SECURITIES AND EXCHANGE COMMISSION
                               Washington, D. C.  20549

                                       Form 10-K

                          Annual Report Pursuant to Section 13
                      or 15(d) of the Securities Exchange Act of 1934


For the fiscal year ended December 31, 1999      Commission File  No. 0-11576
December 31, 1998

                            HARRIS & HARRIS GROUP, INC.
- -----------------------------------------------------------------------------
                 (Exact Name of Registrant Specified in Its Charter)

                 New York                           13-3119827
- ------------------------------------     ----------------------------------------------------------------------------  -----------------------------------
    (State or Other Jurisdiction of       (I.R.S. Employer Identification No.)
     Incorporation or Organization)

   One Rockefeller Plaza, Rockefeller Center, New York, New York     10020
- -------------------------------------------------------------      --------------------------------------------------------------------------   --------
              (Address of Principal Executive Offices)             (Zip Code)

Registrant's telephone number, including area code       (212) 332-3600
                                                         --------------

  Securities registered pursuant to Section 12(b) of the Act:   None

  Securities registered pursuant to Section 12(g) of the Act:

                            Common Stock $ .01 par value
- -----------------------------------------------------------------------------
                                 (Title of class)

    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.   Yes  [X]   No [ ]

    Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X][ X ]

    The aggregate market value of the Common Stock held by non-affiliates of
Registrant as of March 5, 1999February 29, 2000 was $17,230,640$173,717,623 based on the last sale
price as quoted by NasdaqNASDAQ National Market on such date (only officers and
directors are considered affiliates for this calculation).

    As of March 5, 1999,February 29, 2000, the registrant had 10,426,6489,240,831 shares of common
stock, par value $.01 per share, outstanding.

    Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 26, 2000 are incorporated by
reference into Part III of this report.


                             TABLE OF CONTENTS

                                                                      Page
PART I

     Item 1.   Business. . . . . . . . . . . . . . . . . . . . . . . .  1
     Item 2.   Properties. . . . . . . . . . . . . . . . . . . . . . . 711
     Item 3.   Legal Proceedings . . . . . . . . . . . . . . . . . . . 711
     Item 4.   Submission of Matters to a Vote of Security Holders . . 711


PART II

     Item 5.   Market for Company's Common Equity and Related
               Stockholder Matters . . . . . . . . . . . . . . . . . 8. 12
     Item 6.   Selected Financial Data . . . . . . . . . . . . . . . . 914
     Item 7.   Management's Discussion and Analysis of Financial
               Condition and Results of Operations . . . . . . . . . 10. 15
     Item 7a.  Quantitative and Qualitative Disclosures About Market
                 RiskRisk. . . . . . . . . . . . . . . . . . . . . . . . . 2027
     Item 8.   Consolidated Financial Statements
                 and Supplementary DataData. . . . . . . 21. . . . . . . . . 28
     Item 9.   Disagreements on Accounting and Financial Disclosure. . 4253


PART III

     Item 10.  Directors and Executive Officers of the Company . . . . 4253
     Item 11.  Executive Compensation. . . . . . . . . . . . . . . . . 4253
     Item 12.  Security Ownership of Certain Beneficial Owners
                 and Management. . . . . . . . . . . . . . . . . . . . 4253
     Item 13.  Certain Relationships and Related Transactions. . . . . 4253

PART IV

     Item 14.  Exhibits, Consolidated Financial Statements,
                 Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . . .    4354

     Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4556

     Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . 4758


                                    PART I

Item 1.  Business

     Harris & Harris Group, Inc. (the "Registrant" or "Company") is a venture
capital investment company, operating as a Business Development Company
("BDC") under the Investment Company Act of 1940 (the "1940 Act").  The
Company's objective is to achieve long-term capital appreciation, rather
than current income, from its investments.  The Company has invested a
substantial portion of its assets in private development stage or start-up
companies and in the development of new technologies in a broad range of
industry segments.  These private businesses tend to be thinly capitalized,
unproven, small companies based on risky technologies that lack management
depth and have not attained profitability or have no history of operations.
The Company may also invest, to the extent permitted under the 1940 Act, in
publicly traded securities, including high risk securities as well as
investment grade securities.  The Company may participate in expansion
financing and leveraged buyout financing of more mature operating companies
as well as other investments.  As a venture capital company, the Company
invests in and provides managerial assistance to its private investees which,
in its opinion, have significant potential for growth.  There is no assurance
that the Company's investment objective will be achieved.

     The Company was incorporated under the laws of the State of New York in
August 1981.  Prior to September 30, 1992, the Company had a class of
securities registered, and filed under the reporting requirements, of the
Securities Exchange Act of 1934 (the "1934 Act") as an operating company.
On that date the Company commenced operations as a closed-end, non-
diversified investment company under the 1940 Act.  On July 26, 1995, the
Company elected to become a BDC subject to the provisions of Sections 55
through 65 of the 1940 Act.  As a BDC, the Company operates as an internally
managed investment company whereby its officers and employees, under the
general supervision of its Board of Directors, conduct its operations.

     On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification of the Company as a Regulated Investment
Company ("RIC") under Sub-Chapter M of the Internal Revenue Code (the
"Code").  At that time, the Company was taxable under Sub-Chapter C of the
Code (a "C Corporation").  On April 8, 1998, the Company announced that it
had received a certification from the Securities and Exchange Commission
("SEC") for 1997 relating to the Company's status under section 851(e) of
the Code.  That certification was necessary for the Company to qualify as a
RIC for 1998 and subsequent taxable years.

     Pursuant to the Company's receipt of the section 851(e) certification
and its intention to qualify as a RIC , in 1998 the Company's Board of
Directors declared and paid a one-time cash dividend of $0.75 per share,
for a total of $8,019,728, to meet one of the Company's requirements for
qualification for Sub-Chapter M tax treatment.  On February 17, 1999, the
Company received rulings from the Internal Revenue Service (the "IRS")
regarding other issues relevant to the Company's tax status as a RIC.
(See "Note 6 of Notes to Consolidated Financial Statements" contained in

                                        1

"Item 8. Consolidated Financial Statements and Supplementary Data" &and
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Recent Developments - Sub-
ChapterSub-Chapter M Status".Status.")
                                      1

     The qualification of the Company as a RIC under Sub-Chapter M of the
Code depends on it satisfying certain technical requirements regarding its
income, investment portfolio and distributions.  The Company was unable to
satisfy these requirements for the 1998 tax year owing to the nature of the
Company's ownership interest in one of its investee companies, and therefore
it willdid not elect Sub-Chapter M status for 1998.  In addition, because the
Company realized taxablelossestaxable losses in 1998, it was not strategically
advantageous for the Company to elect Sub-Chapter M tax status for 1998.
Moreover, the Company received a tax opinion in 1998 that the Company
interprets to mean that its tax-loss carryforward at December 31, 1998 of
approximately $7.1$7.0 million (resulting in a tax credit of approximately
$2.5 million) would be applicable as a qualifying RIC to its unrealized gains
as of December 31, 1998.  That opinion was confirmed in one of the rulings
received from the IRS in February 1999.

     The Company changed the nature of its ownership interest in the non-
qualifying investee company effective January 1, 1999 in order to meet the
Sub-Chapter M requirements.  In 1999, because of changes in its investment
portfolio, the Company requested recertification from the SEC relating to
the Company's status under section 851(e) of the Code.  On February 24, 2000,
the Company received the certification, and the Company plans to elect Sub-
Chapter M tax treatment for 1999. However, there can be no assurance that
the Company will qualify for Sub-Chapter M treatment for 1999 orin subsequent years.
In addition, under certain circumstances, even if the Company were 
qualified for
Sub-Chapter M treatment in 1999a given year and elected Sub-Chapter M treatment
for that year, the Company might take action in a subsequent year to ensure
that it would be taxed in that subsequent year as a C Corporation,rather
than as a RIC.


Venture Capital Investments

     The Company has invested a substantial portion of its assets in private
development stage or start-up companies. The Company may initially own 100
percent of the securities of a start-up investee company for a period of
time and may control such company for a substantial period.  In connection
with its venture capital investments, the Company may be involved in
recruiting management, formulating operating strategies, product development,
marketing and advertising, assisting in financial plans, as well as providing
management in the initial start-up stages and establishing corporate goals.
The Company may assist in raising additional capital for such companies from
other potential investors and may subordinate its own investment to that of
other investors.  The Company may introduce such companies to potential
joint-venture partners, suppliers and customers. In addition, the Company
may assist in establishing relationships with investment bankers and other
professionals.  The Company may also assist with mergers and acquisitions.
The Company may also find it necessary or appropriate to provide additional
capital of its own.  The Company may derive income from such companies for
the performance of any of the above services. Because of the speculative

                                     2

nature of these investments and the lack of any market for such securities,
there is significantly greater risk of loss than is the case with traditional
investment securities.  The Company expects that some of its venture capital
investments will be a complete loss or will be unprofitable and that some
will appear likely to become successful, but never realize their potential.
The Company has in the past sought, and will continue in the future to seek,
investments that offer the potential for significantly higher returns but
that involve a significantly greater degree of risk than other investments.
                                     2

     The Company may control an investee company for which it has provided
venture capital, or it may be represented on the company's board of directors
by one or more of its officers or directors, who may also serve as officers
of such company. Particularly during the early stages of an investment, the
Company may in effect be conducting the operations of the investee company.
As a venture company emerges from the developmental stage with greater
management depth and experience, the Company expects that its role in the
company's operations will diminish. The Company seeks to assist each
investee company in establishing its own independent capitalization,
management and board of directors. The Company expects to be able to reduce
its active involvement in the management of its investment in those start-up
companies that become successful by a liquidity event, such as a public
offering or sale of a company.

     The Company has invested a substantial portion of its assets in
securities that do not pay interest or dividends and that are subject to
legal or contractual restrictions on resale that may adversely affect the
liquidity and marketability of such securities.

     In addition to the information discussed above, please see "Item 8.
Consolidated Financial Statements and Supplementary Data."

Intellectual Property

     The Company believes there is a role for organizations like itself that
can assist in technology transfer.  Scientists and institutions that develop
and patent intellectual property increasingly seek the rewards of
entrepreneurial commercialization of their inventions, particularly as
governmental, philanthropic and industrial funding for research has become
harder to obtain. The Company believes that several factors combine to give
it a high value-added role to play in the commercialization of technology:
its experience in organizing and developing successful new companies; its
willingness to invest its own capital at the highest risk- seed stage; its
access to high-grade institutional sources of intellectual property; its
experience in mergers, acquisitions and divestitures; its access to and
knowledge of the capital markets; and its willingness to do as much of the
early work as it is qualified and has time to do.

     The Company invests principally but not exclusively in securities
issued by companies involved in: 1) research and development of a technology
and/or obtaining licensing rights to intellectual property or patents; 2)
outright acquisition of intellectual property or patents; and 3) formation

                                    3

and funding of companies or joint ventures to commercialize intellectual
property.  Income from the Company's investments in intellectual property
or its development may take the form of participation in licensing or
royalty income or some other form of remuneration.  At some point during
the commercialization of a technology, the Company's investment may be
transformed into ownership of securities of a development stage or start-up
company as discussed above. Investing in intellectual property is highly
risky.

                                    3

Illiquidity of Investments

     Many of the Company's investments consist of securities acquired
directly from the issuer in private transactions.  These investments may be
subject to restrictions on resale or otherwise be illiquid.  The Company
does not anticipate that there will be any established trading market for
such securities. Additionally, many of the securities that the Company may
invest in will not be eligible for sale to the public without registration
under the Securities Act of 1933, as amended, which could prevent or delay
any sale by the Company of such investments or reduce the amount of proceeds
that might otherwise be realized therefrom.  Restricted securities generally
sell at a price lower than similar securities not subject to restrictions on
resale.  Further, even if a portfolio company registers its securities and
becomes a reporting company under the 1934 Act, the Company may be
considered an insider by virtue of its board representation or otherwise
and would be restricted in sales of such company's securities.

Managerial Assistance

     The Company generally is required by the 1940 Act to make significant
managerial assistance available with respect to investee companies that the
Company treats as qualifying assets for purposes of the 70 percent test (see
"Regulation"). "Making available significant managerial assistance" as
defined in the 1940 Act with respect to a BDC such as the Company means (a)
any arrangement whereby a BDC, through its directors, officers, employees or
general partners, offers to provide, and if accepted, does so provide,
significant guidance and counsel concerning the management, operations, or
business objectives and policies of a portfolio company; or (b) the exercise
by a BDC of a controlling influence over the management or policies of a
portfolio company by a BDC acting individually or as a part of a group
acting together which controls such portfolio company.  The Company believes
that providing managerial assistance to its investees is critical to its
business development activities. The nature, timing and amount of managerial
assistance provided by the Company vary depending upon the particular
requirements of each investee company.

     The Company may be involved with its investees in recruiting management,
product planning, marketing and advertising and the development of financial
plans, operating strategies and corporate goals.  In this connection, the
Company may assist clients in developing and utilizing accounting procedures
to efficiently and accurately record transactions in books of account, which
will facilitate asset and cost control and the ready determination of results

                                    4

of operations.  The Company also seeks capital for its investees from other
potential investors and occasionally subordinates its own investment to
those of other investors.  The Company may introduce its investees to
potential suppliers, customers and joint venture partners and assists its
investees in establishing relationships with commercial and investment
bankers and other professionals, including management consultants,
recruiters, legal counsel and independent accountants.  The Company also
assists with joint ventures, acquisitions and mergers.

     In connection with its managerial assistance, the Company may be
represented by one or more of its officers or directors on the board of
directors of an investee.  As an investment matures and the investee
develops management depth and experience, the Company's role ordinarily will 

                                      4
become progressively less active. However, when the Company owns or acquires
a substantial proportion of a more mature investee company's equity, the
Company may remain active in and may initiate planning of major transactions
by the investee.  The Company typically seeks to assist each investee company
in establishing its own independent and effective board of directors and
management.


Need for Follow-On Investments

     Following its initial investment in investees, the Company has made and
anticipates that it will continue to make additional investments in such
investees as "follow-on" investments, in order to increase its investment
in an investee, and may exercise warrants, options or convertible securities
that were acquired in the original financing.  Such follow-on investments may
be made for a variety of reasons including:

     1) to increase the Company's exposure to an investee,

     2) to acquire securities issued as a result of exercising convertible
        securities that were purchased in the original financing,

     3) to preserve the Company's proportionate ownership in a subsequent
        financing, or

     4) to attempt to preserve or enhance the value of the Company's
        investment.

There can be no assurance that the Company will make follow-on investments
or have sufficient funds to make such investments; the Company has the
discretion to make any follow-on investments as it determines, subject to
the availability of capital resources.  The failure to make such follow-on
investments may, in certain circumstances, jeopardize the continued viability
of an investee and the Company's initial investment, or may result in a
missed opportunity for the Company to increase its participation in a
successful operation.  Even if the Company has sufficient capital to make a
desired follow-on investment, the Company may, under certain circumstances
be inhibited from doing so if such an investment would result in non-compliancenon-
compliance with BDC or RIC regulations.

                                      5

Competition

     Numerous companies and individuals are engaged in the venture capital
business and such business is intensely competitive.  MostMany of the competitors
have significantly greater experience,  resources and managerial capabilities than the
Company and are therefore in a better position than the Company to obtain
access to attractive venture capital investments.

Regulation

     The Small Business Investment Incentive Act of 1980 added the provisions
of the 1940 Act applicable to BDC's, which are a special type of closed-end
investment company.  After filing its election to be treated as a BDC, a
company may not withdraw its election without first obtaining the approval
of holders of a majority of its outstanding voting securities.  The following
is a brief description of the 1940 Act provisions applicable to BDC's, and
is qualified in its entirety by reference to the full text of the 1940 Act
and the rules issued thereunder by the SEC.

     Generally, to be eligible to elect BDC status, a company must primarily
engage in the business of furnishing capital and managerial expertise to
companies which do not have ready access to capital through conventional
financial channels.  Such portfolio companies are termed "eligible portfolio 

                                       5
companies."  In general, in order to qualify as a BDC, a company must (i) be
a domestic company; (ii) have registered a class of its securities pursuant
to Section 12 of the 1934 Act; (iii) operate for the purpose of investing in
the securities of certain types of portfolio companies, namely, immature or
emerging companies and businesses suffering or just recovering from financial
distress (see following paragraph); (iv) make available significant
managerial assistance to such portfolio companies; (v) have a majority of
"disinterested" directors (as defined in the 1940 Act); and (vi) file a
proper notice of election with the SEC.

     An eligible portfolio company generally is a domestic company that is
not an investment company and that (i) does not have a class of equity
securities on which "margin" credit can be extended or (ii) is controlled
by a BDC (control under the 1940 Act is presumed to exist where a BDC owns
at least 25 percent of the outstanding voting securities of the investee).

     The 1940 Act prohibits or restricts companies subject to the 1940 Act
from investing in certain types of companies, such as brokerage firms,
insurance companies, investment banking firms and investment companies.
Moreover, the 1940 Act requires that at least 70 percent of the value of
the Company's assets consist of qualifying assets.  Qualifying assets
include: (i) securities of companies that were eligible portfolio companies
at the time the Company acquired their securities; (ii) securities of
bankrupt or insolvent companies that were eligible at the time of the
Company's initial investment in those companies; (iii) securities received
in exchange for or distributed in or with respect to any of the foregoing;
and (iv) cash items, government securities and high quality short-term
debt.  The 1940 Act also places restrictions on the nature of the
transactions in which, and the persons from whom, securities can be
purchased in order for the securities to be considered qualifying assets.

                                    6

     The Company is permitted by the 1940 Act, under specified conditions, to
issue multiple classes of senior debt and a single class of preferred stock
if its asset coverage, as defined in the 1940 Act, is at least 200 percent
after the issuance of the debt or the preferred stock (i.e., such senior
securities may not be in excess of its net assets).

     The Company may sell its securities at a price that is below the
prevailing net asset value per share only after a majority of its
disinterested directors has determined that such sale would be in the best
interest of the Company and its stockholders and upon the approval by the
holders of a majority of its outstanding voting securities, including a
majority of the voting securities held by non-affiliated persons.  If the
offering of the securities is underwritten, a majority of the disinterested
directors must determine in good faith that the price of the securities
being sold is not less than a price which closely approximates market value
of the securities, less any distribution discount or commission.  As defined
by the 1940 Act, the term "majority of the Company's outstanding voting
securities" means the vote of (i) 67 percent or more of the Company's Common
Stock present at the meeting, if the holders of more than 50 percent of the
outstanding Common Stock are present or represented by proxy or (ii) more
than 50 percent of the Company's outstanding Common Stock, whichever is less.

     6
   
     Certain transactions involving certain closely related persons of the
Company, including its directors, officers and employees, may require the
prior approval of the SEC. However, the 1940 Act ordinarily does not restrict
transactions between the Company and investee companies.

