's most difficult, complex or
subjective judgments. The Company considers the following accounting policies
and related estimates to be critical:
41
Valuation of Portfolio Investments
As a business development company, we invest primarily in illiquid
securities including debt and equity securities of private companies. The
investments are generally subject to restrictions on resale and generally have
no established trading market. We value substantially all of our equity
investments at fair value as determined in good faith by our valuation committee
on a quarterly basis. The valuation committee, comprised of three or more
non-interested board members, reviews and approves the valuation of our
investments within the valuation procedures 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 our assets, 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. Upon sale of investments, the values that are ultimately realized may be
different from what is presently estimated. This difference could be material.
Pension and Post-Retirement Benefit Plan Assumptions
The Company provides a Retirement Healthcare Benefit Plan for employees
who meet certain eligibility requirements. Several statistical and other factors
that attempt to anticipate future events are used in calculating the expense and
liability values related to our post-retirement benefit plans. These factors
include assumptions we make about the discount rate, the rate of increase in
healthcare costs, and mortality, among others.
The discount rate reflects the current rate at which the post retirement
benefit liabilities could be effectively settled considering the timing of
expected payments for plan participants. In estimating this rate, we consider
rates of return on high quality fixed-income investments included in published
bond indexes. We consider the Moody's Aa Corporate Bond Index and the Citigroup
Pension Liability Index in the determination of the appropriate discount rate
assumptions. The weighted average rate we utilized to measure our post
retirement benefit obligation as of December 31, 2005 and calculate our 2006
expense was 5.5%, which is a decrease from 5.75% used in determining the 2005
expense.
Recent Developments -- Portfolio Companies
On January 9, 2006, we made a $1,262,764 follow-on investment in privately
held NanoGram Corporation.
On January 11, 2006, we made a $2,500,000 new investment in privately held
Metabolon, Inc.
On February 28, 2006, we made a $2,800,000 new investment in privately
held Evolved Nanomaterial Sciences, Inc.
On March 2, 2006, we made a $2,850,000 follow-on investment in a privately
held, tiny technology portfolio company.
42
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our business activities contain elements of risk. We consider the
principal types of market risk to be valuation risk and the risk associated with
fluctuations in interest rates. We consider the management of risk to be
essential to our business.
Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market
price for those securities for which a market quotation is readily available and
(ii) fair value as determined in good faith by, or under the direction of, the
Board of Directors for all other assets . (See the "Valuation Procedures" in the
"Footnote to Consolidated Schedule of Investments" contained in "Item 1.
Consolidated Financial Statements.")
Neither our investments nor an investment in us is intended to constitute
a balanced investment program.
We have invested a substantial portion of our assets in private
development stage or start-up companies. These private businesses tend to be
based on new technology and to be thinly capitalized, unproven, small companies
that lack management depth and have not attained profitability or have no
history of operations. Because of the speculative nature and the lack of a
public market for these investments, there is significantly greater risk of loss
than is the case with traditional investment securities. We expect that some of
our 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. Even when our private equity investments complete initial
public offerings (IPOs), we are normally subject to lock-up agreements for a
period of time, and thereafter, the market for the unseasoned publicly traded
securities may be relatively illiquid.
Because there is typically no public market for the equity interests of
many of the small privately held companies in which we invest, the valuation of
the equity interests in that portion of our portfolio is determined in good
faith by our Board of Directors in accordance with our Valuation Procedures. In
the absence of a readily ascertainable market value, the determined value of our
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 our consolidated statements of
operations as "Net increase (decrease) in unrealized appreciation on
investments."
We also invest in short-term money market instruments, and both short and
long-term U.S. government and agency obligations. To the extent that we invest
in short and long-term U.S. government and agency obligations, changes in
interest rates may result in changes in the value of these obligations which
would result in an increase or decrease of our net asset value. The level of
interest rate risk exposure at any given point in time depends on the market
environment and expectations of future price and market movements, and it will
vary from period to period. If the average interest rate on U. S. government and
agency obligations at December 31, 2005, were to increase by 25, 75 and 150
basis points, the value of the securities, and our net asset value of the same
types and time to maturity, would decrease by approximately $242,553, $727,658
and $1,455,315, respectively.
43
In addition, we may from time to time opt to borrow money to make
investments in the future. Our net investment income will be dependent upon the
difference between the rate at which we borrow funds and the rate at which we
invest such funds. As a result, there can be no assurance that a significant
change in market interest rates will not have a material adverse effect on our
net investment income in the event we choose to borrow funds for investing
purposes.
44
Item 8. Consolidated Financial Statements and Supplementary Data
HARRIS & HARRIS GROUP, INC.(R)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
The following reports and consolidated financial schedules of Harris &
Harris Group, Inc.(R) are filed herewith and included in response to Item 8.
Documents Page
--------- ----
Management's Report on Internal Control Over
Financial Reporting ....................................... 46
Report of Independent Registered Public Accounting Firm ....... 47
Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
as of December 31, 2005, and 2004 ......................... 49
Consolidated Statements of Operations for the
years ended December 31, 2005, 2004, 2003 ................. 50
Consolidated Statements of Cash Flows for the
years ended December 31, 2005, 2004, and 2003 ............. 51
Consolidated Statements of Changes in Net Assets for the
years ended December 31, 2005, 2004, and 2003 ............. 52
Consolidated Schedule of Investments as of December 31, 2005 .. 53-58
Consolidated Schedule of Investments as of December 31, 2004 .. 59-63
Footnote to Consolidated Schedule of Investments .............. 64-66
Notes to Consolidated Financial Statements .................... 67-79
Financial Highlights for the years ended December 31, 2005,
2004 and 2003 ............................................. 80
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.
45
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended, as a process designed by, or under
the supervision of, the Company's principal executive and principal financial
officers and effected by the Company's board of directors, management and other
personnel to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles and includes those
policies and procedures that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of
the assets of the Company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the
Company; and
o provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness of internal control over financial reporting to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management has assessed the effectiveness of our internal control over
financial reporting as of December 31, 2005. In making its assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework. Based on the results of this assessment, management (including our
Chief Executive Officer and Chief Financial Officer) has concluded that, as of
December 31, 2005, the Company's internal control over financial reporting was
effective.
Our management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which appears on page 47 of this Annual Report on Form
10-K.
46
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Harris & Harris Group, Inc.:
We have completed integrated audits of Harris & Harris Group, Inc.'s 2005 and
2004 consolidated financial statements and of its internal control over
financial reporting as of December 31, 2005, and an audit of its 2003
consolidated financial statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Our opinions, based on our
audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Harris
& Harris Group, Inc. (the "Company") at December 31, 2005 and December 31, 2004,
and the results of its operations, its cash flows, the changes in its net assets
and the financial highlights for each of the three years in the period ended
December 31, 2005 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at December 31, 2005 by correspondence with the
custodian, provide a reasonable basis for our opinion.
As more fully disclosed in Note 2 of the Notes to Consolidated Financial
Statements, the financial statements include investments valued at $33,187,333
(28.1% of net assets) at December 31, 2005, the fair values of which have been
estimated by the Board of Directors in the absence of readily ascertainable
market values. Those estimated values may differ significantly from the values
that would have been used had a ready market for the investments existed, and
the differences could be material.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2005 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
47
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
March 15, 2006
48
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
--------------------------------------------------------------------------------
ASSETS
December 31, 2005 December 31, 2004
Investments, at value (Cost: $134,026,747 at 12/31/05,
$77,442,110 at 12/31/04 ........................... $ 129,438,197 $ 76,244,682
Cash and cash equivalents ...................................... 1,213,289 650,332
Restricted funds (Note 5) ...................................... 1,730,434 1,591,971
Receivable from portfolio company .............................. 75,000 10,000
Interest receivable ............................................ 248,563 58,960
Income tax receivable .......................................... 9,503 2,480
Prepaid expenses ............................................... 2,993 542,489
Other assets, net of reserve of $0 at 12/31/05,
$255,486 at 12/31/04 (Note 10) ........................... 229,644 260,537
------------- -------------
Total assets .................................................. $ 132,947,623 $ 79,361,451
============= =============
LIABILITIES & NET ASSETS
Accounts payable and accrued liabilities (Note 5) .............. $ 3,174,183 $ 2,905,658
Accrued profit sharing (Note 3) ................................ 2,107,858 311,594
Deferred rent .................................................. 31,003 34,930
Deferred income tax liability (Note 6) ......................... 0 1,364,470
Current taxes payable .......................................... 1,524,470 0
Taxes payable on behalf of shareholders (Note 6) ............... 8,122,367 0
------------- -------------
Total liabilities .............................................. 14,959,881 4,616,652
------------- -------------
Net assets ..................................................... $ 117,987,742 $ 74,744,799
============= =============
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, 30,000,000 shares authorized,
22,585,085 issued at 12/31/05; 25,000,000 shares
Authorized, 19,077,585 issued at 12/31/04 ................. 225,851 190,776
Additional paid in capital (Note 9) ............................ 122,149,642 85,658,150
Accumulated net realized income (loss) ......................... 3,781,905 (4,961,123)
Accumulated unrealized depreciation of investments, including
deferred taxes of $0 at 12/31/05 and
$1,540,045 at 12/31/04 .................................... (4,764,125) (2,737,473)
Treasury stock, at cost (1,828,740 shares at 12/31/05 and
12/31/04) ................................................. (3,405,531) (3,405,531)
------------- -------------
Net assets ..................................................... $ 117,987,742 $ 74,744,799
============= =============
Shares outstanding ............................................. 20,756,345 17,248,845
============= =============
Net asset value per outstanding share .......................... $ 5.68 $ 4.33
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
49
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
Investment income:
Interest from:
Fixed-income securities .................... $ 1,409,273 $ 614,728 $ 125,173
Portfolio companies ........................ 65,620 22,834 450
Other income ................................. 65,969 0 42,162
------------ ------------ ------------
Total investment income .................... 1,540,862 637,562 167,785
------------ ------------ ------------
Expenses:
Profit-sharing provision (Note 3) ............ 1,796,264 311,594 0
Salaries and benefits ........................ 2,459,033 1,928,088 1,540,692
Professional fees ............................ 830,062 667,311 303,795
Administration and operations ................ 1,319,354 718,530 446,185
Rent ......................................... 211,582 151,434 200,711
Directors' fees and expenses ................. 308,874 209,210 162,014
Depreciation ................................. 64,713 43,151 51,073
Custodian fees ............................... 16,741 17,023 10,178
Interest expense ............................. 0 0 16,879
------------ ------------ ------------
Total expenses ............................. 7,006,623 4,046,341 2,731,527
------------ ------------ ------------
Net operating loss ............................... (5,465,761) (3,408,779) (2,563,742)
------------ ------------ ------------
Net realized income (loss) from investments:
Realized income (loss) from investments ...... 23,862,037 813,994 (971,164)
Income tax expense (benefit) (Note 6) ........ 9,653,248 (44,509) 13,761
------------ ------------ ------------
Net realized income (loss) from investments .. 14,208,789 858,503 (984,925)
------------ ------------ ------------
Net realized income (loss) ....................... 8,743,028 (2,550,276) (3,548,667)
------------ ------------ ------------
Net decrease (increase) in unrealized
depreciation on investments:
Change as a result of investment sales ....... (23,181,420) 915,118 1,000,001
Change on investments held ................... 19,790,298 264,170 (656,604)
------------ ------------ ------------
Change in unrealized depreciation
on investments ............................. (3,391,122) 1,179,288 343,397
Income tax (benefit) expense (Note 6) ........ (1,364,470) 695,126 0
------------ ------------ ------------
Net decrease (increase) in unrealized
depreciation on investments ................ (2,026,652) 484,162 343,397
------------ ------------ ------------
Net increase (decrease) in net assets
resulting from operations:
Total ........................................ $ 6,716,376 $ (2,066,114) $ (3,205,270)
============ ============ ============
Per average outstanding share ................ $ 0.36 $ (0.13) $ (0.28)
============ ============ ============
Average outstanding shares ................... 18,471,770 15,476,714 11,511,448
============ ============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
50
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
Cash flows from operating activities:
Net increase (decrease) in net assets
resulting from operations ................................... $ 6,716,376 $ (2,066,114) $ (3,205,270)
Adjustments to reconcile net increase (decrease) in net assets
resulting from operations to net cash (used in) provided
by operating activities:
Net realized and unrealized (gain) loss on investments ...... (20,470,915) (1,993,282) 627,767
Deferred income taxes ....................................... (1,364,470) 695,126 0
Depreciation and amortization ............................... 346,019 43,151 51,073
Taxes payable on behalf of shareholders on deemed dividend .. 8,122,367 0 0
Changes in assets and liabilities:
Restricted funds ............................................ (138,463) (379,893) (455,134)
Receivable from portfolio company ........................... (65,000) (10,000) 786,492
Funds in escrow ............................................. 0 0 750,000
Interest receivable ......................................... (189,603) (58,510) (261)
Income tax receivable ....................................... (7,023) 14,895 (17,375)
Prepaid expenses ............................................ 539,496 (535,648) 89,790
Other assets ................................................ 11,599 (8,666) 44,130
Accounts payable and accrued liabilities .................... 268,525 182,260 1,271,830
Payable to broker for unsettled trade ....................... 0 0 (5,696,725)
Accrued profit sharing ...................................... 1,796,264 311,594 (15,233)
Deferred rent ............................................... (3,927) (4,718) 34,251
Current income tax liability ................................ 1,524,470 0 (857,656)
------------ ------------ ------------
Net cash (used in) operating activities ..................... (2,914,285) (3,809,805) (6,592,321)
------------ ------------ ------------
Cash flows from investing activities:
Net (purchase) sale of short-term investments
and marketable securities ............................... (52,144,482) (17,823,606) (11,669,430)
Investment in private placements and loans .................. (16,251,339) (16,731,216) (3,727,718)
Proceeds from sale of investments ........................... 35,392,200 2,530,483 27,641
Purchase of fixed assets .................................... (45,704) (69,273) (213,416)
------------ ------------ ------------
Net cash (used in) investing activities ..................... (33,049,325) (32,093,612) (15,582,923)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from public offering, net (Note 9) ................. 36,526,567 36,128,175 16,631,962
Collection on notes receivable .............................. 0 0 1,500
------------ ------------ ------------
Net cash provided by financing activities ................... 36,526,567 36,128,175 16,633,462
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents:
Cash and cash equivalents at beginning of the year .......... 650,332 425,574 5,967,356
Cash and cash equivalents at end of the year ................ 1,213,289 650,332 425,574
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ........ $ 562,957 $ 224,758 $ (5,541,782)
============ ============ ============
Supplemental disclosures of cash flow information:
Income taxes paid ........................................... $ 0 $ 0 $ 575,100
Interest paid ............................................... $ 0 $ 0 $ 16,879
The accompanying notes are an integral part of these consolidated
financial statements.
51
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
Changes in net assets from operations:
Net operating loss ............................. $ (5,465,761) $ (3,408,779) $ (2,563,742)
Net realized income (loss) on investments ...... 14,208,789 858,503 (984,925)
Net increase (decrease) in unrealized
depreciation on investments as a
result of sales ............................ (23,181,420) 915,118 1,000,001
Net (increase) decrease in unrealized
depreciation on investments held ........... 19,790,298 264,170 (656,604)
Net change in deferred taxes ................... 1,364,470 (695,126) 0
------------- ------------- -------------
Net increase (decrease) in net assets resulting
from operations ............................ 6,716,376 (2,066,114) (3,205,270)
------------- ------------- -------------
Changes in net assets from
capital stock transactions:
Proceeds from sale of stock .................... 35,075 34,500 23,000
Additional paid in capital on common
stock issued ............................... 36,491,492 36,093,675 16,608,962
------------- ------------- -------------
Net increase in net assets resulting
from capital stock transactions ............ 36,526,567 36,128,175 16,631,962
------------- ------------- -------------
Net increase in net assets .......................... 43,242,943 34,062,061 13,426,692
Net Assets:
Beginning of the year .......................... 74,744,799 40,682,738 27,256,046
------------- ------------- -------------
End of the year ................................ $ 117,987,742 $ 74,744,799 $ 40,682,738
============= ============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
52
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2005
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- ----------
Investments in Unaffiliated Companies (6)(7) - 13.2% of net assets
Private Placement Portfolio (Illiquid) - 13.2% of net assets
AlphaSimplex Group, LLC (2) -- Investment management company headed by
Dr. Andrew W. Lo, holder of the Harris & Harris Group Chair at MIT
Limited Liability Company Interest ................................. (B) -- $ 16,315
----------
Crystal IS, Inc. (1)(2)(5) -- Developing a technology to grow
single-crystal boules of aluminum nitride for gallium nitride
electronics
Series A Convertible Preferred Stock ............................... (A) 274,100 199,983
----------
Exponential Business Development Company (1)(2) --
Venture capital partnership focused on early stage companies
Limited Partnership Interest ....................................... (B) -- 0
----------
Molecular Imprints, Inc. (1)(2) -- Manufacturing nanoimprint lithography
capital equipment
Series B Convertible Preferred Stock ............................... (A) 1,333,333 2,000,000
Series C Convertible Preferred Stock ............................... (A) 1,250,000 2,500,000
Warrants at $2.00 expiring12/31/15 ................................. (B) 125,000 0
----------
4,500,000
----------
Nanosys, Inc. (1)(2)(5) -- Developing nanotechnology-enabled systems
incorporating zero and one-dimensional inorganic
nanometer-scale materials
Series C Convertible Preferred Stock ............................... (C) 803,428 2,370,113
Series D Convertible Preferred Stock ............................... (C) 1,016,950 3,000,003
----------
5,370,116
----------
Nantero, Inc. (1)(2)(5) -- Developing a high-density, nonvolatile, random
access memory chip, using nanotechnology
Series A Convertible Preferred Stock ............................... (C) 345,070 1,046,908
Series B Convertible Preferred Stock ............................... (C) 207,051 628,172
Series C Convertible Preferred Stock ............................... (C) 188,315 571,329
----------
2,246,409
----------
The accompanying notes are an integral part of these consolidated
financial statements.
53
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2005
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Unaffiliated Companies (6)(7) - 13.2% of net assets (cont)
Private Placement Portfolio (Illiquid) - 13.2% of net assets (cont.)
NeoPhotonics Corporation (1)(2) -- Developing and manufacturing
planar optical devices and components
Common Stock ........................................................ (C) 716,195 $ 67,736
Series 1 Convertible Preferred Stock ................................ (C) 1,831,256 2,014,677
Series 2 Convertible Preferred Stock ................................ (C) 741,898 878,120
Warrants at $0.15 expiring 01/26/10 ................................. (C) 16,364 164
Warrants at $0.15 expiring 12/05/10 ................................. (C) 14,063 140
-----------
2,960,837
-----------
Polatis, Inc. (1)(2)(5)(9) -- Developing optical networking components
by merging materials, MEMS and electronics technologies
Series A-1 Convertible Preferred Stock ............................. (B) 16,775 47,828
Series A-2 Convertible Preferred Stock ............................. (B) 71,611 204,172
-----------
252,000
-----------
Total Unaffiliated Private Placement Portfolio (cost: $15,469,546) ........................................ $15,545,660
-----------
Total Investments in Unaffiliated Companies (cost: $15,469,546) ........................................... $15,545,660
-----------
The accompanying notes are an integral part of these consolidated
financial statements.
54
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2005
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- ----------
Investments in Non-Controlled Affiliated Companies (6)(8) - 15.0% of net assets
Private Placement Portfolio (Illiquid) - 15.0% of net assets
Cambrios Technologies Corporation (1)(2)(5) -- Developing commercially
relevant materials by evolving biomolecules to express control over
nanostructure synthesis
Series B Convertible Preferred Stock ............................... (A) 1,294,025 $1,294,025
----------
Chlorogen, Inc. (1)(2)(5) -- Developing patented chloroplast technology
to produce plant-made proteins
Series A Convertible Preferred Stock ............................... (A) 4,478,038 785,000
Series B Convertible Preferred Stock ............................... (A) 2,077,930 364,261
----------
1,149,261
----------
CSwitch, Inc. (1)(2)(5) -- Developing next-generation, system-on-a-chip
solutions for communications-based platforms
Series A Convertible Preferred Stock ............................... (B) 1,000,000 500,000
----------
eLite Optoelectronics Inc. (1)(2)(4) -- Manufacturing high-power light
emitting diodes
Series B Convertible Preferred Stock ............................... (A) 1,861,504 1,000,000
----------
Kereos, Inc. (1)(2)(4)(5) -- Developing molecular imaging agents
and targeted therapeutics to image and treat cancer and
cardiovascular disease
Series B Convertible Preferred Stock ............................... (A) 349,092 960,000
----------
Kovio , Inc. (1)(2)(4)(5) -- Developing semi-conductor products
using printed electronics and thin-film technologies
Series C Convertible Preferred Stock ............................... (A) 2,500,000 3,000,000
----------
Mersana Therapeutics, Inc. (1)(2)(5)(10) -- Developing advanced
polymers for drug delivery
Series A Convertible Preferred Stock ................................ (C) 68,452 136,904
Series B Convertible Preferred Stock ................................ (C) 616,500 1,233,000
Warrants at $2.00 expiring 10/21/10 ................................. (B) 91,625 0
----------
1,369,904
----------
NanoGram Corporation (1)(2)(5) -- Developing a broad suite of intellectual
property utilizing nanotechnology
Series I Convertible Preferred Stock ............................... (B) 63,210 64,259
Series II Convertible Preferred Stock .............................. (B) 1,250,904 1,271,670
----------
1,335,929
----------
The accompanying notes are an integral part of these consolidated
financial statements.