     On September 25, 1997, the Company's Board of Directors approved a
proposal to seek qualification of the Company as a RIC under Sub-Chapter M
of the Code.  The Company was unable to satisfy the requirements for Sub-
Chapter M for the 1998 tax year.  (See "Item 7.  Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Recent
Developments - Sub-- Sub-Chapter M Status.") The Company plans to elect Sub-
Chapter M Status.")tax treatment for 1999.  There can be no assurance that the
Company will qualify for Sub-Chapter M tax treatment for 1999 orin subsequent years.
In addition, under certain circumstances, even if the Company were 
qualified for
Sub-Chapter M tax treatment in 1999a given year and elected Sub-Chapter M
tax treatment for that year, the Company might take action in a subsequent
year to ensure that it would be taxed in that subsequent year as a C
Corporation, rather than as a RIC.

Employees

     The Company currently employs directly four full-time employees and
one part-time employee and, in addition, employs two full-time employees
in a wholly owned subsidiary.

                                     7

Risk Factors

Investing in the Company's Stock is Highly Speculative and You Could Lose
Some or All of the Amount You Invest

     The value of the Company's common stock may decline and may be affected
by numerous market conditions, which could result in the loss of some or all
of your investment in the Company's shares.  The securities markets
frequently experience extreme price and volume fluctuation which affect
market prices for securities of companies generally, and technology
companies in particular.  Because of the Company's focus on the technology
sector, its stock price is likely to be impacted by these market conditions.
General economic conditions, and general conditions in the Internet and
information technology and life sciences and other high technology
industries, will also affect the Company's stock price.

Investing in the Company's Shares May be Inappropriate for Your Risk Tolerance

     Investing in the Company's shares may be inappropriate for your risk
tolerance.  The Company's investments in accordance with its investment
objective and principal strategies may result in an above average amount of
risk and volatility or loss of principal.  The Company's investments in
portfolio companies are highly speculative and aggressive and, therefore,
an investment in its shares may not be suitable for you.

The Market for Venture Capital Investments is Highly Competitive.  In Some
Cases, the Company's Status as a Regulated Business Development Company May
Hinder its Ability to Participate in Investment Opportunities.

     The Company faces substantial competition in its investing activities
from private venture capital funds, investment affiliates of large
industrial, technology, service and financial companies, small business
investment companies, wealthy individuals and foreign investors.  As a
regulated business development company, the Company is required to disclose
quarterly the name and business description of portfolio companies and value
of any portfolio securities.  Most of the Company's competitors are not
subject to this disclosure requirement.  The Company's obligation to
disclose this information could hinder its ability to invest in certain
portfolio companies.  Additionally, other regulations, current and future,
may make the Company less attractive as a potential investor to a given
portfolio company than a private venture capital fund not subject to the same
regulations.

Regulatory Risks

     Securities and tax laws and regulations governing the Company's
activities may change in ways negative to the Company's and its shareholders'
interests and interpretations of such laws and regulations may change with
unpredictable consequences.

                                  8

The Company is Dependent Upon Key Management Personnel for Future Success

     The Company is dependent for the selection, structuring, closing and
monitoring of its investments on the diligence and skill of its senior
management and other management members.  The future success of the Company
depends to a significant extent on the continued service and coordination of
its senior management team, particularly the Chairman and Chief Executive
Officer.  The departure of any of the executive officers or key employees
could materially adversely affect the Company's ability to implement its
business strategy.  The Company does not maintain key man life insurance
on any of its officers or employees.

Investment in Small, Private Companies

     There are significant risks inherent in the Company's venture capital
business.  The Company has invested a substantial portion of its assets in
private development stage or start-up companies.  These private businesses
tend to be thinly capitalized, unproven, small companies with risky
technologies that lack management depth and have not attained profitability
or have no history of operations.  Because of the speculative nature and the
lack of a public market for these investments, there is significantly greater
risk of loss than is the case with traditional investment securities.  The
Company expects that some of its venture capital investments will be a
complete loss or will be unprofitable and that some will appear to be likely
to become successful but never realize their potential.  The Company has been
risk seeking rather than risk averse in its approach to venture capital and
other investments.  Neither the Company's investments nor an investment in
the Company is intended to constitute a balanced investment program.  The
Company has in the past relied, and continues to rely to a large extent,
upon proceeds from sales of investments rather than investment income to
defray a significant portion of its operating expenses.

Illiquidity of Portfolio Investments

     Most of the investments of the Company are or will be equity securities
acquired directly   from small companies.  The Company's portfolio of equity
securities are and will usually be subject to restrictions on resale or
otherwise have no established trading market.  The illiquidity of most of
the Company's portfolio of equity securities may adversely affect the
ability of the company to dispose of such securities at times when it may be
advantageous for the Company to liquidate such investments.

The Inability of the Company's Portfolio Companies to Successfully Market
Their Products Would Have a Negative Impact on its Investment Returns

     Even if the Company's portfolio companies are able to develop
commercially viable products, the market for new products and services is
highly competitive and rapidly changing.  Commercial success is difficult to
predict and the marketing efforts of the Company's portfolio companies may
not be successful.

                                    9

Valuation of Portfolio Investments

     There is typically no public market of equity securities of the small
private companies in which the Company invests.  As a result, the valuation
of the equity securities in the Company's portfolio is subject to the good
faith estimate of the Company's Board of Directors.  (See "Asset Valuation
Policy Guidelines" in "Footnote to Consolidated Schedule of Investments.")
In the absence of a readily ascertainable market value, the estimated value
of the Company's portfolio of equity securities may differ significantly
from the values that would be placed on the portfolio if a ready market for
the equity securities existed.  Any changes in estimated net asset value are
recorded in the Company's statement of operations as "Change in unrealized
appreciation on investments."  (See "Management's Discussion and Analysis
of Financial Condition and Results of Operations.")

Fluctuations of Quarterly Results

     The Company's quarterly operating results could fluctuate as a result of
a number of factors.  These include, among others, variations in and the
timing of the recognition of realized and unrealized gains or losses, the
degree to which the Company encounters competition in its markets and
general economic conditions.  As a result of these factors, results for any
one quarter should not be relied upon as being indicative of performance in
future quarters.  See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Risk of Loss of Pass Through Tax Treatment

     If the Company meets certain diversification and distribution
requirements under the Code, it may qualify as a RIC under the Code for
pass-through tax treatment.  The Company would cease to qualify for pass-
through tax treatment if it were unable to comply with these requirements,
or if it ceased to qualify as a BDC under the 1940 Act.  The Company also
could be subject to a four percent excise tax (and, in certain cases,
corporate level income tax) if it failed to make certain distributions.
(See "Management's Discussion and Analysis of Financial Condition -- Recent
Developments -- Sub-Chapter M Status.")  The lack of Sub-Chapter M tax
treatment could have a material adverse effect on the total return, if any,
obtainable from an investment in the Company.  If the Company fails to
qualify as a RIC, the Company would become subject to federal income tax as
if it were an ordinary C Corporation, which would result in a substantial
reduction in the Company's net assets and the amount of income available for
distribution to the Company's stockholders.

Because the Company Must Distribute Income, the Company Will Continue to Need
Additional Capital

     The Company will continue to need capital to fund investments and to
pay for operating expenses.  The Company must distribute at least 90 percent
of its net operating income other than net realized long-term capital gains
to its stockholders to maintain its RIC status.  As a result such earnings
will not be available to fund investments.  If the Company fails to generate

                                   10

net realized long-term capital gains or to obtain funds from outside sources,
it could have a material adverse effect on the Company's financial condition
and results.  The Company does not normally establish reserves for taxes on
unrealized capital gains.  To the extent that the Company retains capital
gains, either as a C corporation or as a Sub-Chapter M corporation, it will
have to make provisions for federal taxes and possibly state and local taxes.
In addition, as a BDC, the Company is generally required to maintain a ratio
of at least 200 percent of total assets to total borrowings, which may
restrict its ability to borrow in certain circumstances.

Reserves for Taxes

     As a Sub-Chapter M corporation, the Company does not have to pay
federal income taxes on realized capital gains to the extent that such
gains are distributed to shareholders.  Accordingly, it does not
establish reserves for taxes on its unrealized capital gains.  If the
Company were not to qualify or were to elect not to qualify for Sub-
Chapter M tax status, it would have to establish such reserves for taxes,
which would reduce its net asset value, net of a reduction in the reserve
for employee profit sharing, accordingly.  To the extent that the Company
as a Sub-Chapter M corporation were to make a deemed distribution of net
realized capital gains and were to retain such net realized capital gains,
it would have to establish appropriate reserves for taxes upon making such
a decision.

Year 2000 Problem

     The "Year 2000 problem" refers to the inability of many computers,
computer-based systems and related software, and other electronics to
process dates accurately during the Year 2000 and beyond.  As of March 20,
2000, the Company has not experienced any business disruption as a result
of the Year 2000 problem.  Although Year 2000 problems may not become
evident until long after January 1, 2000, the Company does not expect
significant Year 2000 related business disruptions in the future.

Item 2.   Properties

     The Company maintains its offices at One Rockefeller Plaza, Suite 1430, New York,
New York 10020, where it leases approximately 4,700 square feet of office
space pursuant to a lease agreement expiring in 2003.  A portion of this
space was sublet in 1997 and 1998 to an early-stage company in which the
Company then had an equity interest.  In 1999, the same space was sublet
to an unaffiliated party.  See "Note 7 of Notes to theConsolidated Financial
Statements"Statements and SchedulesSchedules" contained in "Item 8.  Consolidated Financial
Statements and Supplementary Data."

Item 3.   Legal Proceedings

     None.

Item 4.   Submission of Matters to a Vote of Security Holders

     The Company did not submit any matters to a vote of its shareholders
during the fourth quarter of the 19981999 fiscal year.

                                      711

                                  PART II

Item 5.   Market for Company's Common Equity and Related Stockholder Matters
          Stock Transfer Agent

     The Bank of New York, 101 Barclay Street, Suite 12W, New York, New York
10286 (Telephone 800-524-4458, Attention: Ms. Diane Ajjan) serves as transfer
agent for the Company's common stock. Certificates to be transferred should be
mailed directly to the transfer agent, preferably by registered mail.

Market Prices

     The Company's common stock is traded on the Nasdaq National Market
under the symbol "HHGP."  The following table sets forth the range of the
high and low selling  price of the Company's shares during each quarter of
the last two years, as reported by the National Association of Securities
Dealers, Inc.  The quarterly stock prices quoted represent interdealer
quotations and do not include markups, markdowns or commissions.

                                     
        1999 Quarter Ending              Low       High
        March 31                         $1.3125   $2.1250
        June 30                          $1.625    $2.00
        September 30                     $1.71875  $3.125
        December 31                      $2.9375   $14.250

        1998 Quarter Ending              Low       High
        March 31                         $2.1875   $3.4375
        June 30                          $2.2500   $3.6875
        September 30                     $1.2500$1.125    $2.3750
        December 31                      $1.1250$1.25     $1.5938