55
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2005
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Non-Controlled Affiliated Companies (6)(8) - 15.0% of net assets (cont.)
Private Placement Portfolio (Illiquid) - 15.0% of net assets (cont.)
Nanomix, Inc. (1)(2)(5) -- Producing nanoelectronic sensors that
integrate carbon nanotube electronics with silicon microstructures
Series C Convertible Preferred Stock ................................... (A) 9,779,181 $ 2,500,000
-----------
NanoOpto Corporation (1)(2)(5) -- Manufacturing discrete and integrated
optical communications sub-components on a chip by utilizing
nano-manufacturing technology
Series A-1 Convertible Preferred Stock ................................. (C) 267,857 32,490
Series B Convertible Preferred Stock ................................... (C) 3,819,935 1,110,073
Series C Convertible Preferred Stock ................................... (C) 1,932,789 842,503
Warrants at $0.4359 expiring 03/15/10 .................................. (C) 193,279 0
-----------
1,985,066
Nextreme Thermal Solutions, Inc. (1)(2)(5) -- Developing thin-film,
superlattice thermoelectric devices
Series A Convertible Preferred Stock ................................... (A) 500,000 500,000
-----------
Questech Corporation (1)(2) -- Manufacturing and markets
proprietary metal decorative tiles
Common Stock .......................................................... (C) 646,954 724,588
Warrants at $1.50 expiring 08/03/06 ................................... (B) 8,500 0
Warrants at $1.50 expiring 11/21/07 ................................... (B) 3,750 0
Warrants at $1.50 expiring 11/19/08 ................................... (B) 5,000 0
Warrants at $1.50 expiring 11/19/09 ................................... (B) 5,000 0
-----------
724,588
Solazyme, Inc. (1)(2)(5) -- Developing energy-harvesting
machinery of photosynthetic microbes to produce industrial
and pharmaceutical molecules
Series A Convertible Preferred Stock .................................. (C) 988,204 385,400
-----------
Starfire Systems, Inc. (1)(2)(5) --Producing ceramic-forming polymers
Common Stock .......................................................... (A) 375,000 150,000
Series A-1 Convertible Preferred Stock ................................ (A) 600,000 600,000
-----------
750,000
Zia Laser, Inc. (1)(2)(4)(5) -- Developing quantum dot semiconductor lasers
Series C Convertible Preferred Stock .................................. (B) 1,500,000 187,500
-----------
Total Non-Controlled Private Placement Portfolio (cost: $22,236,796) ...................................... $17,641,673
-----------
Total Investments in Non-Controlled Affiliated Companies (cost: $22,236,796) .............................. $17,641,673
-----------
The accompanying notes are an integral part of these consolidated
financial statements.
56
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2005
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- ---------- ------------
U.S. Government and Government Agency Securities - 81.5% of net assets
U.S. Treasury Bills -- due date 01/05/06 ........................ (J) 24,500,000 $ 24,495,590
U.S. Treasury Notes -- due date 02/28/06, coupon 1.625% ......... (H) 810,000 806,963
U.S. Treasury Bills -- due date 03/02/06 ........................ (J) 32,845,000 32,640,376
U.S. Treasury Bills -- due date 03/16/06 ........................ (J) 4,750,000 4,712,855
U.S. Treasury Notes -- due date 03/31/06, coupon 1.5% ........... (H) 4,616,000 4,586,965
U.S. Treasury Notes -- due date 11/30/07, coupon 4.25% .......... (H) 6,500,000 6,480,955
U.S. Treasury Notes -- due date 02/15/08, coupon 3.375% ......... (H) 9,000,000 8,814,690
U.S. Treasury Notes -- due date 05/15/08, coupon 3.75% .......... (H) 9,000,000 8,872,020
U.S. Treasury Notes -- due date 09/15/08, coupon 3.125% ......... (H) 5,000,000 4,840,450
------------
Total Investments in U.S. Government and Government Agency
Securities (cost: $96,320,405) ...................................................................... $ 96,250,864
------------
Total Investments (cost: $134,026,747) ................................................................... $129,438,197
============
The accompanying notes are an integral part of these consolidated
financial statements.
57
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF December 31, 2005
--------------------------------------------------------------------------------
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 Schedule of Investments for a description of the Valuation
Procedures.
(4) Initial investment was made during 2005.
(5) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of its
efforts to establishing a new business, and either it has not yet
commenced its planned principal operations, or it has commenced such
operations but has not realized significant revenue from them.
(6) Investments in unaffiliated companies consist of investments in which we
own less than five percent of the voting shares of the portfolio company.
Investments in non-controlled affiliated companies consist of investments
in which we own five percent or more, but less than 25 percent, of the
voting shares of the portfolio company or where we hold one or more seats
on the portfolio company's Board of Directors. Investments in controlled
affiliated companies consist of investments in which we own 25 percent or
more of the voting shares of the portfolio company.
(7) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $15,469,546. The gross unrealized appreciation
based on the tax cost for these securities is $1,732,194. The gross
unrealized depreciation based on the tax cost for these securities is
$1,656,080.
(8) The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $22,236,796. The gross unrealized
appreciation based on the tax cost for these securities is $313,534. The
gross unrealized depreciation based on the tax cost for these securities
is $4,908,657.
(9) Continuum Photonics, Inc., merged with Polatis, Ltd., to form Polatis,
Inc.
(10) Mersana Therapeutics, Inc., was previously named Nanopharma Corp.
The accompanying notes are an integral part of this consolidated schedule.
58
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2004
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Unaffiliated Companies (8)(9) - 11.4% of net assets
Private Placement Portfolio (Illiquid) - 11.4% of net assets
AlphaSimplex Group, LLC (2)(5) -- Investment management company headed by
Dr. Andrew W. Lo, holder of the Harris & Harris Group Chair at MIT
Limited Liability Company Interest ........................................... (C) -- $ 125,000
-----------
Cambrios Technologies Corporation (1)(2)(4)(6) -- Developing commercially
relevant materials by evolving biomolecules to express control over
nanostructure synthesis
Series B Convertible Preferred ............................................... (A) 783,019 783,019
-----------
Crystal IS, Inc. (1)(2)(4)(6) -Developing a technology to grow
single-crystal boules of aluminum nitride for gallium
nitride electronics
Series A Convertible Preferred Stock ......................................... (A) 5,482 199,983
-----------
Exponential Business Development Company (1)(2) --
Venture capital partnership focused on early stage companies
Limited Partnership Interest ................................................. (B) -- 0
-----------
Heartware, Inc. (1)(2)(5)(6) -- Developing ventricular assist devices --
Series A-2 Non-Voting Preferred Stock ........................................ (B) 47,620 0
-----------
Molecular Imprints, Inc. (1)(2)(4) -- Manufacturing nanoimprint lithography
capital equipment
Series B Convertible Preferred Stock ......................................... (A) 1,333,333 2,000,000
-----------
Nanosys, Inc. (1)(2)(5)(6) -- Developing nanotechnology-enabled systems
incorporating zero and one-dimensional inorganic
nanometer-scale materials
Series C Convertible Preferred Stock ......................................... (A) 803,428 1,500,000
-----------
Nantero, Inc. (1)(2)(5)(6) -- Developing a high-density, nonvolatile, random
access memory chip, using nanotechnology
Series A Convertible Preferred Stock ......................................... (C) 345,070 538,309
Series B Convertible Preferred Stock ......................................... (C) 207,051 323,000
-----------
861,309
-----------
The accompanying notes are an integral part of these consolidated
financial statements.
59
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2004
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Unaffiliated Companies (8)(9) - 11.4% of net assets (cont.)
Private Placement Portfolio (Illiquid) - 11.4% of net assets (cont.)
NeoPhotonics Corporation (1)(2)(6)(11) - Manufacturing
planar optical devices and components
Common Stock .................................................................. (C) 60,580 9,105
Series 1 Convertible Preferred Stock .......................................... (A) 1,831,256 2,014,677
Warrants at $0.15 expiring 3/12/11 ............................................ (C) 30,426 304
-----------
2,024,086
-----------
Optiva, Inc. (1)(2)(6) -- Developing and commercializing nanomaterials
for display industry applications
Series C Convertible Preferred Stock ......................................... (B) 1,249,999 $ 0
Secured Convertible Bridge Note with 50% Preferred
Stock Warrant coverage ....................................................... (B) $ 750,000 0
-----------
0
-----------
Polatis, Inc. (1)(2)(6)(13) -- Developing optical networking
components by merging materials, MEMS and
electronics technologies
Series B Convertible Preferred Stock ......................................... (B) 2,000,000 202,702
Series C Convertible Preferred Stock ......................................... (B) 2,689,103 219,125
-----------
421,827
-----------
Solazyme, Inc. (1)(2)(4)(6) -- Developing energy-harvesting
machinery of photosynthetic microbes to produce industrial
and pharmaceutical molecules
Convertible Promissory Note .................................................. (A) $ 310,000 319,359
-----------
Starfire Systems, Inc. (1)(2)(4)(6) -- Producing ceramic-forming polymers
Common Stock ................................................................. (A) 125,000 50,000
Series A-1 Convertible Preferred Stock ....................................... (A) 200,000 200,000
-----------
250,000
-----------
Total Unaffiliated Private Placement Portfolio (cost: $11,760,258) .............................................. $ 8,484,583
-----------
Total Investments in Unaffiliated Companies (cost: $11,760,258) ................................................. $ 8,484,583
-----------
The accompanying notes are an integral part of these consolidated
financial statements.
60
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2004
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Non-Controlled Affiliated Companies (8)(10) - 30.9% of net assets
Publicly Traded Portfolio - 17.5% of net assets
NeuroMetrix, Inc. (1)(2)(10) -- Manufacturing and selling medical
devices for monitoring neuromuscular disorders
Common Stock ................................................................. (B) 1,137,570 $13,113,822
-----------
Total Publicly Traded Portfolio (cost: $4,411,373) ............................................................. $13,113,822
-----------
Private Placement Portfolio (Illiquid) - 13.4% of net assets
Agile Materials & Technologies, Inc. (1)(2)(6) -- Developing and selling
variable integrated passive RF electronic equipment components --
Series A Convertible Preferred Stock ......................................... (B) 3,732,736 0
Convertible Bridge Note with 20% warrants .................................... (B) $ 376,008 11,927
-----------
11,927
-----------
Chlorogen, Inc. (1)(2)(5)(6) -- Developing patented chloroplast
technology to produce plant-made proteins
Series A Convertible Preferred Stock ......................................... (A) 4,478,038 785,000
-----------
CSwitch, Inc. (1)(2)(4)(6) -- Developing next-generation, system-on-a-chip
solutions for communications-based platforms
Series A Convertible Preferred Stock ......................................... (A) 1,000,000 1,000,000
-----------
Experion Systems, Inc. (1)(2)(7) -- Selling software to credit unions
Series A Convertible Preferred Stock ......................................... (B) 294,118 0
Series B Convertible Preferred Stock ......................................... (B) 35,294 0
Series C Convertible Preferred Stock ......................................... (B) 222,184 0
Series D Convertible Preferred Stock ......................................... (B) 64,501 202,103
-----------
202,103
-----------
Mersana Therapeutics, Inc. (1)(2)(5)(6)(14) -- Developing advanced
polymers for drug delivery
Series A Convertible Preferred Stock .......................................... (A) 684,516 700,000
Secured Convertible Bridge Note with 25% Warrants ............................. (A) $ 550,000 557,068
-----------
1,257,068
-----------
NanoGram Corporation (1)(2)(6) -- Developing a broad suite of
intellectual property utilizing nanotechnology
Series I Convertible Preferred Stock ......................................... (A) 63,210 21,672
Series II Convertible Preferred Stock ........................................ (A) 1,250,904 1,000,723
-----------
1,022,395
-----------
Nanomix, Inc. (1)(2)(4)(6) -- Developing nanoelectronic sensors that
integrate carbon nanotube electronics with silicon microstructures --
Series C Convertible Preferred Stock .......................................... (A) 8,801,263 2,250,000
-----------
The accompanying notes are an integral part of these consolidated
financial statements.
61
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2004
--------------------------------------------------------------------------------
Method of Shares/
Valuation (3) Principal Value
------------- --------- -----------
Investments in Non-Controlled Affiliated Companies (8)(10) - 30.9% of net assets (cont.)
Private Placement Portfolio (Illiquid) - 13.4% of net assets (cont.)
NanoOpto Corporation (1)(2)(6) -- Developing discrete and integrated
optical communications sub-components on a chip by utilizing
nano-manufacturing technology
Series A-1 Convertible Preferred Stock ........................................ (C) 267,857 $ 47,561
Series B Convertible Preferred Stock .......................................... (C) 3,819,935 1,625,000
Secured Convertible Bridge Note with 20% warrants ............................. (C) $ 421,251 424,113
-----------
2,096,674
-----------
Nanotechnologies, Inc. (1)(2)(6) -- Developing and commercializes
nanoscale materials for industry
Series B Convertible Preferred Stock .......................................... (B) 1,538,837 132,879
Series C Convertible Preferred Stock .......................................... (B) 473,903 40,921
-----------
173,800
Nextreme Thermal Solutions, Inc. (1)(2)(4)(6) -- Developing
thin-film, superlattice thermoelectric devices
Series A Convertible Preferred Stock .......................................... (A) 500,000 500,000
-----------
Questech Corporation (1)(2)(5) -- Manufacturing and marketing
proprietary metal decorative tiles
Common Stock ................................................................. (C) 646,954 724,588
Warrants at $1.50 expiring 11/16/05 .......................................... (C) 1,250 0
Warrants at $1.50 expiring 08/03/06 .......................................... (C) 8,500 0
Warrants at $1.50 expiring 11/21/07 .......................................... (C) 3,750 0
Warrants at $1.50 expiring 11/19/08 .......................................... (C) 5,000 0
Warrants at $1.50 expiring 11/19/09 .......................................... (C) 5,000 0
-----------
724,588
-----------
Total Non-Controlled Private Placement Portfolio (cost: $16,324,974) ............................................ $10,023,555
-----------
Total Investments in Non-Controlled Affiliated Companies (cost: $20,736,347) .................................... $23,137,377
-----------
U.S. Government and Agency Obligations - 59.7% of net assets
U.S. Treasury Bills -- due date 01/06/05 ..................................... (J) 830,000 $ 829,900
U.S. Treasury Bills -- due date 03/17/05 ..................................... (J) 1,775,000 1,767,474
U.S. Treasury Notes -- due date 04/30/05, coupon 1.625% ...................... (H) 2,692,000 2,685,378
U.S. Treasury Notes -- due date 06/30/05, coupon 1.125% ...................... (H) 21,500,000 21,355,520
U.S. Treasury Notes -- due date 02/28/06, coupon 1.625% ...................... (H) 2,000,000 1,972,900
U.S. Treasury Notes -- due date 06/30/06, coupon 2.75% ....................... (H) 10,000,000 9,973,000
U.S. Treasury Notes -- due date 02/15/07, coupon 2.25% ....................... (H) 2,000,000 1,966,100
U.S. Treasury Notes -- due date 05/15/08, coupon 2.625% ...................... (H) 1,999,000 1,954,342
U.S. Treasury Notes -- due date 03/15/09, coupon 2.625% ...................... (H) 2,192,000 2,118,108
-----------
Total Investments in U.S. Government and Agency Obligations (cost: $44,945,505) ................................. $44,622,722
-----------
Total Investments -- (cost: $77,442,110) ........................................................................ $76,244,682
===========
The accompanying notes are an integral part of these consolidated
financial statements.
62
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 2004
--------------------------------------------------------------------------------
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 Schedule of Investments for a description of the Valuation
Procedures.
(4) Initial investment was made during 2004.
(5) No changes in valuation occurred in these investments during the 12 months
ended December 31, 2004.
(6) These investments are development stage companies. A development stage
company is defined as a company that is devoting substantially all of its
efforts to establishing a new business, and either it has not yet
commenced its planned principal operations, or it has commenced such
operations but has not realized significant revenue from them.
(7) Experion Systems, Inc., was previously named MyPersonalAdvocate.com, Inc.
(8) Investments in unaffiliated companies consist of investments in which we
own less than five percent of the voting shares of the portfolio company.
Investments in non-controlled affiliated companies consist of investments
in which we own five percent or more, but less than 25 percent, of the
voting shares of the portfolio company. Investments in controlled
affiliated companies consist of investments in which we own 25 percent or
more of the voting shares of the portfolio company.
(9) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $11,760,258. The gross unrealized appreciation
based on the tax cost for these securities is $166,498. The gross
unrealized depreciation based on the tax cost for these securities is
$3,442,173.
(10) The aggregate cost for federal income tax purposes of investments in
non-controlled affiliated companies is $20,736,347. The gross unrealized
appreciation based on the tax cost for these securities is $8,702,449. The
gross unrealized depreciation based on the tax cost for these securities
is $6,301,419.
(11) NeoPhotonics filed for bankruptcy on November 17, 2003. We sold our
investment in its Series D Preferred Stock in January 2004. NeoPhotonics
emerged from bankruptcy, as a newly reorganized company, after obtaining
financing from us and other investors.
(12) The Company's 1,137,570 share holding in NeuroMetrix, Inc. (Nasdaq
National Market Symbol: NURO), before a lock-up discount, at the December
31, 2004, market price per share of $11.75, was $13,366,448. The lock-up
expired on January 18, 2005. On March 1, 2005, the market price per share
of NeuroMetrix was $9.99. As of December 31, 2004, Charles E. Harris, our
Chairman and CEO, was a board member of NeuroMetrix, Inc.
(13) Continuum Photonics, Inc., merged with Polatis, Ltd., to form Polatis,
Inc.
(14) Mersana Therapeutics, Inc., was previously named Nanopharma Corp.
The accompanying notes are an integral part of this consolidated schedule.
63
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
--------------------------------------------------------------------------------
VALUATION PROCEDURES
Our 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; and
5) All Other Investments.
The 1940 Act requires periodic valuation of each investment in our
portfolio to determine our 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.
Our Board of Directors is responsible for (1) determining overall
valuation guidelines and (2) ensuring that our investments are valued within the
prescribed guidelines.
Our Valuation Committee, comprised of three or more independent Board
members, is responsible for reviewing and approving the valuation of our assets
within the guidelines established by the Board of Directors. The Valuation
Committee receives information and recommendations from management.
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 our assets, 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.
The values assigned to these investments are based on available
information and do not necessarily represent amounts that might ultimately be
realized, as such amounts depend on future circumstances and cannot reasonably
be determined until the individual investments are actually liquidated or become
readily marketable.
Our valuation policy with respect to the five broad investment categories
is as follows:
EQUITY-RELATED SECURITIES
Equity-related securities are valued using one or more of the following
basic methods of valuation:
A. Cost: The cost method is based on our original cost. This method is
generally used in the early stages of a company's development until significant
positive or negative events occur subsequent to the date of the original
investment that dictate a change to another valuation method. Some examples of
these 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 a company's common stock; and (5) significant positive or negative
changes in a company's business.
64
B. 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 us 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 our 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 we own and the nature of any rights to require the
company to register restricted securities under applicable securities laws.
C. Private Market: The private market method uses actual, executed,
historical transactions in a company's securities by responsible third parties
as a basis for valuation. The private market method may also use, where
applicable, unconditional firm offers by responsible third parties as a basis
for valuation.
D. Public Market: The public market method is used when there is an
established public market for the class of a company's securities held by us or
into which our securities are convertible. Securities for which market
quotations are readily available, and which are not subject to substantial legal
or contractual and transfer restrictions, 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. If, for any reason, the Valuation Committee determines that market
quotations are not reliable, such securities shall be fair valued by the
Valuation Committee in accordance with these valuation procedures. We discount
market value for securities that are subject to significant legal or contractual
transfer restrictions.
INVESTMENTS IN INTELLECTUAL PROPERTY, PATENTS, 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 our original cost. This 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.
65
F. 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 us 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
our 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, projected markets,
and other subjective factors.
G. Private Market: The private market method uses actual third-party
investments in the same or substantially similar 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.
LONG-TERM FIXED INCOME SECURITIES
H. Readily Marketable: Long-term 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.
I. Not Readily Marketable: Long-term fixed-income securities for which
market quotations are not readily available are carried at fair value as
determined in good faith by the Valuation Committee on the basis of available
data, which may include credit quality, and interest rate analysis as well as
quotations from broker-dealers or, where such quotations are not available,
prices from independent pricing services that the Board believes are reasonably
reliable and based on reasonable price discovery procedures and data from other
sources.
SHORT-TERM FIXED-INCOME INVESTMENTS
J. Short-Term Fixed-Income Investments are valued in the same manner as
long-term fixed income securities until the remaining maturity is 60 days or
less, after which time such securities may be valued at amortized cost if there
is no concern over payment at maturity.
ALL OTHER INVESTMENTS
K. All Other Investments are reported at fair value as determined in good
faith by the Valuation Committee.
For all other investments, the reported values shall reflect the Valuation
Committee's judgment of fair values as of the valuation date using the outlined
basic methods of valuation or any other method of valuation within the
prescribed guidelines that the Valuation Committee determines after review and
analysis is more appropriate for the particular kind of investment. They do not
necessarily represent an amount of money that would be realized if we had to
sell such assets in an immediate liquidation. Thus, valuations as of any
particular date are not necessarily indicative of amounts that we may ultimately
realize as a result of future sales or other dispositions of investments we
hold.
66
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1. THE COMPANY
Harris & Harris Group, Inc.(R) (the "Company," "us," "our" and "we"), is a
venture capital company operating as a business development company ("BDC")
under the Investment Company Act of 1940 ("1940 Act"). We operate as an
internally managed company whereby our officers and employees, under the general
supervision of our Board of Directors, conduct our operations.