          1997 Quarter Ending           Low       High
          March 31                      $3.3750   $5.1250
          June 30                       $3.5000   $4.8125
          September 30                  $2.5000   $3.7500
          December 31                   $2.5000   $4.0000
On September 25, 1997, the Company's Board of Directors approved a proposal to seek qualification of the Company as a RIC under Sub-Chapter M of the Code. To initially qualify as a RIC, the Company had, among other things, to pay a dividend to shareholders equal to the Company's cumulative realized earnings and profits ("E&P") from its pre-RIC taxable years. The Company paid a $0.75 dividend per share (approximately $8.0 million) on May 12, 1998 to shareholders of record on April 27, 1998. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments - Sub-Chapter M Status" and "Note 6 of Notes to Financial Statements" contained in "Item 8. Financial Statements and Supplementary Data".) On February 22, 1999, NBX Corporation announced that it had agreed to be acquired by 3Com Corporation for approximately $90 million in cash plus additional consideration for employees of NBX. This transaction was effective on March 5, 1999 and closed on March 8, 1999. On closing, the Company received a total of $12,432,940 in cash, of which $1,475,276 was placed in a one-year escrow. On February 23, 1999, the Company announced that subsequent to the acquisition of NBX Corporation by 3Com Corporation, the Board of Directors of the Company declared a cash dividend of $0.35 per share (approximately $3.7 million) to shareholders of record on March 19, 1999, payable on March 25, 1999. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments -- Sub-Chapter M Status" and "Note 6 of Notes to Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data.") Prior to 1998, the Company had not paid dividends since 1991. 812 Recent Sales of Unregistered Securities The Company hasdid not soldsell unregistered shares forin the years ended December 31, 19981999 and 19971998 other than the restricted common stock shares sold to Directors as part of their compensation program. In 1997, the Board of Directors approvedvoted that, effective January 1, 1998, 50 percent of all Directordirectors' fees be used to purchase Company common stock directly from the Company. During 1998, the Directors have purchased a total of 24,491 shares. (See "Note 4 of Notes Toto Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data.") On March 1, 1999, the Directors voted to purchase their shares in the open market rather than directly from the Company. In 1999, the Directors purchased a total of 29,305 shares, 5,816 shares directly from the Company, prior to March 1, 1999, and 23,489 shares in the open market. Shareholders As of February 26, 1999,29, 2000, there were approximately 164150 holders of record of the Company's common stock which, the Company has been informed, hold the Company's common stock for approximately 2,0008,500 beneficial owners. 13 Item 6. Selected Financial Data The following tables should be read in conjunction with the Consolidated Financial Statements and SchedulesSupplementary Data included in Item 8 of this Form 10-K.
BALANCE SHEET DATA Financial Position as of December 31: 1999 1998 1997 1996 1995 1994 Total assets $65,320,768 $25,358,859 $39,273,784 $38,555,290 $37,524,555 $32,044,073 Total liabilities $11,685,963 $ 2,802,150 $ 5,618,850 $ 2,622,687 $ 962,646 $ 733,271 Net asset value $53,634,805 $22,556,709 $33,654,934 $35,932,603 $36,561,909 $31,310,802 Net asset value per share $ 5.80 $ 2.13 $ 3.15 $ 3.44 $ 3.54 Dividends paid $ 3.430.35 $ 0.75 $ 0.0 $ 0.0 $ 0.0 Shares outstanding 9,240,831 10,591,232 10,692,971 10,442,682 10,333,902 9,136,747 Operating Data for year ended December 31: 1999 1998 1997 1996 1995 1994 Investment income $ 635,486287,684 $ 614,046585,486 $ 561,546 $ 1,013,417 $ 1,109,517 $ 820,276 Net operating loss (2,765,112) (1,498,141)(9,636,336) (2,815,112) (1,550,641) (1,291,065) (1,099,409) (2,278,882) Net realized gain (loss) gain on investments (1,768,528) (2,079,677)8,615,670 (1,718,528) (2,027,177) (2,465,175) 1,371,349 96,856 Net realized (loss) income (1,020,666) (4,533,640) (3,577,818) (3,756,240) 271,940 (2,182,026) Net increase (decrease) in unrealized appreciation on investments 38,102,047 1,655,830 969,243 2,967,248 158,219 (886,040) Net increase (decrease) increase in net assets resulting from operations 37,081,381 (2,877,810) (2,608,575) (788,992) 430,159 (3,068,066) (Decrease) increaseIncrease (decrease) in net assets resulting from operations per outstanding share $ (0.27)4.01 $ (0.24)(0.27) $ (0.08)(0.24) $ 0.04(0.08) $ (0.34)0.04
9Certain reclassifications have been made to the December 31, 1997 and December 31, 1998 financial statements to conform to the December 31, 1999 presentation. 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information contained in this section should be read in conjunction with Company's 1999 Consolidated Financial Statements and notes thereto. Forward-Looking Statements The information contained herein contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives, portfolio growth and availability of funds. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth herein. Other factors that could cause actual results to differ materially include the uncertainties of economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward- looking statements included herein are reasonable, any of the assumptions could be inaccurate and therefore there can be no assurance that the forward- looking statements included or incorporated by reference herein will prove to be accurate. Therefore, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. Statement of Operations The Company accounts for its operations under Generally Accepted Accounting Principles for investment companies. On this basis, the principal measure of its financial performance is captioned "Net increase (decrease) increase in net assets resulting from operations," which is the sum of three elements. The first element is "Net operating loss," which is the difference between the Company's income from interest, dividends, fees and other income and its operating expenses, net of applicable income tax benefit (provision). The second element is "Net realized lossgain (loss) on investments," which is the difference between the proceeds received from dispositions of portfolio securities and their stated cost, net of applicable income tax (benefits) provisions.benefit (provision). These two elements are combined in the Company's financial statements and reported as "Net realized loss." The third element, "Net increase in unrealized appreciation on investments," is the net change in the fair value of the Company's investment portfolio, net of increase (decrease) in deferred income taxes that would become payable if the unrealized appreciation were realized through the sale or other disposition of the investment portfolio. "Net realized lossgain (loss) on investments" and "Net increase (decrease) in unrealized appreciation on investments" are directly related. When a security is sold to realize a gain (loss) gain,, net unrealized appreciation decreases (increases) decreases and net realized gain increases (decreases) increases.. 15 Financial Condition The Company's total assets were $65,320,768 and its net assets were $53,634,805 at December 31, 1999, versus $25,358,859 and $22,556,709 at December 31, 1998, respectively, versus $39,273,784 and $33,654,934 at December 31, 1997, respectively. The decrease is primarily owing to: 1) the payment of a one-time cash dividend of $8,019,728 to meet one of the Company's requirements for qualification for Sub-Chapter M treatment; 2) the payment of the Company's outstanding balance on the Demand Promissory Note of $4,000,000, which reduced the Company's total assets in 1998; and 3) the decrease of $2,877,810 as a result of operations. (See "Statement of Operations" contained in "Item 8. Financial Statements and Supplementary Data".)1998. Net asset value per share ("NAV") was $5.80 at December 31, 1999, versus $2.13 at December 31, 1998. NAV was reduced by $0.35 in 1999 and by $0.75 in 1998 versus $3.15by the cash dividends paid by the Company. Among the significant changes that affected total assets, net assets and NAV during 1999 were: (1) the acquisition of NBX Corporation by 3Com Corporation, which increased the value of the Company's holdings by approximately $5,868,568; (2) an increase in the value of the Company's holding in SciQuest.com, Inc. of $31,981,750 as a result of a successful IPO and subsequent increase in market value; (3) an increase in the market value of the Company's holding in Alliance Pharmaceutical Corp. of $3,839,000; (4) the acquisition of InSite Marketing Technology, Inc. by Silknet Software, Inc. and subsequent increase in the market value of the Company's holding in Silknet totaling $4,899,062; (5) an increase in the market value of the Company's holding in Nanophase Technologies Corporation of $1,935,016; (6) the payment of a cash dividend of $0.35 per share, which reduced assets by approximately $3,647,017; (7) the addition to a deferred income tax liability, which reduced assets by $586,710; (8) the purchase of 275,648 treasury shares in the open market for $540,720 and the successful tender offer for 1,080,569 shares for a total of $1,832,831, which repurchases reduced assets by a total of $2,373,551 while increasing NAV at December 31, 1997. NAV was1999 by $0.59; and (9) the operating loss that reduced $0.75assets by the cash dividend paid by the Company$9,636,336. (See "Consolidated Statements of Operations" contained in 1998."Item 8. Consolidated Financial Statements and Supplementary Data.") The Company's shares outstanding as of December 31, 19981999 were 10,591,232,9,240,831, versus 10,692,97110,591,232 at December 31, 1997.1998. The Company's outstanding shares were reduced as a result of its repurchasepurchases in the open market of a total of 126,230243,523 shares in the first quarter and 32,125 shares in the second quarter as of December 31, 1998.well as the tender offer for 1,080,569 shares completed in the third quarter. However, during 1999, the treasury shares were then decreased by purchases of Company stocka total of 5,816 shares of treasury shares by directors with 50 percent of their director compensation.directors. (See "Note 4 of Notes to Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data".Data.") 10 The Company's financial condition is dependent on the success of its investments. The Company has invested a substantial portion of its assets in private development stage or start-up companies. These private businesses tend to be thinly capitalized, unproven, small companies that lack management depth, orare dependent on new, commercially unproven technologies and have no history of operations. At December 31, 1999, $41,556,607 or 63.6 percent of the Company's total assets consisted of investments at fair value in publicly traded securities (that were private businesses at the time the Company made the investments), of which net unrealized appreciation was $38,864,873; $18,892,731 or 29.0 percent of the Company's total assets consisted of non-publicly traded securities at fair value in private businesses and publicly traded companies, of which net unrealized appreciation was $8,553,549. See "Recent Development -- Portfolio 16 Companies." At December 31, 1998, $1,570,642 or 6.2 percent of the Company's total assets consisted of investments at fair value in publicly traded securities, of which net unrealized appreciation was $156,440; $19,562,386 or 7777.1 percent of the Company's total assets consisted of investments at fair value in private businesses, of which net unrealized appreciation was $10,250,204 before taxes. At December 31, 1997, $13,222,857 or 34 percent of the Company's total assets consisted of investments at fair value in private businesses, of which net unrealized appreciation was $2,464,795 before taxes.$10,250,204. The increase in the percentage of private investments from 34 percent in 1997 to 77 percent in 1998 is primarily owing to 1) an increase in the value of several private investments; 2) the payment ofpublicly traded securities from $1,570,642 in 1998 to $41,556,607 in 1999 is primarily owing to the Company's outstanding balance on the Demand Promissory Note of $4,000,000,investments in then-privately held InSite Marketing Technology, Inc., and SciQuest.com, Inc., which reduced the Company's total assets in 1998; 3) the decrease of $2,877,810 assubsequently became publicly traded securities, through an acquisition by a result of operations (See "Statement of Operations" contained in "Item 8. Financial Statementspublicly traded company and Supplementary Data"); and 4) the payment of a one-time cash dividend of $8,019,728 to meet one of the Company's requirements for qualification for Sub-Chapter M treatment.an IPO, respectively. A summary of the Company's investment portfolio is as follows: December 31, 19981999 December 31, 19971998 Investments, at cost $16,653,130 $14,124,643 $30,500,498 Unrealized appreciation 46,882,521 10,407,548 8,158,732 ----------- ----------- Investments, at fair value $63,535,651 $24,532,191 $38,659,230 __________________ =========== =========== The accumulated unrealized appreciation on investments net of deferred taxes is $6,996,664 at December 31, 1998, versus $5,340,834 at December 31, 1997.===========
__________________ The accumulated unrealized appreciation on investments net of deferred taxes is $45,098,711 at December 31, 1999, versus $6,996,664 at December 31, 1998. Following an initial investment in a private company, the Company may make additional investments in such investee in order to: (1) increase its ownership percentage; (2) exercise warrants or options that were acquired in a prior financing; (3) preserve the Company's proportionate ownership in a subsequent financing; or (4) attempt to preserve or enhance the value of the Company's investment. Such additional investments are referred to as "follow-on" investments. There can be no assurance that the Company will make follow-on investments or have sufficient funds to make additional investments. The failure to make such follow-on investments could jeopardize the viability of the investee company and the Company's investment or could result in a missed opportunity for the Company to participate to a greater extent in an investee's successful operations. The Company attempts to maintain adequate liquid capital to make follow-on investments in its private investee portfolio companies. The Company may elect not to make a follow-on investment either because it does not want to increase its concentration of risk, because it prefers other opportunities, or because it is inhibited by compliance with BDC or RIC requirements, even though the follow-on investment opportunity appears attractive. 11 The following table is a summary of the cash investments and loans made by the Company in its private placement portfolio during the year ended December 31, 1998:1999: New Investments: Amount InSite Marketing Technology,Adaptive Web Technologies, Inc. $$1,000,000 Alliance Pharmaceutical Corp. 1,202,000 Kriton Medical, Inc. 1,000,001 Sundial Marketplace Corporation 500,000 Follow-on Investments: MultiTarget, Inc. $ 51,802---------- Sub-Total $3,702,001 17 Loans: BioSupplyNet, Inc. (SciQuest,Inc.)Sundial Marketplace Corporation $ 250,000 NBX Corporation 10,000 ----------- Sub-total $ 260,000 Interest on Loans*: NeuroMetrix, Inc. $ 48,100 Voice Control Systems, Inc. 17,453 ------------ Sub-total $ 65,553 Exercise of Warrants Held: Voice Control Systems,Questech Corporation $ 50,000 SciQuest.com, Inc. $ 82,953 ------------75,000 ---------- $ 125,000 ---------- Total $ 960,308 ============ *The Company received additional shares in NeuroMetrix, Inc. and Voice Control Systems, Inc. in exchange for the accrued interest on its loans.$4,077,001 ==========
Results of Operations Investment Income and Expenses: The Company had a net operating loss of $2,765,112$9,636,336 in 1999, $2,815,112 in 1998 $1,498,141and $1,550,641 in 19971997. These net operating losses reflect accruals for employee profit-sharing in those years of $8,110,908, $899,751 and $1,291,065$423,808, respectively. If the unrealized appreciation as of December 31, 1999 subsequently decreases or if the gains are not realized, the profit- sharing accrual will be decreased accordingly, resulting in 1996.a credit to expenses, thereby reducing expenses for such subsequent year by that amount. The Company's investment objective is to achieve long-term capital appreciation rather than current income from its investments. Therefore, a significant portion of the investment portfolio is structured to maximizeattempt to enhance the potential for capital appreciation and provides little or no current yield in the form of dividends or interest. The Company does earn interest income from fixed-income securities, including U.S. Government Obligations.obligations. The amount of interest income earned varies based upon the average balance of the Company's fixed-income portfolio and the total average yield on this portfolio. The Company also received or accrued net after-tax distributions from its investment in PHZ Capital Partners, L.P. in 1999 of $490,950, in 1998 of $50,000 and in 1997 of $52,500. The Company does not regard distributions from PHZ as predictable. The Company had total investment income of $635,486$287,684 in 1999, $585,486 in 1998 $614,046and $561,546 in 1997 and $1,013,417 in 1996.1997. The Company had interest income from fixed- income securities of $234,347 in 1999, $355,591 in 1998 and $490,807 in 19971997. The decrease from 1998 to 1999 of $121,244 or 34.1 percent and $803,819 in 1996. Thethe decrease from 1997 to 1998 of $135,216 or 27.5 percent is awere the result primarily of a declinedeclines in the balancebalances of the Company's fixed-income portfolio during 1999 and 1998 as a result of the dividend, operating expenses andpayment of the dividends, additional investments in non-income producing private portfolio investments.and operating expenses. The decrease from 1996 to 1997 of $313,012 or 38.9 percent is a result of the decline of the Company's fixed- income portfolio as a result of operating expenses and additional investments in non-income producing private portfolio investments. The Company also received consulting and administrative fees which totaled $29,870 in 1997 and $68,185 in 1996.1997. The Company did not receive any consulting or administrative fees in 1998. 121998 or 1999. The Company had interest income from affiliated companies of $48,526 in 1999, $124,877 in 1998 and $40,000 in 1997 and $40,7791997. The decrease from 1998 to 1999 of $76,351 or 61.1 percent is owing to a decrease in 1996.loans outstanding. The increase from 1997 to 1998 of $84,877 or 212.2 percent is owing to the receipt of interest income (either in funds or in additional shares) on loans to investee companies and the increase in loans and outstanding lines of credit to investee companies, principally NeuroMetrix, Inc. and BioSupplyNet, Inc. (which in 1998 was merged with SciQuest,Inc.).companies. 18 The Company had other income of $3,911 in 1999, $102,468 in 1998 and $869 in 1997, and $92,610 in 1996. The increasesome of $101,599 or 116.9 percentwhich reflected income from 1997 to 1998 is a result of the receipt of $88,000 froman affiliated company, BioSupplyNet, to reimburse the Company for consulting fees previously paid and expensed by the Company in 1996 as part of the investment costson behalf of BioSupplyNet. AlsoOther income also includes rental income. Operating expenses were $9,924,020 in 1999, $3,634,786 in 1998 and 1997,$3,045,290 in 1997. The increase from 1998 to 1999 of $6,289,234 or 173.0 percent is primarily owing to an increase in the accrual for the Company's profit-sharing plan of $8,110,908 or an 801.5 percent increase over the prior year as a result of the net increase in unrealized appreciation of the Company's investments of approximately $40,709,767. (See "Note 3 of Notes to Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data.") Approximately $8,295,916 of the accrued profit-sharing plan balance will not be paid out until such time as the gains are actually realized. If the unrealized appreciation as of December 31, 1999 decreases or if the gains are not realized, the profit-sharing accrual will be decreased accordingly, resulting in a credit to expenses, thereby reducing expenses for such year by that amount. A total of $1,024,696 or 90 percent of the profit-sharing on the 1999 net realized gains was paid in March 2000, and $113,855, or the remaining 10 percent, will be paid when the Company receivedfiles its tax return for the year 1999. (See "Note 3 of Notes to Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data.") Other than the increase in the profit-sharing accrual and a decrease in professional fees, which decreased by $79,591 or accrued dividends19.3 percent as a result of $50,000lower legal fees, expenses remained stable. Salaries and $52,500benefits increased from its investment1998 to 1999 by $3,579 or less than one percent; administration and operations decreased from 1998 to 1999 by $11,712 or 3.5 percent; depreciation decreased from 1998 to 1999 by $12,481 or 26.0 percent as a result of assets that were fully depreciated as of the end of 1998; rent increased from 1998 to 1999 by $3,472 or 2.2 percent; directors' fees and expenses decreased from 1998 to 1999 by $8,925 or 6.9 percent because the Company had one fewer director in PHZ Capital Partners, L.P. Operating expenses were $3,634,7861999 than in 1998, $3,045,290 in 19971998. During 1999, the Company had no interest expense and $2,985,316 in 1996.no outstanding debt. The increase in operating expenses from 1997 to 1998 of $589,496 or 19.4%19.4 percent is primarily owing to: an increase in the accrual for the Company's profit-sharing plan of $899,751 or 112.3%112.3 percent over the prior year (See "Note 3 of Notes to Consolidated Financial Statements" contained in "Item 8. Consolidated Financial Statements and Supplementary Data"); the final payment on the Harris & Harris Group Senior Professorship Pledgepledge to the Massachusetts Institute of Technology of $728,862; mitigated by a decrease in salaries and benefits of $676,136, or 44.9%. To date, no actual payments have been made under the Company's profit-sharing plan. The increase from 1996 to 1997 of $59,974 or 2.0% is primarily owing to: the accrual of $423,808 for the Company's profit-sharing plan; restructuring expenses of $100,000 incurred by the Company as a result of researching the conversion to RIC status; mitigated by a decrease in overall expenses as a result of the Company's effort to cut expenses. Most of the Company's operating expenses were related to employee and director compensation, office and rent expenses and consulting and professional fees (primarily legal and accounting fees). To date, no actual payments have been made under the Company's profit-sharing plan.44.9 percent. The Company has in the past relied, and continues to rely to a large extent, uponon proceeds from sales of investments, rather than on investment income, to defray a significant portion of its operating expenses. Because such sales cannot be predicted with certainty,are unpredictable, the Company attempts to maintain adequate working capital to provide for fiscal periods when there are no such sales. 19 Realized Gains and Losses on Sales of Portfolio Securities: During the three years ended December 31, 1999, 1998 1997 and 1996,1997, the Company sold various investments and received distributions, realizing net gains (losses) of $10,976,714, ($1,718,528) and ($3,147,002), respectively. During 1999, the Company realized a net lossgain of $1,768,528, $3,199,502approximately $10,584,630 on the acquisition of NBX Corporation by 3Com Corporation; a gain of approximately $160,918 on its sale of Princeton Video Image, Inc. stock; and $3,792,576, respectively.received a cash distribution from PHZ Capital Partners, L.P. of approximately $612,170. The Company also incurred losses of approximately $381,004 on the sale of various publicly traded investments. During 1998, the Company realized losses on:on the salesales of itsits: privately held investment in MultiTarget, Inc. of $209,999; publicly-heldpublicly held investments that were once privately held, including (1) CORDEX Petroleums, Inc. in the amount of $357,736; Nanophase Technologies Corporation of $329,055 (common stock shares purchased in the open market);(2) Princeton Video Image, Inc. of, $288,369; and (3) Voice Control Systems, Inc. 13 (which purchased the Company's investee company, PureSpeech, Inc.) of, $724,826. These losses were offset byThe Company also had a realized net gainloss of $141,457$187,598 in various publicly traded securities. During 1998, the Company received a cash distribution of $50,000 from PHZ Capital Partners, L.P. Net losses of $1,171,496 had been recognized in prior years and realized in 1998. Realizing losses and gains from prior years increases (for losses) or decreases (for gains) the Unrealized Appreciation on Investments. During 1997, the Company realized losses on the salesales of its investments in: nFX Corporation in the amount of $2,631,720; Harber Brothers Productions, Inc. of, $1,205,000; Gel Sciences, Inc. of, $633,028; Dynecology, Inc. of, $99,900; and Micracor Corporation, of $66,444. These losses were offset by gains on the sales ofof: Highline Capital Partners of $750,000 and ofManagement LLC, $750,000; various publicly traded securities, $686,590; and accrued a distribution of $686,590. During 1996, the Company realized a loss on the sale of its equity interest in Sonex International Corporation of $2,579,000. However, because the investment had been written off in 1994, the loss did not affect earnings in 1996. Also during 1996, the Company sold and realized a loss on the sale of its equity interest in Micracor Corporation of $999,993 and net losses on sales of various publicly held securities of $213,583.$52,500 from PHZ Capital Partners, L.P. Unrealized Appreciation and Depreciation of Portfolio Securities: The Board of Directors values the portfolio securities on a quarterly basis pursuant to the Company's Asset Valuation guidelines in accordance with the 1940 Act. (See "Footnote to Consolidated Schedule of Investments" contained in "Item 8. Consolidated Financial Statements and Supplementary Data".Data.") Net unrealized appreciation on investments before taxesincreased by $36,474,973 or 350.5 percent during the year ended December 31, 1999, from $10,407,548 to $46,882,521. The most significant increases in valuation during 1999 were in: SciQuest.com, Inc., $31,981,750; Silknet Software, Inc. (which acquired InSite Marketing Technology, Inc.), $4,899,062; Alliance Pharmaceutical Corp., $3,839,000; and Nanophase Technologies Corporation, $1,935,016. (See "Consolidated Schedule of Investments" contained in "Item 8. Consolidated Financial Statements and Supplementary Data" and "Recent Developments -- Portfolio Companies.") The increase in valuations was offset by the reclassification of the Company's gain in NBX Corporation of $4,716,062 from unrealized to realized. 20 Net unrealized appreciation on investments increased by $2,248,816 or 27.6%27.6 percent during the year ended December 31, 1998, from $8,158,732 to $10,407,548. The most significant increases in valuations during 1998 were inin: NBX Corporation, $1,865,766; NeuroMetrix, Inc., $4,400,125; and PHZ Capital Partners, L.P., $443,432. The most significant decrease during 1998 was in Nanophase Technologies Corporation, $5,508,466. Other changes included an increased valuation of Genomica Corporation, offset primarily by decreased valuations in MedLogic Global Corporation and Princeton Video Image, Inc. Net unrealized appreciation on investments before taxes increased by $1,491,143 or 22.4%22.4 percent during the year ended December 31, 1997, from $6,667,589 to $8,158,732. The most significant increases in valuations during 1997 were in Nanophase Technologies Corporation, $3,775,701; NBX Corporation, $2,850,296; and PHZ Capital Partners, L.P., $405,622. The most significant decreases were in Princeton Video Image, Inc., $1,563,605 and PureSpeech, Inc., $1,243,977 (which was subsequently acquired by Voice Control Systems, Inc.). Net unrealized appreciation on investments before taxes increased by $4,564,996 or 217.1% during the year ended December 31, 1996, from $2,102,593 to $6,667,589. The most significant increases in valuations during 1996 were in Gel Sciences, Inc., $1,127,500; Nanophase Technologies Corporation, $1,452,755; and Princeton Video Image, Inc., $751,000. The most significant decrease was in the valuation of nFX Corporation, $1,892,240. 14 Liquidity and Capital Resources The Company reported totalCompany's primary sources of liquidity are cash, receivables and freely marketable securities. The Company's secondary sources of liquidity are restricted securities (the primary measure of liquidity) atcompanies that are publicly traded. At December 31, 1999, December 31, 1998 of $5,547,984 versus $21,693,067 (net of $4,000,000 drawn from the J.P. Morgan line of credit) atand December 31, 1997, respectively, the Company's total primary liquidity was $6,622,216, $5,547,984 and $19,296,591 at December 31, 1996.$13,060,370. On the corresponding dates, the Company's total secondary liquidity was $38,230,812, $0 and $8,075,978. The decreaseCompany's tertiary source of liquidity is its holding in PHZ Capital Partners,L.P., from which the Company received or accrued net after-tax distributions in 1999, 1998 and 1997 of approximately $490,950, $50,000 and $52,500, respectively. The increase in cash, receivables and marketable securities from December 31, 19971998 to December 31, 19981999 is mainlyprimarily owing to: 1)to an increase in the value of marketable securities (which, with the exception of Nanophase Technologies Corporation, are restricted), including increases in the value of: SciQuest.com, Inc., $31,981,750; Nanophase Technologies Corporation, $1,935,016; Silknet Software, Inc. (which acquired InSite Marketing Technology, Inc.), $4,899,062; Alliance Pharmaceutical Corp., $3,839,000; and to the receipt of total proceeds of $12,432,940 in cash and in funds in escrow ($1,475,276, against which the Company recorded a 10 percent reserve from the sale of NBX Corporation). These increases were offset by the (1) payment on May 12, 1998 of a one-time cash dividend of $0.75$0.35 per share or $3,647,017; (2) the investments of $1,000,001 in Kriton Medical, Inc.; $1,202,000 in Alliance Pharmaceutical Corp.; $750,000 in Sundial Marketplace Corporation; and $1,000,000 in Adaptive Web Technologies, Inc.; and (3) the purchase of treasury shares in the open market for a total of $8,019,728; 2)$540,720 and the declinepurchase of 1,080,569 shares tendered in value of the Company's investment in Nanophase Technologies Corporationtender offer for a total of $1,832,831 including approximately $5.5 million$71,500 of related fees; and 3)(4) the use of funds in the amount of $1,777,657 for 19981999 cash operating expenses and realized losses. Included in marketable securities as of December 31, 1998 were the Company's holdings in Nanophase Technologies Corporation of $1,211,249 and other publicly-held securities of $359,393. Included in marketable securities as of December 31, 1997 were the Company's holdings in Nanophase Technologies Corporation of $6,854,660 and Princeton Video Image, Inc. of $1,064,895.expenses. At December 31, 1997, both1999, the Company valued its holdings in SciQuest.com, Inc., Silknet Software, Inc. and Alliance Pharmaceutical Corp. at $32,831,750, $5,399,062 and $5,041,000, respectively. These holdings were 21 subject to lock-up agreementstrading restrictions and were valued at discounts from market value:value, for both the trading restrictions and a 26"blockage" or illiquidity factor in the calculation of the values of SciQuest.com and Alliance Pharmaceutical and for the trading restrictions and a 10 percent discountescrow in the case of Nanophase Technologies CorporationSilknet Software. (See "Consolidated Schedule of Investments" contained in "Item 8. Consolidated Financial Statements and Supplemental Data.") On January 27, 2000, the Company placed privately, with an unaffiliated investor, for $3 million in cash, a 24one-year, 12 percent discount innote ("Note") with one-year warrants to purchase 25,263 shares of the caseCompany's common stock at $11.8750 per share. The Note may be prepaid at any time. Unless the Note is prepaid, six months after its issuance, the investor will receive additional one-year warrants to purchase an additional $300,000 worth of Princeton Video Image,the Company's common stock at the then-current market price. On February 28, 2000, the Company announced its intent to pre-pay the Note with proceeds of its sale of 43,400 shares of SciQuest.com, Inc. common stock at approximately $77.2264 per share on February 25, 2000. The Company continues to hold 417,639 shares of SciQuest.com common stock. Because the Company intends to use most of the proceeds of the SciQuest.com sale to pre-pay the Note, most or all of the realized long-term capital gains from this sale, approximately $3.3 million, will be retained by the Company and will not be distributed to shareholders as a cash dividend. From 19971998 to 1998, receivables1999, the amounts receivable from brokers decreased by $380,707 or 100 percent. Funds in escrow increased by $380,707$1,327,748 or 100 percent, owing to transactions that settled in January 1999. Note receivables increasedthe escrowed funds net of a reserve of $147,528 received by $32,663 or 100 percent, as a result of the Company receipt of a note fromon the sale of its investment in oneNBX Corporation. The Company received the entirety of its investee companies.the escrowed funds plus accrued interest for a total of $1,541,136 on March 6, 2000. The Company's liabilities offor accrued bonusprofit sharing and deferred income tax liability increased significantly during 1998.1999. Accrued bonusprofit sharing increased by $899,751$8,110,908 or 112.3612.8 percent to $1,323,559$9,434,467 as a result of the gain on the sale of NBX Corporation and the increase in the unrealized appreciation on investments. Ninety percent of investments.the profit-sharing amount attributable to 1999 net realized income or approximately $1,024,696 was paid out in March 2000. The accrued bonusremaining 10 percent or approximately $113,855 will not be paid out untilafter the gains are realized. Therefore,Company has filed its federal tax return for the year. There was no bonuses wereprofit sharing paid in 1998.out during 1999 or previous years. The deferred income tax liability increased by $586,710 or 63.0 percent to $1,517,774. The deferred tax liability is also based on unrealized appreciation,reflects utilization of approximately $6.3 million of the Company's net operating and taxes will not be paid untilcapital loss carryforward to offset the long-term capital gain realized when the Company sold its interest in NBX Corporation. As a result of the utilization of the net operating and capital loss carryforwards, the Company had to accrue additional tax reserves against the remaining built-in gains are realized. Asas of December 31, 1998, the Company had a $6,000,000 line1998. The Company's primary sources of credit in place with J.P. Morgan, on which the Company had no outstanding balance. Management believes that itsliquidity, including cash, receivables and freely marketable securities, provideare more than adequate to cover the Company with sufficient liquidity for its operationsCompany's gross cash operating expenses over the next 12 months. Such gross cash operating expenses totaled $1,777,657, $2,687,099 and $2,572,514 in 1999, 1998 and 1997, respectively. The Company's secondary sources of liquidity are the restricted securities of companies, all of which are scheduled to become freely tradable at various times in the year 2000. 22 The Company cannot predict the amount, if any, of net after-tax distributions that it might receive from its holding in PHZ in the year 2000. In the future, to the extent that the Company decides to buy back shares or make new investments and follow-on investments, the Company would either have to raise capital externally and thereby incur interest or dividend expenses and/or issue new shares of its stock or raise capital internally by selling appreciated securities in its portfolio. To the extent that the Company chooses to sell appreciated securities, if it wishes to retain all or part of the gains instead of distributing them as cash dividends to shareholders as a RIC, it would have to declare a deemed distribution. In the event that the Company declares a deemed distribution or in the event that the Company is taxed as a "C" Corporation, it would owe a federal tax of 35 percent, and might owe state and local taxes, on any net realized gains, and the Company's asset value would decline by the amount of the tax accrual. To the extent that the Company distributes net realized gains to its shareholders in the form of cash dividends, such cash dividends would also reduce the Company's asset value accordingly. Recent Developments Portfolio Companies On February 22, 1999, NBX CorporationJanuary 5, 2000, the Company announced that it had agreedpurchased for $1,000,000 approximately a 15 percent equity interest in MyPersonalAdvocate.com, Inc., a business-to-business e-commerce and e-services trust-based marketing start-up. On January 13, 2000 the Company announced that it would discontinue the operations of, and liquidate, Adaptive Web Technologies, Inc. Adaptive was founded in late 1999, with $1,000,000 in funding from the Company. Because Adaptive was able to determine early in the process of research and analysis not to proceed with the development and commercialization effort, the Company anticipates that the amount of money expended to date by Adaptive is unlikely to prove to be acquired by 3Commaterial and that it will recapture most of its $1,000,000 investment in Adaptive. On January 20, 2000, the Company invested $500,000 in iPacer Corporation, an Internet technology startup, in the form of a six percent Convertible Promissory Note due March 31, 2000. On February 7, 2000, the Company announced that Kana Communications, Inc. and Silknet Software, Inc. had signed a merger agreement, whereby each of the Company's Silknet shares would be exchanged tax free for 0.83 Kana Communications shares. There can be no assurance that the merger will be consummated. On February 9, 2000, the Company announced that it had exercised a warrant to purchase 200,000 common shares of Alliance Pharmaceutical Corp. for $490,000. The exercise price was $2.45 per share, and the warrant had an expiration date of May 20, 2004. The Company also converted its $1,200,000 note due May 20, 2002 into 600,000 shares of Alliance 23 Pharmaceutical. The conversion price was $2.00 per share. The Company now owns 800,000 common shares of Alliance Pharmaceutical. These shares are currently restricted under Rule 144. On February 28, 2000, the Company announced its sale of 43,400 shares of SciQuest.com, Inc. common stock (NASDAQ: SQST) at approximately $90 million in cash plus additional consideration for employees$77.2264 per share on February 25, 2000. The Company continues to hold 417,639 shares of NBX. This transaction was effective on March 5, 1999 and closed onSciQuest.com common stock. On March 8, 1999. On closing,2000, the Company receivedincreased its investment in Sundial Marketplace Corporation by purchasing from Sundial a $150,000 note with equity features under certain circumstances. Thus, the Company has now invested a total of $12,432,940$900,000 in cash, of which $1,475,276 was placed in a one-year escrow.Sundial. On February 23, 1999, the Board of Directors ofMarch 14, 2000, the Company declaredannounced that it had invested an additional $500,000 in Genomica Corporation as part of a cash dividend$15,000,000 private placement of $0.35 per share (approximately $3.7 million) to shareholders of record onGenomica's Series C convertible preferred stock. Including this new investment, the Company owns approximately a 3.4 percent fully diluted interest in Genomica. On March 19, 1999, payable on March 25, 1999. (See "Note 8 of Notes to Financial Statements" contained in "Item 8. Financial Statements15, 2000, the Company noted that Genomica had filed an S-1 registration statement with the Securities and Supplementary Data".) 15Exchange Commission. Recent Developments -- Sub-Chapter M Status On September 25, 1997, the Company's Board of Directors approved a proposal to seek qualification of the Company as a RIC under Sub-Chapter M of the Code. In order to qualify as a RIC, the Company must, in general (1) annually derive at least 90 percent of its gross income from dividends, interest and gains from the sale of securities; (2) quarterly meet certain investment diversification requirements; and (3) annually distribute at least 90 percent of its investment company taxable income as a dividend. In addition to the requirement that the Company must annually distribute at least 90 percent of its investment company taxable income, the Company may either distribute or retain its taxable net capital gains from investments, but any net capital gains not distributed could be subject to corporate level tax. Further, the Company could be subject to a four percent excise tax (and in some cases, corporate level income tax) if it fails to distribute 98 percent of its annual taxable income and would be subject to income tax if it fails to distribute 100 percent of its taxable income. Because of the specialized nature of its investment portfolio, the Company could satisfy the diversification requirements under Sub-Chapter M of the Code only if it received a certification from the SEC that it is "principally engaged in the furnishing of capital to other corporations which are principally engaged in the development or exploitation of inventions, technological improvements, new processes, or products not previously generally available." On April 8, 1998, the Company announced that it had received such a certification from the SEC for 1997. Pursuant to the Company's receipt of the certification, the Company's Board of Directors declared and paid a one- timeone-time cash dividend of $0.75 per share to meet one of the Company's requirements for qualification for Sub-ChapterSub- Chapter M tax treatment. On February 17, 1999, the Company received rulings from the IRS regarding other issues relevant to the Company's tax status as a RIC. (See "Note 6 of Notes to Financial Statements" contained in "Item 8. Financial Statements and Supplementary Data".) Although the SEC certification for 1997 was issued, there can be no assurance that the Company will receive such certification for 1998 or subsequent years (to the extent it needs additional certification as a result of changes in its portfolio) or that it will qualify as a RIC in 1999 or that, if it does qualify in 1999, it will continue to qualify in subsequent years.24 The qualification of the Company as a RIC under Sub-Chapter M of the Code depends on it satisfying certain technical requirements regarding its income, investment portfolio and distributions. The Company was unable to satisfy these requirements for the 1998 tax year owing to the nature of the Company's ownership interest in one of its investee companies. In addition, because it realized taxable losses in 1998, it was not strategically advantageous for the Company to elect Sub-Chapter M tax status for 1998. The Company changed the nature of its ownership interest in the non- qualifying investee company effective January 1, 1999 in order to meet the Sub-Chapter M requirements. However,In 1999, because of changes in its investment portfolio, the Company requested recertification from the SEC relating to the Company's status under section 851(e) of the Code. On February 24, 2000, the Company received the certification, and the Company intends to elect Sub-Chapter M tax treatment for 1999. Although the SEC certification for 1999 was issued, there can be no assurance that the Company will receive such certification for 2000 or subsequent years (to the extent it needs additional certification as a result of changes in its portfolio) or that it will qualify foras a RIC in 2000 or that, if it does qualify in 2000, it will continue to qualify in subsequent years. The Company plans to elect Sub-Chapter M tax treatment for 1999 or subsequent years.1999. In addition, under certain circumstances, even if the Company were qualified for Sub-Chapter M treatment in 19992000 and elected Sub-Chapter M treatment for that year, the Company might take action in a subsequent year to ensure that it would be taxed in that subsequent year as a C Corporation, rather than as a RIC. 16 The Company incurred ordinary and capital losses during its C Corporation taxable years that remain available for use and may be carried forward to its 19992000 and subsequent taxable years. Ordinarily, a corporation that elects to qualify as a RIC may not use its ordinary loss carryforwards from C Corporation taxable years to offset RIC investment company taxable income, although a RIC may in certain cases use capital loss carryforwards to reduce net capital gains. In addition, aA C Corporation that elects to qualify as a RIC and that makes an appropriate election continues to be taxable as a C Corporation on any gains realized within 10 years of its qualification as a RIC from sales of assets that were held by the corporation on the effective date of the election ("C Corporation Assets") to the extent of any gain built into the assets on such date ("Built-In Gain"). On February 17, 1999, the Company received rulings from the IRS regarding issues relevant to the Company's tax status as a RIC, including a ruling from the IRS concluding that the Company can carry forward its C Corporation losses to offset any Built-In Gains resulting from sales of its C Corporation Assets. That ruling may enable the Company to retain some or all of the proceeds from such sales without disqualifying itself as a RIC or incurring corporate level income tax, depending on whether the Company's sale of C Corporation Assets with Built-In Gains will generate C Corporation E&P. In general, a RIC is not permitted to have, as of the close of any RIC taxable year, E&P accumulated during any C Corporation taxable year. However, because the realization of Built-In Gains will occur while the Company is a RIC, a strong argument exists that, under current law and IRS pronouncements, the sale of C Corporation Assets with Built-In Gains during RIC taxable years will not generate C Corporation E&P. TheIn 1999, the Company intends to useused the $7.1$6.3 million loss carryforward (which resultsresulted in a tax credit of approximately $2.5$2.2 million) to reduce the taxes due toresulting from Built-In Gains. The December 31, 19981999 NAV includes the utilization of the ordinary and capital loss carryforwards against Built-in Gains of approximately $0.23$0.03 per share. The IRS recently announced an intention(See "Note 6 of Notes to issue formal guidanceConsolidated Financial Statements" 25 contained in 1999 concerning conversions of C Corporation to RICs. Such guidance may include resolution of the E&P issue described above"Item 8. Consolidated Financial Statements and other issues relevant to the Company.Supplementary Data.") If necessary for liquidity purposes or to fund investment opportunities, in lieu of distributing its taxable net capital gains, the Company may retain such net capital gains and elect to be deemed to have made a distribution of the gains, or part thereof, to the shareholders under the "designated undistributed capital gain" rules of section 852(b)(3) of the Code. In such a case, the Company would have to pay a 35 percent corporatecorporate- level income tax on such "designated undistributed capital gain," but it would not have to distribute the excess of the retained "designated undistributed capital gain" over the amount of tax thereon in order to maintain its RIC status. Tax Consequences of Net Capital Gains The following simplified examples illustrate the tax treatment under Sub- Chapter M of the Code for the Company and its shareholders with regard to three possible alternatives, assuming a net long-term capital gain of $1.00 per share, consisting entirely of sales of non-real property assets held for more than 12 months. Under Alternative A: 100 percent of net capital gain declared as a dividend and distributed to shareholders: 17 1. No federal taxation at the Company level. 