We elected to become a BDC on July 26, 1995, after receiving the necessary
governmental approvals. From September 30, 1992, until the election of BDC
status, we operated as a closed-end, non-diversified investment company under
the 1940 Act. Upon commencement of operations as an investment company, we
revalued all of our assets and liabilities in accordance with the 1940 Act.
Prior to September 30, 1992, we were 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.SM ("Enterprises"), is a 100 percent
wholly owned subsidiary of the Company. Enterprises is a partner in Harris
Partners I, L.P.SM and is taxed under Subchapter C of the Code (a "C
Corporation"). Harris Partners I, L.P, is a limited partnership and owns our
interest in AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P.,
are Enterprises (sole general partner) and Harris & Harris Group, Inc. (sole
limited partner).
We filed for the 1999 tax year to elect treatment as a Regulated
Investment Company ("RIC") under Subchapter M of the Internal Revenue Code of
1986 (the "Code") and qualified for the same treatment for the years 2000
through 2004. We intend to file for RIC certification under Section 851(e) of
the Code for 2005, however, there can be no assurance that we will qualify as a
RIC for 2005 or subsequent years. In addition, under certain circumstances, even
if we qualified for Subchapter M treatment for a given year, we might take
action in a subsequent year to ensure that we would be taxed in that subsequent
year as a C Corporation, rather than as a RIC. As a RIC, we must, among other
things, distribute at least 90 percent of our investment company taxable income
and may either distribute or retain our realized net capital gains on
investments.
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 accounting principles generally accepted in the
United States of America for investment companies and include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates. The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and contingent assets and liabilities
as of December 31, 2005, and December 31, 2004, and the reported amounts of
revenues and expenses for the three years ended December 31, 2005, December 31,
2004, and December 31, 2003. The most significant estimates relate to the fair
valuations of certain of our investments. Actual results could differ from these
estimates.
67
Cash and Cash Equivalents. Cash and cash equivalents include money market
instruments with maturities of less than three months.
Portfolio Investment Valuations. Investments are stated at "value" as
defined in the 1940 Act and in the applicable regulations of the Securities and
Exchange Commission. Value, as defined in Section 2(a)(41) of the 1940 Act, is
(i) the market price for those securities for which a market quotation is
readily available and (ii) the fair value as determined in good faith by, or
under the direction of, the Board of Directors for all other assets. (See
"Valuation Procedures" in the "Footnote to Consolidated Schedule of
Investments.") At December 31, 2005, our financial statements include private
venture capital investments valued at $33,187,333, the fair values of which were
determined in good faith by, or under the direction, of the Board of Directors.
Upon sale of investments, the values that are ultimately realized may be
different from what is presently estimated. The difference could be material.
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. The
Company ceases accruing interest when securities are determined to be non-income
producing and writes off any previously accrued interest. Realized gains and
losses on investment transactions are determined by specific identification for
financial reporting and tax reporting.
Income Taxes. Prior to January 1, 1999, we recorded income taxes using the
liability method in accordance with the provisions of Statement of Financial
Accounting Standards No. 109. Accordingly, deferred tax liabilities had been
established to reflect temporary differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases; the most significant such difference relates to our unrealized
appreciation on investments.
We pay federal, state and local income taxes on behalf of our wholly owned
subsidiary, Harris & Harris Enterprises, which is a C corporation. (See "Note 6.
Income Taxes.")
Restricted Funds. The Company maintains a rabbi trust for the purposes of
accumulating funds to satisfy the obligations incurred by us for the
Supplemental Executive Retirement Plan ("SERP") under the employment agreement
with Charles E. Harris.
Property and Equipment. Property and equipment are included in "Other
Assets" and are carried at cost, less accumulated depreciation. Depreciation is
provided using the straight-line method over the estimated useful lives of the
premises and equipment.
68
NOTE 3. EMPLOYEE PROFIT SHARING PLAN
As of January 1, 2003, we implemented the Amended and Restated Harris &
Harris Group, Inc. Employee Profit-Sharing Plan, which we refer to as the 2002
Plan.
The 2002 Plan (and its predecessor) provides for profit sharing by our
officers and employees equal to 20 percent of our "qualifying income" for that
plan year. For the purposes of the 2002 Plan, qualifying income is defined as
net realized income as reflected on our Consolidated Statements of Operations
for that year (excluding the profit-sharing expense), less nonqualifying gains,
if any.
For purposes of the 2002 Plan, our net realized income includes investment
income, realized gains and losses, and operating expenses (including taxes paid
or payable by us), but is calculated without including dividends paid or
distributions made to shareholders, payments under the Plan, accruals for profit
sharing, unrealized gains and losses, and loss carry-overs from other years,
which net realized income we refer to as qualifying income. The proportion of
net after-tax realized gains attributable to asset values as of September 30,
1997, is considered nonqualifying gain, which reduces qualifying income. As soon
as practicable following the year-end, the Compensation Committee will determine
whether, and if so how much, qualifying income exists for a plan year. Ninety
percent of the amount determined by the Compensation Committee is then paid out
to Plan participants pursuant to the distribution percentages set forth in the
2002 Plan. The remaining 10 percent is paid out after we have filed our federal
tax return for that plan year.
On October 15, 2002, our shareholders approved the performance goals under
the 2002 Plan in accordance with Section 162(m) of the Code, effective as of
January 1, 2003. The Code generally provides that a public company such as the
Company may not deduct compensation paid to its chief executive officer or to
any of its four most highly compensated officers to the extent that the
compensation paid to the officer/employee exceeds $1,000,000 in any tax year,
unless payment is made upon the attainment of objective performance goals that
are approved by our shareholders.
Under the 2002 Plan, awards previously granted to four individuals who
were participants at that time (Charles Harris, Mel Melsheimer, Helene Shavin
and Jacqueline Matthews, herein referred to as the "grandfathered participants")
were reduced by 10 percent with respect to "Non-Tiny Technology Investments" (as
defined in the 2002 Plan) and by 25 percent with respect to "Tiny Technology
Investments" (as defined in the 2002 Plan), and these reduced awards became
permanent. We refer to these reduced awards as "grandfathered participations."
Grandfathered participations cover only investments made prior to the time the
2002 Plan was adopted and do not affect awards related to any investments made
after that date. The amount by which the awards of the grandfathered
participants are reduced are allocable and reallocable each year by the
Compensation Committee among current and new participants as awards under the
2002 Plan. The grandfathered participations will be honored by us whether or not
the grandfathered participant is still employed by us or is still alive (in the
event of death, the grandfathered participations will be paid to the
grandfathered participant's estate), unless the grandfathered participant is
dismissed for cause, in which case all future awards, including the
grandfathered participations, will be immediately cancelled and forfeited. With
regard to new investments and follow-on investments made after January 1, 2003,
both current and new participants are required to be employed by us at the end
of a plan year in order to participate in profit-sharing on our investments with
respect to that year.
69
Notwithstanding any provisions of the 2002 Plan, in no event may the
aggregate amount of all awards payable for any Plan Year during which we remain
a "business development company" within the meaning of the 1940 Act be greater
than 20 percent of our "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards as calculated exceed that
amount, the 2002 Plan requires that the awards be reduced on a pro rata basis.
The 2002 Plan may be modified, amended or terminated by the Compensation
Committee at any time. Notwithstanding the foregoing, the grandfathered
participations may not be further modified or amended. Nothing in the 2002 Plan
precludes the Compensation Committee from naming additional participants in the
2002 Plan or, except for grandfathered participations, changing the Award
Percentage of any Participant (subject to the overall percentage limitations
contained in the 2002 Plan). In one case, for a former employee who left on July
27, 2001, any amount earned will be accrued and may subsequently be paid to the
participant.
At December 31, 2005, under the 2002 Plan, the distribution amounts for
non-grandfathered investments for each officer and employee were: Charles E.
Harris, 8.43 percent; Douglas W. Jamison, 4.06 percent; Daniel V. Leff, 3.77
percent; Sandra M. Forman, 1.62 percent; Daniel B. Wolfe, 1.62 percent; and
Jacqueline M. Matthews, 0.50 percent, which together equal 20 percent.
For 2006, under the 2002 Plan, the distribution amounts for
non-grandfathered investments for each officer and employee are: Charles E.
Harris, 3.56 percent; Douglas W. Jamison, 3.56 percent; Daniel V. Leff, 3.56
percent; Alexei A. Andreev, 3.56 percent; Daniel B. Wolfe, 1.76 percent; Sandra
M. Forman, 1.39 percent; Patricia N. Egan, 0.90 percent; Mary P. Brady, 0.71
percent; Jacqueline M. Matthews, 0.50 percent; and Carmen DeForest, 0.50
percent, which together equal 20 percent.
The grandfathered participations are set forth below:
Grandfathered Participations
-------------------------------
Non-Tiny Tiny
Name of Officer/Employee Technology (%) Technology (%)
------------------------ -------------- --------------
Charles E. Harris 12.41100 10.34250
Mel P. Melsheimer 3.80970 3.17475
Helene B. Shavin 1.37160 1.14300
Jacqueline M. Matthews 0.40770 0.33975
-------- --------
TOTAL 18.00000 15.00000
======== ========
Accordingly, an additional two percent of qualifying income with respect
to grandfathered Non-Tiny Technology Investments, five percent of qualifying
income with respect to grandfathered Tiny Technology Investments and the full 20
percent of qualifying income with respect to non-grandfathered investments is
available for allocation and reallocation from year to year.
At Deember 31, 2005, Douglas W. Jamison, Daniel V. Leff, Sandra M. Forman
and Daniel B. Wolfe were allocated 0.7329229 percent, 0.6807388 percent,
0.2931692 percent and 0.2931692 percent, respectively, of the Non-Tiny
Grandfathered Participations and 1.832072 percent, 1.701847 percent, 0.7329229
percent and 0.7329229 percent, respectively, of the Tiny Technology
Grandfathered Participations.
For 2006, Douglas W. Jamison, Daniel V. Leff, Alexei A. Andreev, Daniel B.
Wolfe, Sandra M. Forman, Patricia N. Egan, Mary P. Brady and Carmen DeForest are
allocated 0.45 percent, 0.45 percent, 0.45 percent, 0.22 percent, 0.17 percent,
0.11 percent, 0.09 percent and 0.06 percent, respectively, of the Non-Tiny
Technology Grandfathered Participations and 1.12 percent, 1.12 percent, 1.12
percent, 0.55 percent, 0.43 percent, 0.28.percent, 0.22 percent and 0.16
percent, respectively, of the Tiny Technology Grandfathered Participations.
We perform a calculation to determine the accrual for profit-sharing. We
calculate 20 percent of qualifying income (i.e. realized income) pursuant to the
terms of the 2002 Plan and estimate the amount of additional qualifying income,
if any, that would result from selling all the portfolio investments that are
valued above cost (i.e., that are in an unrealized appreciation position).