2. ShareholdersTaxable shareholders receive a $1.00 per share dividend and pay a maximum federal tax of 20 percent* or $.20 per share, retaining $.80 per share. Under Alternative B: 100 percent of net capital gain retained by the Company and designated as "undistributed capital gain" or deemed dividend: 1. The Company pays a corporate levelcorporate-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. ShareholdersTaxable shareholders increase their cost basis in their stock by $.65 per share. They pay a 20 percent* federal capital gains tax on 100 percent of the undistributed gain of $1.00 per share or $.20 per share in tax. Offsetting this tax, shareholders receive a tax credit equal to 35 percent of the undistributed gain or $.35 per share. Under Alternative C: 100 percent of net capital gain retained by the Company, with no designated undistributed capital gain or deemed dividend: *Assumes all capital gains qualify for long-term rates of 20 percent. 26 1. The Company pays a corporate levelcorporate-level federal income tax of 35 percent on the retained gain or $.35 per share plus an excise tax of 4four percent of $.98 per share, or about $.04 per share. 2. There is no tax consequence at the shareholder level. *Assumes all capital gains qualify for long-term ratesItem 7a. Quantitative and Qualitative Disclosures About Market Risk The Company's business activities contain elements of 20 percent. Risk Factors Investment in Small, Private Companies Thererisk. The Company considers a principal type of market risk to be valuation risk. Investments are significant risks inherentstated at "fair value" as defined in the 1940 Act and in the applicable regulations of the Securities and Exchange Commission. All assets are valued at fair value as determined in good faith by, or under the direction of, the Board of Directors. See the Asset Valuation Policy Guidelines in the Footnote to Consolidated Schedule of Investments. Neither the Company's venture capital business.investments nor an investment in the Company is intended to constitute a balanced investment program. The Company has exposure to public-market price fluctuations to the extent of its publicly traded portfolio. The Company has invested a substantial portion of its assets in private development stage or start-up companies. These private businesses tend to be thinly capitalized, unproven, small companies that lack management depth and have not attained profitability or have no history of operations. Because of the speculative nature and the lack of a public market for these investments, there is significantly greater risk of loss than is the case with traditional investment securities. The Company expects that some of its venture capital investments will be a complete loss or will be unprofitable and that some will appear to be likely to become successful but never realize their potential. The Company has been risk seeking rather than risk averse in its approach to venture capital and other investments. Neither the Company's investments nor an investment in the Company is intended to constitute a balanced investment program. The Company has in the past relied and continues to rely to a large extent upon proceeds from sales of investments rather than investment income to defray a significant portion of its operating expenses. 18 Valuation of Portfolio Investments ThereBecause there is typically no public market offor the equity securitiesinterests of the small private companies in which the Company invests. As a result,invests, the valuation of the equity securitiesinterests in the Company's portfolio is subject to the good faith estimate of the Company's Board of Directors. (See "AssetDirectors in accordance with the Company's Asset Valuation Policy Guidelines" in "Footnote to Schedule of Investments.")Guidelines. In the absence of a readily ascertainable market value, the estimated value of the Company's portfolio of equity securitiesinterests may differ significantly from the values that would be placed on the portfolio if a ready market for the equity securitiesinterests existed. Any changes in estimated net asset valuevaluation are recorded in the Company's statementconsolidated statements of operations as "Change"Net increase (decrease) in unrealized appreciation on investments." (See "Management's Discussion and Analysis of Financial Condition and Results of Operations.") Illiquidity of Portfolio Investments Most of the investments of the Company are or will be equity securities acquired directly from small companies. The Company's portfolio of equity securities are and will usually be subject to restrictions on resale or otherwise have no established trading market. The illiquidity of most of the Company's portfolio of equity securities may adversely affect the ability of the company to dispose of such securities at times when it may be advantageous for the Company to liquidate such investments. Fluctuations of Quarterly Results The Company's quarterly operating results could fluctuate as a result of a number of factors. These include, among others, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which the Company encounters competition in its markets and general economic conditions. As a result of these factors, results for any one quarter should not be relied upon as being indicative of performance in future quarters. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risk of Loss of Pass Through Tax Treatment If the Company meets certain diversification and distribution requirements under the Code, it may qualify as a RIC under the Code for pass-through tax treatment. The Company would cease to qualify for pass-through tax treatment if it were unable to comply with these requirements, or if it ceased to qualify as a BDC under the 1940 Act. The Company also could be subject to a four percent excise tax (and, in certain cases, corporate level income tax) if it failed to make certain distributions. (See "Management's Discussion and Analysis of Financial Condition -- Recent Developments - Sub-Chapter M Status.") The lack of Sub-Chapter M taxtreatment could have a material adverse effect on the total return, if any, obtainable from an investment in the Company. If the Company fails to qualify as a RIC, the Company would become subject to federal income tax as if it were an ordinary C Corporation, which would result in a substantial reduction in the Company's net assets and the amount of income available for distribution to the Company's stockholders. 19 Risks Relating to the Year 2000 Issue The "Year 2000" computer problem has arisen because many computer applications worldwide will not properly recognize the date change from December 31, 1999, to January 1, 2000. The computer applications may revert to 1900 or some other date because of the way in which dates were encoded and calculated, potentially causing production of erroneous data, miscalculations, system failures and other operational problems. The Company has undertaken the evaluation of the Year 2000 impact on its critical computer hardware and software. The Company has not incurred, nor does it anticipate that it will incur, any material cost in addressing its Year 2000 problem. The Company is developing a strategic plan focusing on achieving Year 2000 compliance. Certain systems are being replaced and or modified to be Year 2000 compliant. At the present time, it is not possible to determine whether any such events are likely to occur or to quantify any potential negative impact they may have on the Company's future results of operations and financial condition. Ultimately, the potential impact of the Year 2000 issue will depend not only on the success of the corrective measures undertaken by the Company, but also on the way in which the Year 2000 issue is addressed by vendors, service providers, counterparties, utilities, governmental agencies and other entities with which the Company does business. Forward-Looking Statements The information contained herein contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives, portfolio growth and availability of funds. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth herein. Other factors that could cause actual results to differ materially include the uncertainties of economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward- looking statements included herein are reasonable, any of the assumptions could be inaccurate and therefore there can be no assurance that the forward- looking statements included or incorporated by reference herein will prove to be accurate. Therefore, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.27 Item 7a. Quantitative and Qualitative Disclosures About Market Risk The Company does not hold any derivatives. 20 Item 8. Consolidated Financial Statements and Supplementary Data HARRIS & HARRIS GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES The following reports and consolidated financial schedules of Harris & Harris Group, Inc. are filed herewith and included in response to Item 8. Documents Page Report of Independent Public Accountants. . . . . . . . . . . 2229 Consolidated Financial Statements Consolidated Statements of Assets and Liabilities as of December 31, 19981999 and 19971998 . . . . . . . . . . . . 2330 Consolidated Statements of Operations for the years ended December 31, 1999, 1998 1997 and 19961997 . . . . . . 2431 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 1997 and 1996.1997. . . . . . . 2532 Consolidated Statements of Changes in Net Assets for the years ended December 31, 1999, 1998 1997 and 1996.1997. . . . . . . 2633 Consolidated Schedule of Investments as of December 31, 1998 . . . . . . . 27-30 Footnote to Schedule of Investments . . . . . . . . . . . . . 31-33 Notes to Financial Statements1999 . . . . . . . . . . . . . . . . 34-40. . . . 34-38 Footnote to Consolidated Schedule of Investments. . . . . . . 39-41 Notes to Consolidated Financial Statements. . . . . . . . . . 42-51 Selected Per Share Data and Ratios for the years ended December 31, 1999, 1998, 1997, 1996 1995 and 1994. 411995. . . . . . . . . . . . . . . . . . . . . . . . . 52 Schedules other than those listed above have been omitted because they are not applicable or the required information is presented in the consolidated financial statements and/or related notes. 2128 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Harris & Harris Group, Inc.: We have audited the accompanying consolidated statements of assets and liabilities of Harris & Harris Group, Inc. (a New York corporation) as of December 31, 19981999 and 1997,1998, including the consolidated schedule of investments as of December 31, 1998,1999, and the related consolidated statements of operations, cash flows and changes in net assets for the three years ended December 31, 1998,1999, and the selected per share data and ratios for each of the five years ended December 31, 1998.1999. These consolidated financial statements and selected per share data and ratios are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and selected per share data and ratios based on our audits. We conducted our audits in accordance with auditing standards generally accepted auditing standards.in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements and selected per share data and ratios are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 19981999 and 1997,1998, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As explained in Note 2, the consolidated financial statements include securities valued at $19,562,386 (86.7$18,892,731 (35.22 percent of net assets), whose values have been estimated by the Board of Directors in the absence of readily ascertainable market values. However, because of the inherent uncertainty of valuation, those estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. In our opinion, the consolidated financial statements and selected per share data and ratios referred to above present fairly, in all material respects, the financial position of Harris & Harris Group, Inc. as of December 31, 19981999 and 1997,1998, the results of its consolidated operations, its consolidated cash flows and the consolidated changes in its net assets for the three years ended December 31, 1998,1999, and the selected per share data and ratios for each of the five years ended December 31, 19981999 in conformity with accounting principles generally accepted accounting principles.in the United States. /s/ Arthur Andersen LLP ------------------------ New York, New York February 10, 1999 22March 20, 2000 29
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES ASSETS December 31, 19981999 December 31, 19971998 Investments, at value (See accompanying consolidated schedule of investments and notes). . . . . . $ 63,535,651 $ 24,532,191 Cash and cash equivalents . . . $ 24,532,191 $ 38,659,230 Cash and cash equivalents. . . . . 133,256 164,143 Funds in escrow (Note 7). . . . . . . . 164,143 145,5881,327,748 0 Receivable from brokers.brokers . . . . . . . . 0 380,707 Interest receivable . . . . . . . . . 380,707 0 Interest receivable.. 44,189 666 Prepaid expenses. . . . . . . . . . . . 666 111,106 Prepaid expenses74,328 90,649 Note receivable . . . . . . . . . . . . 32,663 32,663 Other assets. . . . . . . . . . . . . . 90,649 85,126 Note receivable.172,933 157,840 --------------- ---------------- Total assets. . . . . . . . . . . . . . 32,663 0 Other assets$ 65,320,768 $ 25,358,859 =============== ================ LIABILITIES & NET ASSETS Accounts payable and accrued liabilities. . . . . . . . . . . . . $ 700,566 $ 505,118 Accrued profit sharing (Note 3) . . . . 9,434,467 1,323,559 Deferred rent . . . . . . . . . . . . . 33,156 42,409 Deferred income tax liability (Note 6). 1,517,774 931,064 --------------- ----------------- Total liabilities . . 157,840 272,734. . . . . . . . . 11,685,963 2,802,150 --------------- ------------- Total assets .----------------- Commitments and contingencies (Notes 7 and 8) Net assets. . . . . . . . . . . . . . . $ 25,358,859 $ 39,273,784 =============== ============= LIABILITIES & NET ASSETS Accounts payable and accrued liabilities $ 505,118 $ 475,683 Accrued bonus (Note 3) . . . . . . . . . . 1,323,559 423,808 Deferred rent. . . . . . . . . . . . . . . 42,409 51,662 Deferred income tax liability (Note 6) . . 931,064 667,697 Demand Promissory Note Payable (Note 7). . 0 4,000,000 -------------- ------------ Total liabilities. . . . . . . . . . . . . 2,802,150 5,618,850 -------------- ------------ Commitments and contingencies (Notes 7 and 8) Net assets . . . . . . . . . . . . . . . .53,634,805 $ 22,556,709 $ 33,654,934 ============== ============================ ================ Net assets are comprised of: Preferred stock, $0.10 par value, 2,000,000 shares authorized; none issued. . . . . . . . . . . . . . . $ 0 $ 0 Common stock, $0.01 par value, 25,000,000 shares authorized; 10,692,971 issued at 12/31/9899 and issued and outstanding at 12/31/97 . . . . .98. . . . . . . . . . . 106,930 106,930 Additional paid in capitalcapital. . . . . . . 16,159,504 16,158,381 Accumulated net realized loss . . . 16,158,381 16,178,979 Accumulated net realized (loss) income . . .(5,192,860) (525,177) 12,028,191 Accumulated unrealized appreciation of investments, net of deferred tax liability of $1,783,810 at 12/31/99 and $3,410,884 at 12/31/98 and $2,817,898. . . . . 45,098,711 6,996,664 Treasury stock, at cost (1,452,140 shares at 12/31/9799 and 101,739 at 12/31/98) . . . . . . . . 6,996,664 5,340,834 Treasury stock, at cost (101,739 shares) . . . . (2,537,480) (180,089) 0 ------------- --------------------------- ----------------- Net assets. . . . . . . . . . . . . . . . . .$$ 53,634,805 $ 22,556,709 $ 33,654,934 ============= =========================== ================= Shares outstandingoutstanding. . . . . . . . . . . . . .9,240,831 10,591,232 10,692,971 ------------- -------------============== ================= Net asset value per outstanding share . . . .$$ 5.80 $ 2.13 $ 3.15 ============= =========================== =================
The accompanying notes are an integral part of these consolidated financial statements. 2330
CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended Year Ended Year Ended 12/31/98 12/31/97 12/31/96Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997 Investment income: Interest from: Fixed-income securitiessecurities. . . . .$ 234,347 $ 355,591 $ 490,807 $ 803,819 Affiliated companies . . . . . .48,526 124,877 40,000 40,779 Dividend income-- unaffiliated companies. . . . .900 2,550 0 8,024 Dividend income-- affiliated companies. . . . . . 50,000 52,500 0 Consulting and administrative fees . . . . . .0 0 29,870 68,185 Other income . . . . . . . . . .3,911 102,468 869 92,610 ----------- ----------- --------------------- Total investment income. . . . . 635,486 614,046 1,013,417287,684 585,486 561,546 Expenses: Salaries and benefits. . . . . . 831,121 1,507,257 1,524,826 BonusProfit-sharing accrual (Note 3) . . . . . 899,751 423,808 0 Administration and operations. . 330,879 392,114 474,537 Professional fees. . . . . . . . 411,480 327,038 675,241 Depreciation . . . . . . . . . 8,110,908 899,751 423,808 Salaries and benefits. . 47,936 48,968 57,426. . 834,700 831,121 1,507,257 Professional fees. . . . . . 331,889 411,480 327,038 Administration and operations. . . . . . . . 319,167 330,879 392,114 Rent . . . . . . . . . . . . . .162,987 159,515 130,092 160,601 Directors' fees and expensesexpenses. . . . . . . . . 120,328 129,253 100,496 80,702Depreciation . . . . . . . . 35,455 47,936 48,968 Custodian fees . . . . . . . . .8,586 10,513 15,517 11,983 Restructuring charges. . . . . .0 0 100,000 0 Other expense (Note 7) . . . . .0 728,862 0 0 Interest expense . . . . . . . .0 85,476 0 0 ----------- ----------- ----------------------- ------------ ------------ Total expenses . . . . . . . .9,924,020 3,634,786 3,045,290 2,985,316 ----------- ----------- ----------------------- ------------ ------------ Operating loss before income taxestaxes. . . . . . (2,999,300) (2,431,244) (1,971,899). (9,636,336) (3,049,300) (2,483,744) Income tax benefit (Note 6). . .0 234,188 933,103 680,834 ----------- ------------ ----------------------- ------------ Net operating loss . . . . . . . . (2,765,112) (1,498,141) (1,291,065)(9,636,336) (2,815,112) (1,550,641) Net realized lossgain (loss) on investments: Realized lossgain (loss) on sale of investments . . . . . (1,768,528) (3,199,502) (3,792,576) ----------- ----------- -----------10,976,714 (1,718,528) (3,147,002) ------------ ------------ ------------ Total realized loss. . . . . . (1,768,528) (3,199,502) (3,792,576)gain (loss) 10,976,714 (1,718,528) (3,147,002) Income tax (expense) benefit (Note 6). . . . . (2,361,044) 0 1,119,825 1,327,401 ----------- ----------- ----------------------- ------------ ------------ Net realized lossgain (loss) on investments (1,768,528) (2,079,677) (2,465,175) ----------- ----------- -----------. . . . . . . 8,615,670 (1,718,528) (2,027,177) ------------ ------------ ------------ Net realized loss. . . . . . . . .(1,020,666) (4,533,640) (3,577,818) (3,756,240) Net increase in unrealized appreciation on investments: Increase as a result of investment salessales. . . . . 704,801 2,135,176 93,999 Decrease as a result of investment sales. . . . . (4,939,595) (963,680) (2,892,408) Increase on investments held. . . . . . . . 2,135,176 93,999 2,525,548. . . 43,186,960 9,766,320 7,297,164 Decrease as a result of investment saleson investments held. . . . . . . . (963,680) (2,892,408) 0 Increase on investments held . . 9,766,320 7,297,164 4,112,413 Decrease on investments held . .(2,477,193) (8,689,000) (3,007,612) (2,072,965) ------------ ------------- ------------ ----------- Change in unrealized appreciation on investments . . . . . . . .36,474,973 2,248,816 1,491,143 4,564,996 Income tax provisionbenefit (provision) (Note 6). . . 1,627,074 (592,986) (521,900) (1,597,748) ------------ ----------- ----------------------- ------------ Net increase in unrealized appreciation on investments . . . . . . . .38,102,047 1,655,830 969,243 2,967,248 ------------ ----------- ---------------------- ------------ Net decreaseincrease (decrease) in net assets resulting from operations: Total. . . . . . . . . . . . . . $(2,877,810) $(2,608,575) $ (788,992)37,081,381 $ (2,877,810) $ (2,608,575) ============ ============ ======================= Per outstanding share. . . . . .$ 4.01 $ (0.27) $ (0.24) $ (0.08) ============ ============ =======================
The accompanying notes are an integral part of these consolidated financial statements. 2431
CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended Year Ended Year Ended 12/31/98 12/31/97 12/31/96Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997 Cash flows (used in) provided by operating activities: Net decreaseincrease (decrease) in net assets resulting from operations . . .$37,081,381 $ (2,877,810) $ (2,608,575) $ (788,992) Adjustments to reconcile net decrease in net assets resulting from operations to net cash (used in) provided by operating activities: Net realized and unrealized (gain) loss on investments.investments . . . . . . . (47,451,687) (480,288) 1,708,359 (772,420) Deferred income taxes . . . . .586,710 263,367 (1,442,094) 1,636,817 Depreciation. . . . . . . . . .35,455 47,936 48,968 57,426 Other . . . . . . . . . . . . .0 (2,927) 0 (10,144) Changes in assets and liabilities: Funds in escrow . . . . . . . (1,327,748) 0 0 Receivable from brokers . . . .380,707 (380,707) 0 205,789 Prepaid expenses. . . . . . . .16,321 (5,523) (3,625) 5,475 Interest receivable . . . . . .(43,523) 110,440 87,236 102,376 Taxes receivable. . . . . . . .0 0 2,119,492 (1,679,377) Notes receivable. . . . . . . .0 (32,663) 0 0 Other assets. . . . . . . . . .(41,281) 86,312 40,296 (103,981) Accounts payable and accrued liabilities.liabilities . . .195,448 81,235 49,555 22,197 Accrued bonus . . . . . . . . .profit sharing (Note 3) 8,110,908 899,751 423,808 0 Deferred rent . . . . . . . . .(9,253) (9,253) (9,252) 10,279 Collection on notes receivable.receivable 10,000 800,000 0 0 Purchase of fixed assets. . . .(9,261) (16,426) (10,169) (35,777) ----------- ----------- -------------------- Net cash (used in) provided by operating activities. . . .activities (2,465,823) (1,516,556) 403,999 (1,350,332) Cash provided by (used in) investing activities: Net sale (purchase) of short-term investments and marketable securities.securities . . . .12,515,222 14,715,834 (155,667) 6,035,532 Investment in private placements and loans . . . . (4,077,001) (960,308) (4,511,434) (4,981,614) ----------- ----------- ----------- Net cash provided by (used in) investing activities 8,438,221 13,755,526 (4,667,101) 1,053,918 Cash flows (used in) provided by financing activities: Payment of dividenddividend. . . . . . .(3,647,017) (8,019,728) 0 0 Purchase of treasury stock (Note 4). . (2,373,551) (254,786) 0 0 Proceeds from exercise of stock options (Note 3). . .0 0 253,250 87,500 Proceeds (payment of) from note payable (Note 7) . .0 (4,000,000) 4,000,000 0 Proceeds from sale of stock (Note 4). . . . . . . .17,283 54,099 0 0----------- ------------ ----------- --------------------- Net cash (used in) provided by financing activities. . . .activities (6,003,285) (12,220,415) 4,253,250 87,500----------- ------------ ---------- Net (decrease) increase (decrease) in cash and cash equivalents: Cash and cash equivalents at beginning of the year. . . .year 164,143 145,588 155,440 364,354 Cash and cash equivalents at end of the year.year 133,256 164,143 145,588 ----------- ----------- ---------- Net (decrease) increase in cash and cash equivalents. . $ (30,887) $ 18,555 $ (9,852) =========== =========== ========== Supplemental disclosures of cash flow information: Income taxes paid . . . . . . 164,143 145,588 155,440 ------------ ------------ ---------- Net increase (decrease) in cash and cash equivalents$ 122,560 $ 372 $ 5,909 Interest paid . . . . . . . . $ 18,5550 $ (9,852) $ (208,914) ============ =========== =========== Supplemental disclosures of cash flow information: Income taxes paid. . . . . . . . $ 372 $ 5,909 $ 57,234 Interest paid. . . . . . . . . . $ 85,378 $ 085,476 $ 0
The accompanying notes are an integral part of these consolidated financial statements. 2532
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS Year Ended Year Ended Year Ended 12/31/98 12/31/97 12/31/96Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997 Changes in net assets from operations: Net operating loss.loss . . . . . . .$(2,765,112) $(1,498,141) $(1,291,065)$ (9,636,336) $ (2,815,112) $ (1,550,641) Net realized lossgain (loss) on investments. (1,768,528) (2,079,677) (2,465,175). . 8,615,670 (1,718,528) (2,027,177) Net (decrease) increase (decrease) in unrealized appreciation on investments as a result of sales . . . . .(4,234,794) 1,171,496 (1,818,966) 1,641,606 Net increase in unrealized appreciation on investments held . . . . . . .42,336,841 484,334 2,788,209 1,325,642------------- ------------ ------------ ------------------------- Net decreaseincrease (decrease) in net assets resulting from operationsoperations. . . . . . . 37,081,381 (2,877,810) (2,608,575) (788,992) Changes in net assets from capital stock transactions: Payment of dividend. . . . . . .(3,647,017) (8,019,728) 0 0 Purchase of treasury stock . . .(2,373,551) (254,786) 0 0 Proceeds from exercise of stock options and warrants . . . 0 0 253,250 87,500 Proceeds from sale of stock. . .stock 17,283 54,099 0 0 Tax benefit of restricted stock award and common stock transactions . . . . 0 0 77,656 72,186 ----------------------- ----------- ---------- ----------- Net (decrease) increase in net assets resulting from capital stock transactions . .(6,003,285) (8,220,415) 330,906 159,686 ------------ ---------------------- ----------- Net decreaseincrease (decrease) in net assets . . . .(11,098,225). . . . . 31,078,096 (11,098,225) (2,277,669) (629,306) Net assets: Beginning of the yearyear. . . . . . .22,556,709 33,654,934 35,932,603 36,561,909 ----------- ----------- ------------------------ ------------- ------------- End of the year . . . . . . . . .$$ 53,634,805 $ 22,556,709 $33,654,934 $35,932,603 =========== =========== ===========$ 33,654,934 ============= ============= =============
The accompanying notes are an integral part of these financialconsolidated statements. 2633
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 19981999 Method of Shares/ Valuation (3) Principal Value Investments in Unaffiliated Companies (10)(11)(12)(14)(15)(16) -- 12.0%71.8% of total investments Publicly Traded Portfolio (Common stock unless noted otherwise) -- 6.4%60.2% of total investments Somnus Medical Technology,Silknet Software, Inc. (1)(4)(2)(8) -- BiotechnologyProvides customer-centric e-business applications and Healthcare related . .(C) 47,200 $ 141,600 Nanophase Technologies Corporation (1)(6)systems -- Manufactures and markets inorganic crystals of nanometric dimensions -- 4.59%0.24% of fully diluted equity Common Stock . . . . . . . . (C) 40,864 $ 5,399,062 SciQuest.com, Inc. (1)(2)(9) -- Internet e-commerce source for scientific products -- 1.25% of fully diluted equity . . (C) 461,039 32,831,750 ------------ Total Publicly Traded Portfolio (cost: $1,350,000) . . . . $ 38,230,812 Private Placement Portfolio (Illiquid) -- 11.6% of total investments Alliance Pharmaceutical Corp. (2)(4)(10) -- Research and development of pharmaceutical products $1,200,000 subordinated 6% notes due 5/20/02 convertible into 600,000 common shares @ $2.00 per share . . . . . . (C) $ 1,200,000 Warrants convertible into 200,000 common shares @ $2.45 expiring 5/20/04. . . . . . .(C) 672,916 1,211,249 Princeton Video Image, Inc. (1) -- Real time sports and entertainment advertising -- 0.59% of fully diluted equity . . . . .(C) 62,600 178,410 Voice Control Systems, Inc. (1)(2) -- Supplier of speech recognition and related speech input technology . . . .(C) 22,964 39,383 ---------- Total Publicly Traded Portfolio (cost: $1,414,202). . . . . . . $1,570,642 ---------- Private Placement Portfolio (Illiquid) -- 5.6% of total investments200,000 $ 5,041,000 Exponential Business Development Company (1)(2)(5) -- Venture capital partnership focused on early stage companies Limited partnership interest . . . . . .(A) -- $ 25,000 MedLogic Global Corporation (1)(2) -- Medical cyanoacrylate adhesive -- 0.40% of fully diluted equity Series B Convertible Preferred Stock . .(B) 60,319 Common Stock . . . . . . . . . . . . . .(B) 25,798 565,978 SciQuest, Inc. (1)(2)(6)(9) -- Internet e-commerce source for scientific products -- 3.61% of fully diluted equity Series C Convertible Preferred Stock . .(A) 277,163 Warrants at $2.7962 expiring 6/30/07 . .(A) 26,822 775,000 ---------- Total Private Placement Portfolio (cost: $1,833,774). . . . . . $1,365,978 ---------- Total Investments in Unaffiliated Companies (cost: $3,247,976) . . . . . . . . . . $2,936,620 ----------
The accompanying notes are an integral part of this schedule. 27
SCHEDULE OF INVESTMENTS DECEMBER 31, 1998 Method of Shares/ Valuation(3) Principal Value Private Placement Portfolio (Illiquid) in Non-Controlled Affiliates (10)(12) -- 49.9% of total investments Genomica Corporation (1)(2)(6)(7)(11) -- Develops software that enables the study of complex genetic diseases -- 7.05%4.47% of fully diluted equity Common Stock . . . . . . . . . . . . . (B) 199,800 Series A Voting Convertible Preferred Stock . . . . . (B) 1,660,200 $1,209,730 InSite Marketing Technology,1,209,730 Kriton Medical, Inc. (1)(2)(4)(6) -- Integrates marketing scienceResearch and sales strategy into e-commercedevelopment of medical devices -- 7.12%1.88% of fully diluted equity Series B Convertible Preferred Stock. . . . .(A) 476,191 1,000,001 MedLogic Global Corporation (1)(2)(6) -- Medical cyanoacrylate adhesive -- 0.37% of fully diluted equity Series B Convertible Preferred Stock . . . .(D) 54,287 Common Stock . . . . . . . . . . .(D) 25,798 101,876 ----------- Total Private Placement Portfolio (cost: $4,261,080) . . . . . . . . . . . . . (A) 1,351,351 500,000 NBX Corporation (1)(2)(6) -- Exploits innovative distributed computing technology for use. . . . . . $ 7,377,607 ----------- Total Investments in small business telephone systems -- 13.95% of fully diluted equity Promissory Note -- 8% due March 16, 2001Unaffiliated Companies (cost: $5,611,080) . . . . . . . $ 45,608,419
The accompanying notes are an integral part of this consolidated schedule. 34
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 1999 Method of Shares/ Valuation (3) Principal Value Investments in Non-Controlled Affiliates (14)(16) -- 21.7% of total investments Publicly Traded Portfolio - 5.2% of total investments Nanophase Technologies Corporation (1)(7) Manufactures and markets inorganic crystals of nanometric dimensions -- 5.16% of fully diluted equity. . (A). . . . . (C) 758,016 $ 10,0003,325,795 ----------- Total Publicly Traded Portfolio (cost $1,341,734). . . . . . . $ 3,325,795 ----------- Private Placement Portfolio (Illiquid) (14)(16) -- 16.5% of total investments NeuroMetrix, Inc. (1)(2)(6) -- Developing devices for detection of neuromuscular disorders -- 16.19% of fully diluted equity Series A Convertible Preferred Stock . . . . (B) 500,000175,000 Series CB Convertible Preferred Stock . . . . (B) 240,793125,000 Series DC-2 Convertible Preferred Stock . . . . (B) 59,965 6,416,064229,620 $ 5,958,225 PHZ Capital Partners Limited Partnership (2)(12) -- Organizes and manages investment partnerships -- 20.0% of fully diluted equity Limited partnership interest . . . . . (D) -- 1,849,0541,770,802 Questech Corporation (1)(2)(6) -- Manufactures and markets proprietary decorative tiles and signs -- 12.40%12.30% of fully diluted equity Common Stock . . . . . . . . . . . . .(D) 565,792 2,263,168(D) 580,037 2,035,930 Warrants at $4.00$5.00 expiring 11/28/01 . .(A) 166,667 167 ----------- Private Placement Portfolio in Non-Controlled Affiliates (cost: $5,920,308)15/09. . . . . . . $12,238,183(A) 1,965 Warrants at $4.00 expiring 11/28/01. . . . . . . (A) 152,422 167 Sundial Marketplace Corporation (1)(2)(4)(6) -- Business-to- business e-commerce company providing retail wireless communications services -- 20% of fully diluted equity Series A Convertible Preferred Stock. . . . . (A) 2,000,000 500,000 12% Convertible Note . . . . . . . . (A) $ 250,000 250,000 ----------- Total Private Placement Portfolio (cost: $5,614,538). . .. . . . . . . . . $10,515,124 ----------- Total Investments in Non-Controlled Affiliates (cost: $6,956,272). . . . . . . $13,840,919
The accompanying notes are an integral part of this consolidated schedule. 2835
CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 19981999 Method of Shares/ Valuation (3) Principal Value Private Placement Portfolio in Controlled Affiliates (10)(12)(14)(16) (Illiquid) -- 24.3%1.6% of total investments NeuroMetrix,Adaptive Web Technologies Inc.(1)(2)(4)(6)(8)(13) -- Developing devices for: 1) diabetics to monitor their blood glucose and 2) detection of carpal tunnel syndrome -- 27.67%100.0% of fully diluted equity Series A Convertible Preferred Stock . . .(B) 175,000 Series B Convertible Preferred Stock . . .(B) 125,000 Series C-2 Convertible Preferred Stock . .(B) 229,620. . (A) 1,000,000 $ 5,958,225 -----------1,000,000 ------------ Total Private Placement Portfolio in Controlled Affiliates (cost: $1,558,100). $1,000,000). . . . . . . . . $ 5,958,225 -----------1,000,000 U.S. Government Obligations -- 13.8%4.9% of total investments U.S. Treasury Bill dated 02/05/9807/15/99 due date 02/04/9901/13/00 -- 4.4%3.9% yield . . . . . . . . . .(K)(K) $ 300,0001,200,000 $ 298,8781,198,308 U.S. Treasury Bill dated 02/05/9807/29/99 due date 02/04/9901/27/00 -- 4.4%4.2% yield . . . . . . . . . .(K)(K) $ 600,000 597,7561,500,000 1,495,245 U.S. Treasury Bill dated 08/13/9811/04/99 due date 02/11/9905/04/00 -- 4.3%5.3% yield . . . . . . . . . .(K)(K) $ 400,000 398,160 U.S. Treasury Bill dated 03/05/98 due date 03/04/99 -- 4.3% yield . . . . . . . . . .(K) $ 1,550,000 1,538,902 U.S. Treasury Bill dated 11/19/98 due date 05/20/99 -- 4.5% yield . . . . . . . . . .(K) $ 575,000 565,467 -------------392,760 ----------- Total Investments in U.S. Government Obligations (cost: $3,398,259)$3,085,778). . . . . . . . . . . . . . . . . . . . . . . $ 3,399,163 -------------3,086,313 ----------- Total Investments -- 100% (cost: $14,124,643)$16,653,130). . . . . . . . $ 24,532,191 =============. . $63,535,651 ===========
The accompanying notes are an integral part of this consolidated schedule. 2936 CONSOLIDATED SCHEDULE OF INVESTMENTS DECEMBER 31, 19981999 Notes to Consolidated Schedule of Investments (1) Represents a non-income producing security. Equity investments that have not paid dividends within the last twelve12 months are considered to be non-income producing. (2) Legal restrictions on sale of investment. (3) See Footnote to Consolidated Schedule of Investments for a description of the Method of Valuation A to L. (4) These investments were made during 1998. Accordingly, the amounts shown on the schedule represent the gross additions in 1998.1999. (5) No changes in valuation occurred in these investments during the year ended December 31, 1998.1999. (6) These investments are in development stage companies. A development stage company is defined as a company that is devoting substantially all of its efforts to establishing a new business, and either has not yet commenced its planned principal operations or has commenced such operations but has not realized significant revenue from them. (7) As of December 31, 1999, the market price per share of Nanophase Technologies Corporation ("NANX") was $4.875. The Company's holding in Nanophase Technologies Corporation before a discount for illiquidity was valued at $3,695,328. During January and February 2000, the Company sold 85,100 shares of Nanophase Technologies Corporation stock in the open market for a total of $420,555 or $4.94 per share. On March 20, 2000, the market price per share of Nanophase Technologies Corporation was $13.1875. (8) On October 5, 1999, Silknet Software, Inc. ("SILK") acquired InSite Marketing Technology, Inc. The Company is subject to a lock-up agreement on the Silknet Software stock that expires on October 5, 2000. On December 31, 1999, the market price per share of Silknet Software, Inc. was $165.75. The Company's holding in Silknet Software before a discount for trading restrictions and a 10 percent escrow was valued at $6,773,208. On February 7, 2000, Kana Communications, Inc. and Silknet Software, Inc. announced a merger agreement, in which the Silknet Software shares will be exchanged tax free for 0.83 Kana Communications (pre two-for-one stock split) shares. See Note 8 of Notes to Consolidated Financial Statements. On March 20, 2000, the market prices per share of Silknet Software and Kana Communications were $165.375 and $103.00 (post two-for-one stock split), respectively. (9) The Company is subject to a lock-up agreement on the stock which expires on May 18, 2000. On December 31, 1999, the market price per share of SciQuest.com, Inc. ("SQST") was $79.50. The Company's holding in SciQuest.com before a discount for trading restrictions was valued at $36,652,600. On February 25, 2000, the Company sold 43,400 shares of SciQuest.com at $77.23 per share. On March 20, 2000, the market price per share of SciQuest.com, Inc. was $38.25. The accompanying notes are an integral part of this consolidated schedule. 37 (10) As of December 31, 1999, the market price per share of Alliance Pharmaceutical Corp. ("ALLP") was $7.375. The Company's holding in Alliance Pharmaceutical, before a discount for delays in converting the note and warrants to registered shares, was valued at $5,410,000, including valuing the warrants at their in the money common stock value. On February 9, 2000, the Company exercised the warrant to purchase 200,000 common shares of Alliance Pharmaceutical Corp. and converted its $1,200,000 note due May 20, 2002 into 600,000 shares of common stock. These shares are currently restricted under Rule 144. On March 20, 2000, the market price per share of Alliance Pharmaceutical Corp. was $13.1875. (11) In 1996, Genomica Corporation was cofounded by the Company, Cold Spring Harbor Laboratory ("CSHL"), a not-for-profit institution, and Falcon Technology Partners, LP. Mr. G. Morgan Browne serves on the Board of Directors of the Company and is Administrative Director of Cold Spring Harbor Laboratory. (8)CSHL. In late 1998, Charles E. Harris, Chairman and CEO of Harris & Harris Group, became a trustee of CSHL. (See "Note 8 of Notes to Consolidated Financial Statements.") (12) Harris Partners I L.P. owns a 20 percent limited partnership interest in PHZ Capital Partners L.P. The percentagepartners of Harris Partners I L.P. are Harris & Harris Enterprises, Inc. (sole general partner) and Harris & Harris Group, Inc. (sole limited partner). Harris & Harris Enterprises, Inc. is a 100 percent owned bysubsidiary of Harris & Harris Group, Inc. (13) On January 13, 2000, the Company proforma forannounced its decision not to proceed with the January 21, 1999 financing is 18.04%. (9) SciQuest,development and commercialization of, and to liquidate, Adaptive Web Technologies, Inc. acquired BioSupplyNet, Inc. (10)(See "Note 8 of Notes to Consolidated Financial Statements.") (14) Investments in unaffiliated companies consist of investments wherein which Harris & Harris Group, Inc. (the "Company") owns less than 5 percent of the investee company. Investments in non-controlled affiliated companies consist of investments wherein which the Company owns more than 5 percent but less than 25 percent of the investee company. Investments in controlled affiliated companies consist of investments wherein which the Company owns more than 25 percent of the investee company. (11)(15) The aggregate cost for federal income tax purposes of investments in unaffiliated companies is $3,247,976.$5,611,080. The gross unrealized appreciation based on tax cost for these securities is $156,440.$40,929,238. The gross unrealized depreciation on the cost for these securities is $467,796. (12)$931,899. (16) The percentage ownership of each investee disclosed in the Consolidated Schedule of Investments expresses the potential common equity interest in each such investee. The calculated percentage represents the amount of issuer's common stock the Company owns or can acquire as a percentage of the issuer's total outstanding common stock plus common shares reserved for issued and outstanding warrants, convertible securities and stock options. The accompanying notes are an integral part of this consolidated schedule. 3038 FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS ASSET VALUATION POLICY GUIDELINES The Company's investments can be classified into five broad categories for valuation purposes: 1) EQUITY-RELATED SECURITIES 2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT 3) LONG-TERM FIXED-INCOME SECURITIES 4) SHORT-TERM FIXED-INCOME INVESTMENTS 5) ALL OTHER INVESTMENTS The Investment Company Act of 1940 (the "1940 Act") requires periodic valuation of each investment in the Company's portfolio to determine net asset value. Under the 1940 Act, unrestricted securities with readily available market quotations are to be valued at the current market value; all other assets must be valued at "fair value" as determined in good faith by or under the direction of the Board of Directors. The Company's Board of Directors is responsible for 1) determining overall valuation guidelines and 2) ensuring the valuation of investments within the prescribed guidelines. The Company's Investment and Valuation Committee, comprised of at least three or more independent Board members, is responsible for reviewing and approving the valuation of the Company's assets within the guidelines established by the Board of Directors. Fair value is generally defined as the amount that an investment could be sold for in an orderly disposition over a reasonable time. Generally, to increase objectivity in valuing the assets of the Company, external measures of value, such as public markets or third-party transactions, are utilized whenever possible. Valuation is not based on long-term work-out value, nor immediate liquidation value, nor incremental value for potential changes that may take place in the future. Valuation assumes that, in the ordinary course of its business, the Company will eventually sell its investment. The Company's valuation policy with respect to the five broad investment categories is as follows: EQUITY-RELATED SECURITIES Equity-related securities are carried at fair value using one or more of the following basic methods of valuation: A. Cost: The cost method is based on the original cost to the Company. This method is generally used in the early stages of a company's development until significant positive or negative events occur subsequent to the date of the original investment that dictate a change to another valuation method. 39 Some examples of such events are: 1)(1) a major recapitalization; 2)(2) a major refinancing; 3)(3) a significant third-party transaction; 4)(4) the development of a meaningful public market for the company's common stock; 5)(5) significant positive or negative changes in the company's business. 31 B. Private Market: The private market method uses actual third-party transactions in the company's securities as a basis for valuation, using actual, executed, historical transactions in the company's securities by responsible third parties. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation. C. Public Market: The public market method is used when there is an established public market for the class of the company's securities held by the Company. The Company discounts market value for securities that are subject to significant legal, contractual or practical restrictions, including large blocks in relation to trading volume. Other securities, for which market quotations are readily available, are carried at market value as of the time of valuation. Market value for securities traded on securities exchanges or on the Nasdaq National Market is the last reported sales price on the day of valuation. For other securities traded in the over-the-counter market and listed securities for which no sale was reported on that day, market value is the mean of the closing bid price and asked price on that day. This method is the preferred method of valuation when there is an established public market for a company's securities, as that market provides the most objective basis for valuation. D. Analytical Method: The analytical method is generally used to value an investment position when there is no established public or private market in the company's securities or when the factual information available to the Company dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of the Company's Investment and Valuation Committee members, based on the data available to them. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the financial condition and operating results of the company, the long-term potential of the business of the company, the values of similar securities issued by companies in similar businesses, the proportion of the company's securities owned by the Company and the nature of any rights to require the company to register restricted securities under applicable securities laws. INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT Such investments are carried at fair value using the following basic methods of valuation: E. Cost: The cost method is based on the original cost to the Company. Such method is generally used in the early stages of commercializing or developing intellectual property or patents or research and development in technology or product development until significant positive or adverse events occur subsequent to the date of the original investment that dictate a change to another valuation method. 40 F. Private Market: The private market method uses actual third-party investments in intellectual property or patents or research and development in technology or product development as a basis for valuation, using actual executed historical transactions by responsible third parties. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation. 32 G. Analytical Method: The analytical method is used to value an investment after analysis of the best available outside information where the factual information available to the Company dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of the Company's Investment and Valuation Committee members. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the results of research and development, product development progress, commercial prospects, term of patent and projected markets. LONG-TERM FIXED-INCOME SECURITIES H. Fixed-Income Securities for which market quotations are readily available are carried at market value as of the time of valuation using the most recent bid quotations when available. Securities for which market quotations are not readily available are carried at fair value using one or more of the following basic methods of valuation: I. Fixed-Income Securities are valued by independent pricing services that provide market quotations based primarily on quotations from dealers and brokers, market transactions, and other sources. J. Other Fixed-Income Securities that are not readily marketable are valued at fair value by the Investment and Valuation Committee. SHORT-TERM FIXED-INCOME INVESTMENTS K. Short-Term Fixed-Income Investments are valued at market value at the time of valuation. Short-term debt with remaining maturity of 60 days or less is valued at amortized cost. ALL OTHER INVESTMENTS L. All Other Investments are reported at fair value as determined in good faith by the Investment and Valuation Committee. The reported values of securities for which market quotations are not readily available and for other assets reflect the Investment and Valuation Committee's judgment of fair values as of the valuation date using the outlined basic methods of valuation. They do not necessarily represent an amount of money that would be realized if the securities had to be sold in an immediate liquidation. The Company makes many of its portfolio investments with the view of holding them for a number of years, and the reported value of such investments may be considered in terms of disposition over a period of time. Thus valuations as of any particular date are not necessarily indicative of amounts that may ultimately be realized as a result of future sales or other dispositions of investments held. 3341 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY Harris & Harris Group, Inc. (the "Company") is a venture capital investment company operating as a business development company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type of investment company under the 1940 Act. The Company operates as an internally managed investment company whereby its officers and employees, under the general supervision of its Board of Directors, conduct its operations. The Company elected to become a BDC on July 26, 1995, after receiving the necessary approvals. From September 30, 1992 until the election of BDC status, the Company operated as a closed-end, non-diversified, investment company under the 1940 Act. Upon commencement of operations as an investment company, the Company revalued all of its assets and liabilities at fair value as defined in the 1940 Act. Prior to such time, the Company was registered and filed under the reporting requirements of the Securities and Exchange Act of 1934 as an operating company and, while an operating company, operated directly and through subsidiaries. On September 25, 1997,Harris & Harris Enterprises, Inc. ("Enterprises") is a 100 percent wholly owned subsidiary of the Company's BoardCompany. Enterprises holds the lease for the office space, which it subleases to the Company and an unaffiliated party; owns a financial relations and consulting firm; is a partner in Harris Partners I, L.P. and is taxed as a C corporation. Harris Partners I L.P. is a limited partnership and owns a 20 percent limited partnership interest in PHZ Capital Partners, L.P. The partners of Directors approved a proposalHarris Partners I L.P. are Harris & Harris Enterprises, Inc. (sole general partner) and Harris & Harris Group, Inc. (sole limited partner). The Company intends for 1999 to seek qualificationelect treatment as a Regulated Investment Company ("RIC") under Sub-Chapter M of the Internal Revenue Code. As a RIC, the Company must, among other things, distribute at least 90 percent of its taxable net income and may either distribute or retain its taxable net realized capital gains on investments. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations --- Recent Developments.Developments Sub Chapter M Status.") There can be no assurance that the Company will qualify as a RIC or that if it does qualify, it will continue to qualify. In addition, even if the Company were to qualify as a RIC, and elected Sub-Chapter M treatment for that year, the Company might take action in a subsequent year to ensure that it would be taxed in that subsequent year as a C Corporation, rather than a RIC. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements: Principles of Consolidation. The consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles for investment companies and include the accounts of the Company and its wholly owned subsidiary. All significant intercompany accounts and transactions have ben eliminated in consolidation. Cash and Cash Equivalents. Cash and cash equivalents include money market instruments with maturities of less than three months. 42 Portfolio Investment Valuations. Investments are stated at "fair value" as defined in the 1940 Act and in the applicable regulations of the Securities and Exchange Commission. All assets are valued at fair value as determined in good faith by, or under the direction of, the Board of Directors. See the Asset Valuation Policy Guidelines in the Footnote to Consolidated Schedule of Investments. Securities Transactions. Securities transactions are accounted for on the date the securities are purchased or sold (trade date); dividend income is recorded on the ex-dividend date; and interest income is accrued as earned. Realized gains and losses on investment transactions are determined on the first-in, first-out basisspecific identification for financial reporting and tax reporting or purposes.reporting. Income Taxes. Prior to January 1, 1998,1999, the Company recorded income taxes using the liability method in accordance with the provision of Statement of Financial Accounting Standards No. 109. Accordingly, deferred tax liabilities had been established to reflect temporary differences between the recognition of income and expenses for financial reporting and tax purposes, the most significant difference of which relates to the Company's unrealized appreciation on investments. 34 The December 31, 19981999 consolidated financial statements include a provision for deferred taxes on the remaining net unrealizedbuilt-in gains as of December 31, 1998, net of the unutilized operating and capital loss carryforwards incurred by the Company through December 31, 1998. The Company pays federal, state and local income taxes on behalf of its wholly owned subsidiary, Harris & Harris Enterprises, which is a C corporation. (See Note 6. Income Taxes.) Reclassifications. Certain reclassifications have been made to the December 31, 19961997 and December 31, 19971998 financial statements to conform to the December 31, 19981999 presentation. Estimates by Management. The preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of December 31,199831,1999 and 1997,1998, and the reported amounts of revenues and expenses for the three years ended December 31, 1998.1999. Actual results could differ from these estimates. NOTE 3. STOCK OPTION PLAN, AND WARRANTS OUTSTANDING AND EMPLOYEE PROFIT- SHARING PLAN On August 3, 1989, the shareholders of the Company approved the 1988 Long Term Incentive Compensation Plan. On June 30, 1994, the shareholders of the Company approved various amendments to the 1988 Long Term Incentive Compensation Plan: 1) to conform to the provisions of the BDC regulations under the 1940 Act, which allow for the issuance of stock options to qualified participants; 2) to increase the reserved shares under the amended plan; 3) to call the plan the 1988 Stock Option Plan, as Amended and Restated (the "1988 Plan"); and 4) to make various other amendments. On October 20, 1995, the shareholders of the Company approved an amendment to the 1988 Plan authorizing automatic 20,000 share grants of non-qualified stock options to newly elected non-employee directors of the Company. The Company's 1988 Plan was cancelled as of December 31, 1997, canceling all outstanding stock options and eliminating all potential stock option grants. As a substitution for the 1988 Stock Option Plan, the Company adopted an employee profit-sharingprofit- sharing plan. 43 The Company accounted for the 1988 Plan under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for the 1988 Plan been determined consistent with the fair value method required by FASB Statement No. 123 ("FASB No. 123"), the Company's net realized loss and net asset value per share would have been reduced to the following pro- forma amounts: 1999 1998 1997 1996 Net Realized Loss: As Reported N/A N/A $(3,577,818) $ (3,756,240) Pro Forma N/A N/A $(3,921,583) $ (4,197,096) Net Asset Value per share: As Reported N/A $3.15 $3.44N/A $ 3.15 Pro Forma N/A $3.12 $3.40N/A $ 3.12
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: 1999 1998 1997 1996 Stock volatility N/A 0.60N/A 0.60 Risk-free interest rate N/A N/A 6.3% 6.8% Option term in years N/A 7N/A 7 Stock dividend yield N/A - -N/A - -
35 A summary of the status of the Company's 1988 Plan at December 31, 1997 and 1996 and changes during the yearsyear then ended is presented in the table and narrative below: December 31, 1997 December 31, 1996 ------------------- ------------------- Shares Weighted----------------- Shares Weighted Average Average --------- -------- ---------------- -------- Exercise Exercise Price Price -------- ---------------------- Outstanding at beginning of year 1,080,000 $4.584 1,050,000 $4.445 Granted 300,000 $3.875 160,000 $5.008 Exercised 158,000 $1.603 50,000 $1.750 Forfeited 397,000 $5.267 80,000 $5.375 Expired - - - - - - - - Canceled 825,000 $4.569 - - - - Outstanding at end of year 0 0 1,080,000 $4.584 Exercisable at end of year 0 0 390,000 $3.334 Weighted average fair value of options granted $2.50 - - $3.222 - -
During 1997, the Chairman of the Company exercised a warrant to purchase 237,605 shares of common stock at a price of $2.0641. 44 As of January 1, 1998, the Company began implementing the Harris & Harris Group, Inc. Employee Profit Sharing Plan (the "Plan""1998 Plan") that provides for profit sharing equal to 20 percent of the net realized income of the Company as reflected on the statementConsolidated Statement of operationsOperations of the Company for such year, less the nonqualifying gain, if any. Under the 1998 Plan, net realized income of the Company includes investment income, realized gains and losses, and operating expenses (including taxes paid or payable by the Company), but it will be calculated without regard to dividends paid or distributions made to shareholders, payments under the 1998 Plan, unrealized gains and losses, and loss carry-overs from other years ("Qualifying Income"). The portion of net after-tax realized gains attributable to asset values as of September 30, 1997 will be considered nonqualifying gain, which will reduce "Qualifying Income." As soon as practicable following year end, the Board of Directors will determine whether, and if so, how much "Qualifying Income" exists for a plan year, and 90 percent of the Qualifying Income will be paid out to 1998 Plan participants pursuant to the distribution percentages set forth in the 1998 Plan. The remaining 10 percent will be paid out after the Company has filed its federal tax return for that year in which "Qualifying Income" exists. The distribution amounts for each officer and employee is as follows: Charles E. Harris, 13.790%;13.790 percent; Mel P. Melsheimer, 4.233%;4.233 percent; Rachel M. Pernia, 1.524%;1.524 percent; and Jacqueline M. Matthews, 0.453%.0.453 percent. If a participant leaves the Company for other than cause, the amount earned will be accrued and paid to such participant, and the remaining amount allocable under the 1998 Plan will be redistributed by the Compensation Committee and paid to the other participants. 36 Notwithstanding any provisions of the 1998 Plan, in no event may the aggregate amount of all awards payable for any 1998 Plan year during which the Company remains a "business development company" within the meaning of the Investment Company Act of 1940, as amended (the "1940 Act"), be greater than 20 percent of the Company's "net income after taxes" within the meaning of Section 57(n)(1)(B) of the 1940 Act. In the event the awards exceed such amount, the awards will be reduced pro rata. The 1998 Plan may be modified, amended or terminated by the Company's Board of Directors at any time; provided however, no such modification, amendment or termination may adversely affect any participant that has not consented to such modification, amendment or termination. The Company calculates the 1998 Plan accrual at each quarter end based on the unrealized gains at that date, net of operating expenses for the year. Any adjustments to the 1998 Plan accrual are then reflected in the Consolidated Statement of Operations for the quarter. The 1998 Plan accrual is not paid out until the gains are realized. During 1998,1999, the Company accrued bonusprofit-sharing expense of $899,751,$8,110,908, of which $8,295,916 represents a profit sharing accrual on unrealized gains and will not be paid out until the gains are realized, bringing the cumulative accrual under the 1998 Plan to $1,323,559$9,434,467 at December 31, 1998.1999. The 1998 Plan was terminated as of December 31, 1999 subject to the payment of any amounts owed under the 1998 Plan. As of January 1, 2000, the Company adopted the Harris & Harris Group Employee Profit-Sharing Plan (the "2000 Plan") with substantially the same terms as the 1998 Plan, except for a limitation on the amount of an award that may be paid out to any one participant during any one year if the shareholders do not approve the performance goals of the 2000 Plan. The Shareholders are being asked to approve the performance 45 goals under the 2000 Plan in accordance with Section 162(m) of the Internal Revenue Code at the Annual Meeting of Shareholders to be held on April 26, 2000. If the Shareholders do not approve the performance goals, the Company could implement the 2000 Plan in its current form, or modify or terminate the 2000 Plan. At present, the Company has no plans to take any particular action in the event of a negative shareholder vote. In March 2000, the Company paid out under the 1998 Plan 90 percent of the profit sharing on the 1999 realized gains of approximately $1,024,696; the remaining 10 percent or approximately $113,855 will be paid out on the completion and filing of the Company's 1999 federal tax return. NOTE 4. CAPITAL TRANSACTIONS In 1998, the Board of Directors approved that effective January 1, 1998, 50 percent of all Directordirectors' fees be used to purchase Company common stock from the Company. However, effective on March 1, 1999, the Directorsdirectors may purchase the Company's common stock in the market, rather than from the Company. During 1998, the directors bought a total of 24,491 shares. On April 15, 1998, the Company announced that the Board of Directors had approved the purchase of up to 700,000 shares of Company stock in the open market. As of December 31, 1998, the Company had purchased a total of 126,230 shares for a total of $254,786 or an average of $2.02 per share. However, the treasury shares purchased were decreased by the directordirectors' purchases of a total of 24,491 shares of Company stock. In the first six months of 1999, the Company purchased a total of 275,648 shares of treasury shares in the open market for a total of $540,720 or $1.96 per share. On July 14, 1999, the Company announced an offer to purchase up to 1,100,000 shares of its common stock for cash at a price equal to $1.63 per share. A total of 1,080,569 shares were tendered for a total cost, including related expenses of approximately $71,500, of $1,832,831. Of these shares, 1,075,269 were tendered by one shareholder, which tendered all of its holdings. Since 1998, as a result of the shares purchased in the open market and through the tender offer in 1999, the Company has purchased a total of 1,482,447 shares for a total of $2,628,337, including commissions and expenses, at an average price of $1.77 per share. NOTE 5. EMPLOYEE BENEFITS The Company has an employment and severance contract ("Employment Contract") with its Chairman,On October 19, 1999, Charles E. Harris pursuantsigned an Employment Agreement with the Company (disclosed in a Form 8-K filed on October 27, 1999) ("The Employment Agreement"), which superseded an employment agreement that was about to which he is to receive compensation in the form of salary and other benefits. On January 1, 1998, Mr. Harris'sexpire on December 31, 1999. The Employment Contract was amended to reduce his salary to $200,000 and to allow him to participate in other business opportunities and investments. The term of the contractAgreement expires on December 31, 1999. Base salary is2004 ("Term"); on January 1, 2000 and on each day thereafter, the Term extends automatically by one day unless at any time the Company or Mr. Harris, by written notice, decides not to be increased annually to reflect inflation andextend the Term, in addition may be increased by such amountwhich case the Term will expire five years from the date of the written notice. During the period of employment, Mr. Harris shall serve as the Compensation CommitteeChairman and Chief Executive Officer of the Company; be responsible for the general management of the affairs of the Company and all its subsidiaries, reporting directly to the Board of Directors of the Company; serve as a member of the 46 Board for the period of which he is and shall from time to time be elected or reelected; and serve, if elected, as President of the Company deems appropriate.and as an officer and director of any subsidiary or affiliate of the Company. Mr. Harris is to receive compensation under his Employment Agreement in the form of base salary of $202,980, with automatic yearly adjustments to reflect inflation. In addition, the Board may increase such salary, and consequently decrease it, but not below the level provided for by the automatic adjustments described above. Mr. Harris is also entitled to participate in the Company's Profit-Sharing Plan as well as in all compensation or employee benefit plans or programs, and to receive all benefits, perquisites, and emoluments for which salaried employees are eligible. Under the Employment Agreement, the Company is to furnish Mr. Harris with certain perquisites which include a company car, membership in certain clubs and up to a $5,000 annual reimbursement for personal, financial or tax advice. The Employment Agreement provides Mr. Harris with life insurance for the benefit of his designated beneficiaries in the amount of $2,000,000; provides reimbursement for uninsured medical expenses, not to exceed $10,000 per annum, adjusted for inflation, over the period of the contract; provides Mr. Harris and spouse with long-term care insurance; and disability insurance in the amount of 100 percent of his base salary. These benefits are for the term of the contract. The Employment Agreement provides for the Company to adopt a supplemental executive retirement plan (the "SERP") for the benefit of Mr. Harris. Under the SERP, the Company will cause an amount equal to one-twelfth of the Mr. Harris's current base salary to be credited each month (a "Monthly Credit") to a special account maintained for this purpose on the books of the Company for the benefit of Mr. Harris (the "SERP Account"). The amounts credited to the SERP Account will be deemed invested or reinvested in such mutual funds or U.S. Government securities as determined by Mr. Harris. The SERP Account will be credited and debited to reflect the deemed investment returns, losses and expenses attributed to such deemed investments and reinvestments. Mr. Harris's benefit under the SERP will equal the balance in the SERP Account and such benefit will always be 100 percent vested (i.e., not forfeitable). Mr. Harris will determine the form and timing of the distribution of the balance in the SERP Account; provided, however, in the event of the termination, the balance in the SERP Account will be distributed to Mr. Harris or his beneficiary, as the case may be, in a lump-sum payment within 30 days of such termination. The Company will establish a rabbi trust for the purpose of accumulating funds to satisfy the obligations incurred by the Company under the SERP. During 1999, the Company accrued $41,442 in accordance with this provision of the SERP. Mr. Harris's rights to benefits pursuant to this SERP will be no greater than those of a general creditor of the Company. The Employment Agreement provides severance pay in the event of termination without cause or by constructive discharge and also provides for certain death benefits payable to the surviving spouse equal to the executive's base salary for a period of two years. In addition, Mr. Harris would beis entitled under certain circumstances, to receive severance pay pursuant to the severance compensation agreement that he entered into with the Company, effective August 15, 1990. The severance compensation agreement provides that if, following a change in control of the Company, as defined in the agreement, such individual's employment is terminated by the Company without cause or by the executive within one year of such change in control, the individual shall be entitled to receive compensation in a lump sum payment equal to 2.99 times the individual's average annualized compensation and payment of other welfare benefits. If Mr. Harris's termination is without cause or is a constructive 47 discharge, the amount payable under the employment andEmployment Agreement will be reduced by the amounts paid pursuant to the severance contracts.compensation agreement. As of January 1, 1989, the Company adopted an employee benefits program covering substantially all employees of the Company under a 401(k) Plan and Trust Agreement. As of January 1, 1999, the Company adopted the Harris & Harris Pension Plan and Trust, a money purchase plan which would allow the Company to stay compliant with the 401(k) top-heavy regulations and deduction limitation regulations. Contributions to the plan are at the discretion of the Company. During 1998,1999, contributions to the planboth plans that have been charged to operationssalaries and benefits totaled approximately $37,000. On June 30, 1994, the Company adopted a plan to provide medical and health insurance for retirees, their spouses and dependents who, at the time of their retirement, have ten years of service with the Company and have attained 50 years of age or have attained 45 years of age and have 15 years of service with the Company. On February 10, 1997, the Company amended this plan to include employees who "have seven full years of service and have attained 58 years of age." The coverage is secondary to any government provided or 37 subsequent employer provided health insurance plans. Based upon actuarial estimates, the Company provided an original reserve of $176,520 that was charged to operations for the period ending June 30, 1994. As of December 31, 19981999 the Company had a reserve of $283,305$317,600 for the plan. NOTE 6. INCOME TAXES As of December 31, 1998, the Company had not elected tax treatment available to RICs under Sub-Chapter M of the Code. Accordingly, for federal and state income tax purposes, the Company is taxed at statutory corporate rates on its income, which enables the Company to offset any future net operating losses against prior years' net income. The Company may carry back operating losses against net income two years and carryforward such losses 15 years. For the years ended December 31, 1998, 1997 and 1996, the Company's income tax (benefit) provision was allocated as follows: 1998 1997 1996 Investment operations $(234,188) $ (933,103) $ (680,834) Realized loss on investments 0 (1,119,825) (1,327,401) Increase in unrealized appreciation on investments 592,986 521,900 1,597,748 Total income tax (benefit) ---------- ------------ ------------ provision $ 358,798 $(1,531,028) $ (410,487) ========== ============ ============ The above tax (benefit) provision consists of the following: Current -- Federal $ 95,430 $ 0 $(2,047,304) Deferred -- Federal 263,368 (1,531,028) 1,636,817 Total income tax (benefit) --------- ------------ ------------ provision $ 358,798 $(1,531,028) $ (410,487) ========= ============ ============