Although the accrual will fluctuate as a result of changes in qualifying income
and changes in unrealized appreciation, payments are made only to the extent
that qualifying income exists. At December 31, 2005, we accrued $2,107,858 for
profit sharing as a result of net realized gains. On March 1, 2006, the Company
paid $1,897,072 to plan participants (employees and former employees), which
represents 90 percent of the total estimated profit sharing payment. The balance
is expected to be paid in September 2006. At December 31, 2004, we had $311,594
accrued for profit sharing. No actual profit sharing payments were made in 2004.
70
NOTE 4. DISTRIBUTABLE EARNINGS
As of December 31, 2005, December 31, 2004 and December 31, 2003, there
were no distributable earnings. The difference between the book basis and tax
basis components of distributable earnings is primarily attributed to Built-In
Gains existing at the time of our qualification as a RIC (see Note 6. "Income
Taxes"), nondeductible deferred compensation and net operating losses.
On December 20, 2005, the Company declared a designated undistributed
capital gain dividend ("deemed dividend") for shareholders of record as of
December 31, 2005. The deemed dividend for 2005 was $23,206,763. See Note 6
"Income Taxes." The Company did not declare dividends for the years ended
December 31, 2004 or 2003.
NOTE 5. EMPLOYEE BENEFITS
Employment Agreement with CEO
On October 19, 1999, Charles E. Harris signed an Employment Agreement with
us (the "Employment Agreement"), which superseded an employment agreement that
was about to expire on December 31, 1999. The Employment Agreement was to
terminate on December 31, 2004 ("Term"); provided, on January 1, 2000 and on
each day thereafter, the Term extends automatically by one day unless at any
time we or Mr. Harris, by written notice, decide not to extend the Term, in
which case the Term will expire five years from the date of the written notice.
On October 14, 2004, Mr. Harris signed an Amended and Restated Employment
Agreement with us (the "Amended Employment Agreement") for the purpose of
changing the termination date to be consistent with his retirement date under
the Company's Executive Mandatory Retirement Benefit Plan. The Amended
Employment Agreement provides that the term of Mr. Harris's employment may not
be extended beyond December 31, 2008, unless a committee of the Board consisting
of non-interested Directors extends the date by one year pursuant to the
Executive Mandatory Retirement Benefit Plan, and Mr. Harris agrees to serve
beyond December 31, 2008.
During the period of employment, Mr. Harris shall serve as our Chairman
and Chief Executive Officer; be responsible for the general management of our
affairs and all our subsidiaries, reporting directly to our Board of Directors;
serve as a member of the Board for the period of which he is and shall from time
to time be elected or reelected; and serve, if elected, as an officer and
director of any subsidiary or affiliate of us.
71
Mr. Harris is to receive compensation under his Amended Employment
Agreement in the form of base salary, with automatic yearly adjustments to
reflect inflation, which amounted to $235,609 for 2005. 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. For 2006, the
Compensation Committee increased Mr. Harris' base salary to $300,000. Mr. Harris
is also entitled to participate in our 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
Amended Employment Agreement, we furnish Mr. Harris with certain perquisites
which include a company car, a personal trainer, membership in certain clubs and
up to a $5,000 annual reimbursement for personal, financial or tax advice,
adjusted for inflation.
The Amended 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 his spouse with long-term care insurance; and with disability
insurance in the amount of 100 percent of his base salary. These benefits are
for the term of the Amended Employment Agreement.
The Amended 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 us, effective
August 15, 1990. The severance compensation agreement provides that if,
following a change in our control, as defined in the agreement, his employment
is terminated by us without cause or by the executive within one year of such
change in control, he shall be entitled to receive compensation in a lump sum
payment equal to 2.99 times his average annualized compensation and payment of
other welfare benefits. If Mr. Harris's termination is without cause or is a
constructive discharge, the amount payable under the Amended Employment
Agreement will be reduced by the amounts paid pursuant to the severance
compensation agreement.
SERP
The Amended Employment Agreement provides that we adopt a supplemental
executive retirement plan (the "SERP") for the benefit of Mr. Harris. Under the
SERP, we will cause an amount equal to one-twelfth of Mr. Harris's current
annual salary to be credited each month (a "Monthly Credit") to a special
account maintained for this purpose on our books for the benefit of Mr. Harris
(the "SERP Account"). The amounts credited to the SERP Account are deemed
invested or reinvested in such investments as determined by Mr. Harris. The SERP
Account is 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 equals the balance in the SERP Account and such
benefit will always be 100 percent vested (i.e., not forfeitable). In 2005, Mr.
Harris received a $125,000 distribution from the SERP Account. The balance in
the SERP Account will be distributed to Mr. Harris in a lump sum on December 31,
2008; provided, however, in the event of the termination of his employment, 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. We have established a rabbi trust for the purpose of accumulating
funds to satisfy the obligations incurred by us under the SERP, which amounted
to $1,730,434 and $1,591,971 at December 31, 2005 and 2004, respectively, and
are included in accounts payable and accrued liabilities. The restricted funds
for the SERP Account totaled $1,730,434 and $1,591,971 at December 31, 2005 and
2004, respectively. Mr. Harris's rights to benefits pursuant to this SERP will
be no greater than those of a general creditor of us.
72
401(k) Plan
As of January 1, 1989, we adopted an employee benefits program covering
substantially all of our employees under a 401(k) Plan and Trust Agreement. As
of January 1, 1999, we adopted the Harris & Harris Pension Plan and Trust, a
money purchase plan that would allow us to stay compliant with the 401(k)
top-heavy regulations and deduction limitation regulations. In 2001, Congress
enacted the Economic Growth and Tax Relief Reconciliation Act of 2001, which has
increased the deduction limits for plans such as the 401(k) Plan. This Act
eliminated the need for us to maintain two separate plans. Effective December
31, 2001, the Pension Plan merged into the 401(k) Plan, with the 401(k) Plan
being the surviving plan. Matching contributions to the plan are at the
discretion of the Compensation Committee. For the year ended December 31, 2005,
the Compensation Committee approved a 100 percent match which amounted to
$119,360. The 401(k) company match for the years ended December 31, 2004 and
2003 was $99,249 and $64,500, respectively.
Retirement Healthcare Benefit Plan
On June 30, 1994, we adopted a plan to provide medical and dental
insurance for retirees, their spouses and dependents who, at the time of their
retirement, have ten years of service with us and have attained 50 years of age
or have attained 45 years of age and have 15 years of service with us. On
February 10, 1997, we amended this plan to include employees who "have seven
full years of service and have attained 58 years of age." On November 3, 2005,
we amended this plan to reverse the 1997 amendment for future retirees and to
remove dependents other than spouses from the plan. The coverage is secondary to
any government or subsequent employer provided health insurance plans. The
annual premium cost to us with respect to the entitled retiree shall not exceed
$12,000, subject to an index for inflation. As of December 31, 2005 and 2004, we
had a liability of $685,600 and $613,447, respectively, for the plan; there are
no plan assets. On December 8, 2003, the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (the Act) was signed into law. The Act introduces
a prescription drug benefit under Medicare (Medicare Part D) as well as a
federal subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. The Act,
which goes into effect January 1, 2006, provides a 28 percent subsidy for
post-65 prescription drug benefits. Our reserve assumes our plan is actuarially
equivalent under the Act and reflects a decrease in the accumulated
postretirement benefit obligation of $34,000 and a decrease in the aggregated
service and interest cost of $7,000 at the adoption date of December 31, 2004,
reflecting the prescription drug subsidy.
73
We are making the following disclosures about our plan to provide medical
and dental insurance for retirees as of the measurement date of December 31:
Reconciliation of Accumulated
Postretirement Benefit Obligations 2005 2004 2003
---------------------------------- --------- --------- ---------
Projected accumulated postretirement
benefit obligation at beginning of year $ 546,090 $ 525,288 $ 404,912
Service cost 49,990 60,788 58,710
Interest cost 32,573 26,343 26,281
Actuarial (gain)/loss 57,091 (66,329) 35,385
Benefits paid (10,410) 0 0
--------- --------- ---------
Projected accumulated postretirement
benefit obligation at end of year $ 675,334 $ 546,090 $ 525,288
========= ========= =========
In accounting for the plan, the assumption made in 2005 for the discount
rate was 5.5 percent. The assumed health care cost trend rates in 2005 were 10.0
percent grading to 6.0 percent over four years for medical and 3.0 percent per
year for dental. The effect on disclosure information of a one percentage point
change in the assumed health care cost trend rate for each future year is shown
below.
1% Decrease Assumed 1% Increase
in Rates Rates in Rates
----------- -------- -----------
Aggregated service and interest cost $ 70,165 $ 82,563 $ 95,274
Accumulated postretirement benefit obligation $595,084 $675,334 $754,196
Executive Mandatory Retirement Benefit Plan
On March 20, 2003, in order to begin planning for eventual management
succession, the Board of Directors voted to establish the Executive Mandatory
Retirement Benefit Plan for individuals who are employed by us in a bona fide
executive or high policy making position. There are currently three such
individuals that qualify under the plan, Charles E. Harris, the Chairman and
Chief Executive Officer, Douglas W. Jamison, the President, Chief Operating
Officer and Chief Financial Officer and Mel P. Melsheimer, the former President,
Chief Operating Officer and Chief Financial Officer. Under this plan, mandatory
retirement will take place effective December 31 of the year in which the
eligible individuals attain the age of 65. On an annual basis beginning in the
year in which the designated individual attains the age of 65, a committee of
the Board consisting of non-interested directors may determine to postpone the
mandatory retirement date for that individual for one additional year for our
benefit.
74
Under applicable law prohibiting discrimination in employment on the basis
of age, we can impose a mandatory retirement age of 65 for our executives or
employees in high policy-making positions only if each employee subject to the
mandatory retirement age is entitled to an immediate retirement benefit at
retirement age of at least $44,000 per year. The benefits payable at retirement
to Mr. Harris and Mr. Melsheimer under our existing 401(k) plan do not equal
this threshold. A plan was established to provide the difference between the
benefit required under the age discrimination laws and that provided under our
existing plans. At December 31, 2005 and 2004, we had accrued $281,656 and
$267,426, respectively, for benefits under this plan. At December 31, 2005,
$231,109 was accrued for Mr. Melsheimer and $50,547 was accrued for Mr. Harris.
Currently, there is no accrual for Mr. Jamison. This benefit will be unfunded,
and the expense as it relates to Mr. Melsheimer and Mr. Harris is being
amortized over the fiscal periods through the years ended December 31, 2004, and
2008, respectively. On December 31, 2004, Mr. Melsheimer retired pursuant to the
Executive Mandatory Retirement Benefit Plan. His annual benefit under the plan
is $22,915.
NOTE 6. INCOME TAXES
Provided that a proper election is made, a corporation taxable under
Subchapter C of the Code or a C 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 (the "Inclusion Period") from sales of assets that
were held by the corporation on the effective date of the RIC election ("C
Corporation Assets"), to the extent of any gain built into the assets on such
date ("Built-In Gain"). If the corporation fails to make a proper election, it
is taxable on its Built-In Gain as of the effective date of its RIC election. We
had Built-In Gains at the time of our qualification as a RIC and made the
election to be taxed on any Built-In Gain realized during the Inclusion Period.
At December 31, 2004, the Company had recorded a deferred tax liability of
$1,540,045 related to Built-In Gains on our investment in NeuroMetrix, Inc. At
December 31, 2004, we had $501,640 in pre-1999 loss carryforwards available.
Prior to 1999, we incurred ordinary and capital losses from operations. After
our election of RIC status, those losses remained available to be carried
forward to subsequent taxable years. We have previously used loss carryforwards
to offset Built-In Gains. As of December 31, 2004, we had a capital loss
carryforward of $140,751 that will expire in 2011.
During 2005, we sold our investment in NeuroMetrix, Inc. and realized the
Built-In Gains. During 2005, we utilized all of our loss carryforwards and
Built-In Gains.
At December 31, 2005, we had no deferred tax asset or liability. Our net
deferred tax liability at December 31, 2004, consisted of the following:
December 31, 2004
-----------------
Tax on unrealized Built-In Gains $(1,540,045)
Net operating loss and capital carryforward 175,575
-----------
Net deferred income tax asset (liability) $(1,364,470)
===========
75
To the extent that we retain capital gains and declare a deemed dividend
to shareholders, the dividend is taxable to the shareholders. We would pay tax
on behalf of shareholders, at the corporate rate, on the distribution, and the
shareholders would receive a tax credit equal to their proportionate share of
the tax paid. We took advantage of this rule for 2005. Included in net realized
income from investments in 2005 were net realized gains before taxes of
$23,862,037, which consisted primarily of a net realized long term capital gain
on the sale of our investment in Neurometrix, Inc. offset by realized net long
term capital losses on the sales of Agile Materials & Technologies, Inc.,
Experion Systems, Inc., Nanotechnologies Inc., and Optiva, Inc. We applied
$140,751 of our capital loss carryforwards and $501,640 of our pre-1999 loss
carryforwards on Built-In Gains to these gains.
In December 2005, we declared a deemed dividend on net taxable realized
long term capital gains of $23,206,763. The Company recorded a tax payable on
its Consolidated Statements of Assets and Liabilities of $8,122,367 for taxes
payable on behalf of its shareholders. This distribution of $8,122,367 is also
recorded as an income tax expense on the Consolidated Statements of Operations.
Shareholders of record at December 31, 2005, receive a tax credit of $0.39131971
per share. The balance of $15,084,396 is retained by the Company.
Included in net realized income from investments in 2004 were realized net
gains of $775,732, which consisted primarily of a realized long-term capital
gain of $1,681,259, resulting from the sale of our investment in NanoGram
Devices Corporation, offset by a realized long-term capital loss of $915,108
resulting from the sale of our shares of Series D Convertible Preferred Stock in
NeoPhotonics Corporation. We applied $775,732 of our capital loss carryforward
and neither owed federal income tax on the gain nor were required to distribute
any portion of this gain to shareholders.
We pay federal, state and local taxes on behalf of our wholly owned
subsidiary, Harris & Harris Enterprises, Inc., which is taxed as a C
Corporation. For the years ended December 31, 2005, 2004 and 2003, our income
tax (benefit) provision for Harris & Harris Enterprises, Inc, was $6,411,
$(44,509) and $13,761, respectively.
For the years ended December 31, 2005, 2004 and 2003, the Company's income
tax (benefit) expense was allocated as follows:
2005 2004 2003
----------- ----------- -----------
Investment operations $ 0 $ 0 $ 0
Realized income on investments 1,530,881 (44,509) 13,761
Taxes paid on behalf of shareholders 8,122,367 0 0
Increase (decrease) in unrealized
appreciation on investments (1,364,470) 695,126 0
----------- ----------- -----------
Total income tax (benefit) expense $ 8,288,778 $ 650,617 $ 13,761
=========== =========== ===========
76
The above tax expense consists of the following:
2005 2004 2003
----------- ----------- -----------
Current $ 9,653,248 $ (44,509) $ 13,761
Deferred -- Federal (1,364,470) 695,126 0
----------- ----------- -----------
Total income tax (benefit) expense $ 8,288,778 $ 650,617 $ 13,761
=========== =========== ===========
Continued qualification as a RIC requires us to satisfy certain investment
asset diversification requirements in future years. Our ability to satisfy those
requirements may not be controllable by us. There can be no assurance that we
will qualify as a RIC in subsequent years.
NOTE 7. COMMITMENTS
On April 17, 2003, we signed a seven-year sublease for office space at 111
West 57th Street in New York City to replace the expired lease. On December 17,
2004, we signed a sublease for additional office space at our current location.
The subleases expire on April 29, 2010. Total rent expense for our office space
in New York City was $171,171 for 2005. Future minimum sublease payments in each
of the following years are: 2006 -- $181,427; 2007 -- $184,968; 2008 --
$188,598; 2009 -- $192,318; and thereafter, for the remaining term -- $64,301.
NOTE 8. ASSET ACCOUNT LINE OF CREDIT
On November 19, 2001, we established an asset account line of credit. Any
borrowings under the asset account line of credit were secured by government and
government agency securities. Under the asset account line of credit, we were
able to borrow up to $8,000,000. The asset account line of credit could be
increased to up to 95 percent of the current value of the government and
government agency securities with which we secured the line. The asset account
line of credit bore interest at the Broker Call Rate, which is the interest rate
that banks charge to brokers to finance margin loans to investors, plus 50 basis
points. We had no outstanding balance under the asset account line of credit at
December 31, 2004. On November 1, 2005, we terminated this asset line of credit.
NOTE 9. CAPITAL TRANSACTIONS
In 1998, the Board of Directors approved that effective January 1, 1998,
50 percent of all Directors' fees be used to purchase our common stock from us.
However, effective March 1, 1999, the Board of Directors approved that Directors
may purchase our common stock in the open market, rather than from us.
Since 1998, we have repurchased a total of 1,859,047 of our shares for a
total of $3,496,388, including commissions and expenses, at an average price of
$1.88 per share. These treasury shares were reduced by the purchases made by the
Directors. On July 23, 2002, because of our strategic decision to invest in tiny
technology, the Board of Directors reaffirmed its commitment not to authorize
the purchase of additional shares of stock in the foreseeable future.
77
On December 30, 2003, we sold 2,300,000 shares of common stock for gross
proceeds of $17,296,000; net proceeds of the offering, less offering costs of
$664,038, were $16,631,962. From the completion of the offering through December
1, 2004, we used the net proceeds of the offering, less offering costs, to make
new investments in tiny technology as well as follow-on investments in our
existing venture capital investments, and for working capital.
In 2004, we registered with the Securities and Exchange Commission for the
sale of up to 7,000,000 shares of our common stock from time to time. In July of
2004, we sold 3,450,000 common shares for gross proceeds of $36,501,000; net
proceeds of the offering, after offering costs of $372,825, were $36,128,175.
In September of 2005, we completed the sale of an additional 3,507,500
shares for gross proceeds of $37,091,813; net proceeds of the offering, after
offering costs of $565,246, were $36,526,567. We intend to use, and have been
using, the net proceeds of the offerings, less offering costs, to make new
investments in tiny technology as well as follow-on investments in our existing
venture capital investments, and for working capital.
NOTE 10. OTHER
At December 31, 2004, we had a total of $255,486 of funds in escrow as a
result of the merger of NanoGram Devices Corporation and a wholly owned
subsidiary of Wilson Greatbatch Technologies, Inc. The funds were held for one
year, until March 16, 2005, in an interest-bearing escrow account to secure the
indemnification obligations of the former stockholders of NanoGram Devices
Corporation. During 2004, we set up, by a charge to realized income from
investments, a reserve of 100 percent of the $255,486. On March 16, 2005, we
received the entire $255,486, released the reserve and realized the income.
NOTE 11. SUBSEQUENT EVENTS
On January 9, 2006, we made a $1,262,764 follow-on investment in privately
held NanoGram Corporation.
On January 11, 2006, we made a $2,500,000 new investment in privately held
Metabolon, Inc.
On February 28, 2006, we made a $2,800,000 new investment in privately
held Evolved Nanomaterial Sciences, Inc.
On March 2, 2006, we made a $2,850,000 follow-on investment in a privately
held, tiny technology portfolio company.
78
NOTE 12. SELECTED QUARTERLY DATA (UNAUDITED)
2005
-----------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 260,108 $ 158,717 $ 315,374 $ 801,662
Net operating loss $ (745,590) $(3,302,094) $(3,273,797) $ 1,851,274
Net increase (decrease) in net
assets resulting from operations $(2,233,447) $ 7,001,847 $ 7,336,923 $(5,388,947)
Net (decrease) increase in net
assets resulting from operations
Per average outstanding share $ (0.13) $ 0.41 $ 0.40 $ (0.26)
2004
-----------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Total investment income $ 56,536 $ 79,231 $ 253,581 $ 248,214
Net operating loss $ (749,865) $ (774,584) $ (978,773) $ (905,557)
Net increase (decrease) in net
assets resulting from operations $ 820,515 $(2,237,037) $ 1,111,121 $(1,760,713)
Net (decrease) increase in net
assets resulting from operations
Per average outstanding share $ 0.06 $ (0.16) $ 0.06 $ (0.09)
79
--------------------------------------------------------------------------------
HARRIS & HARRIS GROUP, INC.(R)
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
Per share operating performance
for a share outstanding throughout the year :*
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
----------------- ----------------- -----------------
Net asset value, beginning of year $ 4.33 $ 2.95 $ 2.37
------------ ------------ ------------
Net operating (loss) income* (0.30) (0.22) (0.22)
Net realized income (loss) on investments* 0.77 0.06 (0.09)
Net increase (decrease) in unrealized
appreciation (depreciation) as a
result of sales* (1.18) 0.06 0.09
Net increase (decrease) in unrealized
appreciation (depreciation) on
investments held* 1.07 (0.03) (0.06)
------------ ------------ ------------
Total from investment operations* 0.36 (0.13) (0.28)
------------ ------------ ------------
Net increase (decrease) from capital
stock transactions 0.99 1.51 0.86
------------ ------------ ------------
Net asset value, end of year* $ 5.68 $ 4.33 $ 2.95
============ ============ ============
Cash dividends paid per share $ 0.00 $ 0.00 $ 0.00
Taxes payable on behalf of shareholders
on the deemed dividend per share $ 0.39 $ 0.00 $ 0.00
Market value per share, end of year $ 13.90 $ 16.38 $ 11.53
Ratio of expenses to average net assets 7.5% 7.4% 9.5%
Ratio of net operating income (loss) to
average net assets (5.8)% (6.3)% (8.9)%
Total return based on:
Stock price (15.1)% 42.1% 368.7%
Net assets, end of year $117,987,742 $ 74,744,799 $ 40,682,738
Number of shares outstanding, end of year 20,756,345 17,248,845 13,798,845
*Based on average shares outstanding.
The accompanying notes are an integral part of this schedule.
80
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company's
management, under the supervision and with the participation of our chief
executive officer and chief financial officer, conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures (as required by Rules 13a-15 of the Securities Exchange Act of 1934
(the "1934 Act")). Disclosure controls and procedures means controls and other
procedures of an issuer that are designed to ensure that information required to
be disclosed by the issuer in the reports that it files or submits under the
1934 Act is recorded, processed, summarized and reported, within time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the issuer's management, as appropriate, to allow timely
decisions regarding required disclosures. As of December 31, 2005, based upon
this evaluation of our disclosure controls and procedures, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures were effective.
Internal Control Over Financial Reporting
Management's Report on Internal Control Over Financial Reporting and the
Report of Independent Registered Public Accounting Firm, which attests to
management's assessment of the Company's internal control over financial
reporting, is included in Item 8 of this Annual Report on Form 10-K.
Remediation of Material Weakness
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As we reported in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2004, management identified a material weakness in our
internal control over financial reporting as of December 31, 2004, which is
described below.
At December 31, 2004, we determined that we had a material weakness with
respect to maintaining effective controls over the accuracy of the Financial
Highlights ratios based on an audit adjustment to the line item referred to as
"Total return based on: Net asset value" in the Company's Financial Highlights
section of the financial statements for the year ended December 31, 2004.
Specifically, our procedures for preparing the Financial Highlights ratios were
not sufficiently detailed to detect errors in the underlying calculations. This
control deficiency could have resulted in a misstatement to the other Financial
Highlights ratios. In addition, during the preparation and review of the
financial statements for the fiscal period ended June 30, 2005, an error was
identified in the spreadsheet used to compute the line item referred to as
"Portfolio Turnover" in the Financial Highlights section, which existed at
December 31, 2004 and had not yet been addressed in the remediation process. The
error was corrected in the financial statements included in our Quarterly Report
on Form 10-Q for the quarter ended June 30, 2005, and did not have a material
impact on previously issued financial statements.
81
Throughout 2005, we implemented the following changes to the design of our
internal control over financial reporting to correct the material weakness noted
above:
1. We hired Patricia N. Egan, C.P.A, to serve as Chief Accounting Officer
and Senior Controller, effective June 13, 2005.
2. On March 5, 2005, we engaged an independent accounting and consulting
firm with industry experience, Eisner LLP ("Eisner"), to read the financial
statements contained in the draft Annual Report and to provide financial
reporting and accounting advisory services to the Company. On April 4, 2005, we
engaged Eisner to provide financial reporting and accounting advisory services
to the Company on an ongoing basis, including reading and commenting on the
Company's quarterly and annual financial statements prior to submission to our
external auditors.
3. In March and July 2005, we revised the worksheet that we use for
preparing our Annual and Interim Reports to clarify how ratios in the Financial
Highlights section are calculated.
4. In March 2005, we mapped out a detailed sequence of reviews of our
Annual and Interim Reports that must occur rather than merely stating that
additional reviews should occur as necessary.
5. We hired Mary P. Brady, C.P.A., to serve as Controller, effective
November 30, 2005.
During the fourth quarter 2005, we performed additional testing of these
new procedures for preparing the Financial Highlights ratios to conclude that
they are operating effectively for a sufficient period of time.
As a result of the implementation of the above-mentioned changes and the
testing of operating effectiveness, management has concluded that as of December
31, 2005, we have remediated the material weakness described above.
Changes in Internal Control Over Financial Reporting
Other than the remediation of the material weakness noted in "Remediation
of Material Weakness" above, there were no other changes in our internal control
over financial reporting that occurred during the fourth quarter of 2005 to
which this report relates that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None
82
PART III
Item 10. Directors and Executive Officers of the Registrant
The information set forth under the captions "Nominees," "Executive
Officers," "Board of Directors and Committees - Audit Committee" and "Section
16(a) Beneficial Ownership Reporting Compliance" in our Proxy Statement for
Annual Meeting of Shareholders to be held May 4, 2006, filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934 on or about March 15,
2006 (the "2005 Proxy Statement"), is herein incorporated by reference.
We have adopted a Code of Conduct for Directors and Employees, which also
applies to our Chief Executive Officer, Chief Financial Officer, Treasurer and
Controller and is posted on our website at
http://www.tinytechvc.com/shareholder_information/Code_of_Conduct.html.
The Board of Directors has determined that Dugald A. Fletcher and James E.
Roberts are both "Audit Committee Financial Experts" serving on our Audit
Committee. Messrs. Fletcher and Roberts are independent as defined under Section
2(a)19 of the Investment Company Act of 1940 and under the rules of the NASD.
Item 11. Executive Compensation
The information set forth under the captions "Remuneration of Chief
Executive Officer and Other Executive Officers" and "Remuneration of Directors"
in the 2006 Proxy Statement is herein incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information set forth under the caption "Principal Shareholders and
Ownership by Directors and Executive Officers" in the 2006 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, 2005.
Item 14. Principal Accountant Fees and Services
The information set forth under the captions "Audit Committee's
Pre-Approval Policies," "Audit Fees," "Tax Fees" and "All Other Fees" in the
2006 Proxy Statement is herein incorporated by reference.
83
PART IV
Item 15. Exhibits and Financial Statements Schedules
(a) The following documents are filed as a part of this report:
(1) Listed below are the financial statements which are filed as part of
this report:
o Consolidated Statements of Assets and Liabilities as of
December 31, 2005, and 2004;
o Consolidated Statements of Operations for the years ended
December 31, 2005, 2004, and 2003;
o Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004, and 2003;
o Consolidated Statements of Changes in Net Assets for the years
ended December 31, 2005, 2004, and 2003;
o Consolidated Schedule of Investments as of December 31, 2005;
o Footnote to Consolidated Schedule of Investments;
o Consolidated Schedule of Investments as of December 31, 2004;
o Footnote to Consolidated Schedule of Investments;
o Notes to Consolidated Financial Statements; and
o Financial Highlights for the years ended December 31, 2005,
2004, and 2003.
(2) No financial statement schedules are required to be filed herewith
because (i) such schedules are not required or (ii) the information
has been presented in the above financial statements.
(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.
3.1(a) Restated Certificate of Incorporation, incorporated by reference as
Exhibit 99 to Form 8-K dated September 27, 2005.
3.1(b) Restated By-laws, incorporated by reference as Exhibit B to
Pre-Effective Amendment No.1 to the Registration Statement on Form
N-2 filed on March 22, 2004.
4.1 Specimen certificate of common stock certificate, incorporated by
reference to Exhibit D to Pre-Effective Amendment No. 2 to the
Registration Statement on Form N-2 filed April 13, 2004.
84
10.1 Harris & Harris Group, Inc.(R) Custodian Agreement with JP Morgan,
incorporated by reference as Exhibit J to Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 filed on March 22,
2004.
10.2 Severance Compensation Agreement by and between the Company and
Charles E. Harris dated August 15, 1990, incorporated by reference
as Exhibit I(4) to Pre-Effective Amendment No. 1 to the Registration
Statement on Form N-2 filed on March 22, 2004.
10.3 Form of Indemnification Agreement which has been established with
all directors and executive officers of the Company, incorporated by
reference as Exhibit K(1) to Pre-Effective Amendment No. 1 to the
Registration Statement filed on March 22, 2004.
10.4 Amended and Restated Employment Agreement Between Harris & Harris
Group, Inc.(R) and Charles E. Harris, dated October 14, 2004,
incorporated by reference as Exhibit 10.4 to the Company's Form 8-K
filed on October 15, 2004.
10.5 Deferred Compensation Agreement Between Harris & Harris Group,
Inc.(R) and Charles E. Harris, incorporated by reference as Exhibit
10.5 to the Company's Form 10-K for the year ended December 31, 2004
filed on March 16, 2005.
10.6 Trust Under Harris & Harris Group, Inc.(R) Deferred Compensation
Agreement, incorporated by reference as Exhibit 10.6 to the
Company's Form 10-K for the year ended December 31, 1999.
10.7 Harris & Harris Group, Inc.(R) Amended and Restated Employee
Profit-Sharing Plan, incorporated by reference as Exhibit A to the
Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders filed on September 3, 2002.
10.7 Harris & Harris Group, Inc.(R) Directors Stock Purchase Plan 2001,
incorporated by reference as Exhibit 10.23 to the Company's Form
10-K for the year ended December 31, 2000.
10.8 Harris & Harris Group, Inc.(R) Executive Mandatory Retirement Plan
incorporated by reference as Exhibit 10.1 to the Company's Form 10-Q
for the quarter ended March 31, 2003.
10.9 Amendment No. 1 to Deferred Compensation Agreement incorporated by
reference as Exhibit 10.2 to the Company's Form 10-Q for the quarter
ended March 31, 2003.
10.10 Amendment No. 2 to Deferred Compensation Agreement incorporated by
reference as Exhibit 10 to the Company's Form 8-K filed on October
15, 2004.
85
11.0 Computation of Per Share Earnings, incorporated by reference as
"Consolidated Statements of Operations" in Item 8 in this Annual
Report on Form 10-K.
14. Code of Conduct for Directors and Employees of Harris & Harris
Group, Inc.(R) incorporated by reference as Exhibit 14 to the
Company's Form 8-K filed on October 5, 2004.
21. Subsidiaries of the Registrant is set forth under Item 1.
31.01* Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.02* Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.01* Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-------------
*Filed herewith
86
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 16, 2006 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 16, 2006
--------------------- and Chief Executive Officer
Charles E. Harris
/s/ Douglas W. Jamison President, Chief Operating March 16, 2006
---------------------- Officer, and Chief Financial Officer
Douglas W. Jamison
/s/ Patricia N. Egan Chief Accounting Officer March 16, 2006
-------------------- and Senior Controller
Patricia N. Egan
/s/ C. Wayne Bardin Director March 16, 2006
-------------------
C. Wayne Bardin
/s/ Phillip A. Bauman Director March 16, 2006
---------------------
Phillip A. Bauman
87
/s/ G. Morgan Browne Director March 16, 2006
--------------------
G. Morgan Browne
/s/ Dugald A. Fletcher Director March 16, 2006
----------------------
Dugald A. Fletcher
/s/ Kelly S. Kirkpatrick Director March 16, 2006
------------------------
Kelly S. Kirkpatrick
/s/ Mark A. Parsells Director March 16, 2006
--------------------
Mark A. Parsells
/s/ Lori D. Pressman Director March 16, 2006
--------------------
Lori D. Pressman
/s/ Charles E. Ramsey Director March 16, 2006
---------------------
Charles E. Ramsey
/s/ James E. Roberts Director March 16, 2006
--------------------
James E. Roberts
88
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
----------- -----------
31.01 Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.02 Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.01 Certification of CEO and CFO pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
89