The Company's net deferred tax liability at December 31, 1998 and 1997 consists of the following: 1998 1997 Unrealized appreciation on investments $ 3,410,885 $ 2,817,898 Net operating and capital loss carryforward (2,479,821) (1,856,989) Medical retirement benefits - - (81,345) Other - - (211,867) ------------ ------------ Net deferred income tax liability $ 931,064 $ 667,697 ============ ============
On September 25, 1997, the Company's Board of Directors approved a proposal to seek qualification as a RIC under Sub-Chapter M of the Code. As a RIC, the Company annually must distribute at least 90 percent of its investment company taxable income as a dividend and may either distribute or retain its taxable net capital gains from investments. To initially qualify as a RIC, among other requirements, the Company had to pay a dividend to shareholders equal to the Company's cumulative realized earnings and profits ("E&P"). On April 9, 1998, the Company declared a one-time cash dividend of $0.75 per share to meet this requirement (for a total of $8,019,728). The cash dividend was paid on May 12, 1998. Continued qualificationThe Company intends to elect Sub-Chapter M status for the year ended December 31, 1999. Accordingly, on February 23, 1999, the Company declared a cash dividend of $0.35 per share (for a total of $3,647,017) as a RIC requiresresult of the long-term capital gain generated in 1999 by the acquisition of NBX Corporation by 3Com Corporation. The Company utilized its net operating loss and capital loss carryforwards of approximately $6.3 million in order to retain most of the remaining long-term capital gain to invest in new opportunities. Approximately $300,000 of the long-term capital gain was not distributed during 1999. Therefore, the Company to satisfy certain portfolio diversification requirementsincurred approximately $26,044 in future years.excise taxes. The Company's ability to satisfy those requirements may not be controllable by the Company. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Recent Developments - Sub-Chapter M Status.") 38 The Company had incurred net ordinary and capital losses for a total of approximately $7.1$7.0 million (which results in a tax credit of approximately $2.5 million) during its C Corporation taxable years that remainof which $0.8 million still remains available for use and may be carried forward to its 1999 and subsequent taxable years. Ordinarily, a corporation that elects to qualify as a RIC may not use its loss carryforwards from C Corporation taxable years to offset RIC investment company taxable income or net capital gains. In addition, ause. A corporation that elects to qualify as a RIC continues to be taxable as a C Corporation on any gains realized within 10 years of its qualification as a RIC from sales of assets that were held by the corporation on the effective date of the election ("C Corporation Assets") to the extent of any gain built into the assets on such date ("Built-In Gain"). On February 17, 1999, the Company received a ruling from the IRS concluding that the Company can carry forward its C Corporation losses to offset any Built-In Gains resulting from sales of its C Corporation Assets. That ruling 48 may enable the Company to retain some or all of the proceeds from such sales without disqualifying itself as a RIC or incurring corporate level income tax, depending on whether the Company's sale of C Corporation Assets with Built- InBuilt-In Gains will generate C Corporation E&P. In general, a RIC is not permitted to have, as of the close of any RIC taxable year, E&P accumulated during any C Corporation taxable year. However, because the realization of Built-In Gains will occur while the Company is a RIC, a strong argument exists that, under current law and IRS pronouncements, the sale of C Corporation Assets with Built-In Gains during RIC taxable years will not generate C Corporation E&P. The Company intends to use the $7.1remaining $0.8 million loss carryforward (which results in a tax credit of approximately $2.5$0.3 million) to reduce its taxes which are due tothe result of Built-In Gains. Continued qualification as a RIC requires the Company to satisfy certain portfolio diversification requirements in future years. The December 31, 1998 NAV includes the utilization of ordinary and capital loss carryforwards of approximately $0.23 per share. The IRS recently announced an intentionCompany's ability to issue formal guidance in 1999 concerning conversions of C Corporations to RICs. Such guidancesatisfy those requirements may include resolution of the E&P issue described above and other issues relevant tonot be controllable by the Company. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Recent Developments - Sub-Chapter M Status.") There can be no assurance that the Company will qualify as a RIC for 2000 or subsequent years or that, if it does qualify, it will continue to elect RIC status. For the years ended December 31, 1999, 1998 and 1997, the Company's income tax (benefit) provision was allocated as follows: 1999 1998 1997 Investment operations $ 0 $ (234,188) $ (933,103) Realized gain (loss) on investments 2,361,044 0 (1,119,825) Increase in unrealized appreciation on investments (1,627,074) 592,986 521,900 ------------ ----------- ------------ Total income tax (benefit) provision $ 733,970 $ 358,798 $(1,531,028) ============ =========== ============
The above tax (benefit) provision consists of the following: 1999 1998 1997 Current -- Federal $ 2,361,044 $ 95,430 $ 0 Deferred -- Federal (1,627,074) 263,368 (1,531,028) ------------ ---------- ------------- Total income tax (benefit) provision $ 733,970 $ 358,798 $ (1,531,028) ============ ========== ==============
The Company's net deferred tax liability at December 31, 1999 and 1998 consists of the following: 1999 1998 Unrealized appreciation on investments $1,783,810 $ 3,410,884 Net operating and capital loss carryforward (266,036) (2,479,820) ----------- ------------ Net deferred income tax liability $1,517,774 $ 931,064 =========== ============
49 NOTE 7. COMMITMENTS AND CONTINGENCIES During 1993, the Company signed a ten-year10-year lease with sublet provisions for office space. In 1995, this lease was amended to include additional office space. Rent expense under this lease for the year ended December 31, 1998,1999, was $159,515.$162,987. Future minimum lease payments in each of the following years are: 1999 -- $176,030; 2000 -- $178,561; 2001 -- $178,561; 2002 -- $178,561; 2003 -- $101,946. In December 1993, the Company and MIT announced the establishment by the Company of the Harris & Harris Group Senior Professorship at MIT. Prior to the arrangement for the establishment of this Professorship, the Company had made gifts of stock in start-up companies to MIT. These gifts, together with the contribution of $700,000 in cash in 1993, which was expensed by the Company in 1993, were used to establish this named chair. During 1993, 1994 and 1995, the Company contributed to MIT securities which were applied to the MIT Pledge at their market value at the time the shares became publicly traded or otherwise monetized in a commercial transaction and were free from restriction as to sale by MIT. On December 31, 1998, the Company finalized the establishment of the Harris & Harris Group Senior Professorship by making the final payment of $728,862 due on the pledge. 39 In June 1997, the Company agreed to provide one of its investee companies with a $450,000 revolving line of credit, of which $50,000 had been used through December 31, 1997. During 1998, through September 30, 1998, the investee company borrowed an additional $250,000 which was repaid in the fourth quarter of 1998. In December 1997, the Company signed a Demand Promissory Note for a $4,000,000 line of credit with J.P. Morgan collateralized by the Company's U.S. Treasury obligations. In March 1998, the line of credit was increased to $6,000,000. As of December 31, 1997, the Company had borrowed $4,000,000 against the line of credit. From December 31, 1997 to January 2, 1998, the rate on the line of credit was prime (8.5 percent). From January 2, 1998 to April 2, 1998, the interest rate on the line of credit was LIBOR plus 1.5 percent (7.3125 percent). In March 1998, the Company paid down $2,500,000; in April 1998, the Company paid the remaining balance and did not draw against the line for the remainder of the year. This Demand Promissory Note for a line of credit is no longer available to the Company. The Company had a total of $1,475,276 of funds in escrow as a result of the acquisition of NBX Corporation by 3Com Corporation. The funds were in a one-year interest-bearing escrow account for the benefit of the Company, subject to any 3Com Corporation warranty claims associated with its acquisition of NBX Corporation. The Company set up a reserve of 10 percent for any potential claims, therefore the funds in escrow account reflected $1,327,748 net of the reserve of $147,528. The Company received the full escrow monies including interest for a total of $1,541,136 on March 6, 2000. NOTE 8.8 SUBSEQUENT EVENTS On February 22, 1999, NBX CorporationJanuary 5, 2000, the Company announced that it had agreedpurchased for $1,000,000 approximately a 15 percent equity interest in MyPersonalAdvocate.com, Inc., a business-to-business e-commerce and e-services trust-based marketing start-up. On January 13, 2000 the Company announced that it would discontinue the operations of, and liquidate, Adaptive Web Technologies, Inc. Adaptive was founded in late 1999, with $1,000,000 in funding from the Company. Because Adaptive was able to determine early in the process of research and analysis not to proceed with the development and commercialization effort, the Company anticipates that the amount of money expended to date by Adaptive is unlikely to prove to be acquired by 3Commaterial and that it will recapture most of its $1,000,000 investment in Adaptive. On January 20, 2000, the Company invested $500,000 in iPacer Corporation, an Internet technology startup, in the form of a six percent Convertible Promissory Note, maturing on March 31, 2000. On January 27, 2000, the Company announced that it had placed privately, with an unaffiliated investor, for approximately $90$3 million in cash, plusa one-year 12 percent note with one-year warrants to purchase 25,263 shares of the Company's common stock at $11.8750 per share. The note may be prepaid at any time. Unless the note is prepaid, six months after its issuance, the investor will receive additional considerationone-year warrants to purchase an additional $300,000 worth of the Company's common stock at the then-current market price. On February 28, 2000, the Company announced its intent to pre-pay the Note from the proceeds 50 of its sale of 43,400 shares of SciQuest.com, Inc. common stock (NASDAQ: SQST) at $77.2264 per share on February 25, 2000. The Company continues to hold 417,639 shares of SciQuest.com common stock. Because the Company intends to use most of the proceeds of the SciQuest.com sale to pre-pay indebtedness, most or all of the realized long-term capital gains from this sale, approximately $3.3 million, will be retained by the Company and will not be distributed to shareholders as a cash dividend. On February 7, 2000, the Company announced that Kana Communications, Inc. and Silknet Software, Inc. had signed a merger agreement, whereby each of the Company's Silknet shares would be exchanged tax free for employees0.83 Kana Communications shares. There can be no assurance that the merger will be consummated. On February 9, 2000, the Company announced that it had exercised a warrant to purchase 200,000 common shares of NBX. This transactionAlliance Pharmaceutical Corp. for $490,000. The exercise price was effective on March 5, 1999$2.45 per share, and closed onthe warrant had an expiration date of May 20, 2004. The Company also converted its $1,200,000 note due May 20, 2002 into 600,000 shares of Alliance Pharmaceutical. The conversion price was $2.00 per share. The Company now owns 800,000 common shares of Alliance Pharmaceutical. These shares are currently restricted under Rule 144. On March 8, 1999. On closing,2000, the Company receivedincreased its investment in Sundial Marketplace Corporation by purchasing from Sundial a $150,000 note with equity features under certain circumstances. Thus, the Company has now invested a total of $12,432,940$900,000 in cash, of which $1,475,276 was placed in a one-year escrow.Sundial. On February 23, 1999, the Board of Directors ofMarch 14, 2000, the Company declaredannounced that it had invested an additional $500,000 in Genomica Corporation as part of a cash dividend$15,000,000 private placement of $0.35 per share (approximately $3.7 million) to shareholders of record on March 19, 1999, payable on March 25, 1999.Genomica's Series C convertible preferred stock. Including this new investment, the Company owns approximately a 3.4 percent fully diluted interest in Genomica. On March 18, 1999,15, 2000, Genomica filed an S-1 registration statement with the Company invested $1,000,000 in the equity of a privately held medical device company with a patented product addressing a very large potential market. At this writing, the Company is still under non-disclosure with respect to the identity of this company. But this investment is the Company's first private equity commitment of part of the proceeds from the capital gains generated by the sale of NBX. 40Securities and Exchange Commission. 51
SELECTED PER SHARE DATA AND RATIOS Per share operating performance: Year Ended Year Ended Year Ended Year Ended Year Ended December December December December DecemberDec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 1999 1998 31, 1997 31, 1996 31, 1995 31, 1994 Net asset value, beginning of period $ 3.15 $ 3.44 $ 3.54 $ 3.43 $ 3.66 Net operating loss (0.26) (0.14) (0.12) (0.11) (0.25) Net realized (loss) gain on investments (0.16) (0.19) (0.24) 0.14 0.01 Net increase (decrease) in unrealized appreciation as a result of sales 0.11 (0.17) 0.16 (0.01) (0.11) Net increase in unrealized appreciation on investments held 0.05 0.26 0.13 0.03 0.01 Net decrease as a result of dividend (0.75) -- -- -- -- Net (decrease) increase from capital stock transactions (0.01) (0.05) (0.03) 0.06 0.11 ----------- ------------ ---------- ----------- --------- Net asset value, end of period $ 2.13 $ 3.15 $ 3.44 $ 3.54 $ 3.43 =========== ===========Net operating loss (1.04) (0.26) (0.14) (0.12) (0.11) Net realized (loss) gain on investments 0.93 (0.16) (0.19) (0.24) 0.14 Net (decrease) increase in unrealized appreciation as a result of sales (0.46) 0.11 (0.17) 0.16 (0.01) Net increase in unrealized appreciation on investments held 4.58 0.05 0.26 0.13 0.03 Net decrease as a result of dividend (0.35) (0.75) 0.0 0.0 0.0 Net increase (decrease) from capital stock transactions 0.01 (0.01) (0.05) (0.03) 0.06 ---------- ----------- ---------- ---------- ---------- Net asset value, end of period* $ 5.80 $ 2.13 $ 3.15 $ 3.44 $ 3.54 ========= ========== ========== =================== ========== Dividends paid per share $ 0.35 $ 0.75 $ 0.00 $ 0.00 $ 0.00 Market value per share, end of period*period $ 11.50 $ 1.50 $ 3.50 $ 3.75 $ 7.875 $ 6.375 Deferred income tax per share $ 0.16 $ 0.09 $ 0.06 $ 0.21 $ 0.050 $ 0.030 Ratio of expenses to average net assets 34.08% 10.9% 9.1% 8.1% 8.3% 13.6% Ratio of net operating loss to average net assets (3.50)% (10.4)% (4.5)% (3.5)% (3.2)% (7.1)% Investment return based on: Stock price 666.7% (45.5)% (6.7)% (52.4)% 23.5% (22.7)% Net asset value (11.3)188.7% (8.3)% (8.4)% (2.8)% 3.2% (6.3)% Portfolio turnover 53.54% 19.71% 77.2% 51.3% 51.2% 136.4% Net assets, end of period $53,634,805 $22,556,709 $33,654,934 $35,932,603 $36,561,909 $31,310,802 Number of shares outstanding 9,240,831 10,591,232 10,692,971 10,442,682 10,333,902 9,136,747
*The marketnet asset value as of December 31, 19981999 reflects the decline in market pricenet asset value as a result of the $0.35 dividend paid in 1999 and $0.75 dividend paid on May 12,in 1998. The accompanying notes are an integral part of this schedule. 4152 Item 9. Disagreements on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Company The information set forth under the captions "Election of Directors" on page 2, "Executive Officers" on page 8 and "Section 16(a) Beneficial Ownership Reporting Compliance" on page 1315 in the Company's Proxy Statement for Annual Meeting of Shareholders to be held April 28, 1999,26, 2000, filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 on or about March 24, 19992000 (the "1999"2000 Proxy Statement") is herein incorporated by reference. Item 11. Executive Compensation The information set forth under the captions "Summary Compensation Table" on pages 9 and 10 and "Compensation of Directors" on page 1214 in the 19992000 Proxy Statement is herein incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information set forth under the caption "Security Ownership of Directors and Executive Officers and other principal holders of the Company's voting securities" on page 7 in the 19992000 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, 1998. 421999. 53 PART IV Item 14. Exhibits, Consolidated Financial Statements, Schedules and Reports on Form 8-K (a) The following documents are filed as a part of this report: (1) The following Consolidated Financial Statements of the Company are set forth under Item 8: Consolidated Statements of Assets and Liabilities as of December 31, 1999 and 1998 and 1997Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997 and 1996Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 and 1996Consolidated Statements of Changes in Net Assets for the years ended December 31, 1999, 1998 and 1997 and 1996Consolidated Schedule of Investments as of December 31, 19981999 Footnote to Consolidated Schedule of Investments Notes to Consolidated Financial Statements Selected Per Share Data and Ratios for the years ended December 31, 1999, 1998, 1997, 1996 1995 and 19941995 (2) Report of Independent Public Accountants. (3) The following exhibits are filed with this report or are incorporated herein by reference to a prior filing, in accordance with Rule 12b-32 under the Securities Exchange Act of 1934. (Asterisk denotes exhibits filed with this report.) 3.1(a) Restated Certificate of Incorporation of the Company, as amended, incorporated by reference to Exhibit 3.1 (a) to the Company's Form 10-K for the year ended December 31, 1995. 3.1(b) Restated By-laws of the Company, incorporated by reference to Exhibit 3.1(b) to the Company's Form 10-K for the year ended December 31, 1995 and the Company's Form 10-Q for the quarter ended September 30, 1998. 4.1 Specimen certificate of common stock certificate, incorporated by reference to Exhibit 4 to Company's Registration Statement on Form N-2 filed October 29, 1992. 9.1 Harris & Harris Group, Inc. Custodian Agreement with JP Morgan, incorporated by reference to Exhibit 9.1 to the Company's Form 10-K for the year ended December 31, 1995. 10.1 Amended and Restated Employment Agreement between Harris & Harris Group, Inc. and Charles E. Harris dated January 1, 1998. 10.5 Severance Compensation Agreement by and between the Company and Charles E. Harris dated August 15, 1990, incorporated by reference to exhibit 10(s)10 (s) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990. 54 10.13 Stock Purchase Agreement, Standstill Agreement and Termination and Release by and among Harris & Harris Group, Inc. and American Bankers Life Assurance Company of Florida dated May 18, 1995, incorporated by reference to Exhibit 10.13 to the Company's Form 10-K for the year ended December 31, 1995. 10.14 Form of Indemnification Agreement which has been established with all directors and executive officers of the Company, incorporated by reference to Exhibit 10.14 to the Company's Form 10-K for the year ended December 31, 1995. 10.16 Demand Promissory Note, Corporate Certificate-Borrowing, Statement of Purpose for an Extension of Credit Secured by Margin Stock by and among Harris & Harris Group, Inc. and J.P. Morgan. 10.17 Harris & Harris Group, Inc. Employee Profit Sharing Plan, incorporated by reference as Exhibit (c) to the Company's Form 8-K filed June 15, 1998. 10.18 Employment Agreement Between Harris & Harris Group, Inc. and Charles E. Harris, dated October 19, 1999, incorporated by reference as Exhibit (C) to the Company's Form 8-K filed on October 27, 1999. 10.19* Deferred Compensation Agreement Between Harris & Harris Group, Inc. and Charles E. Harris. 10.20* Trust Under Harris & Harris Group, Inc. Deferred Compensation Agreement. 10.21* Note due January 26, 2001; Form of Warrant to Purchase 25,263 Shares of Harris & Harris Group, Inc. common stock. 10.22* Harris & Harris Group, Inc. Employee Profit-Sharing Plan. 11.0* Computation of Per Share Earnings is set forth under Item 8. 23* Consent of Arthur Andersen LLP. 27.0* Financial Data Schedule. (b) Reports on Form 8-K. TheOn October 27, 1999, the Company did not file any reports onfiled a Form 8-K duringto disclose the last quarterEmployment Agreement between Charles E. Harris, Chief Executive Officer of 1998. 44Harris & Harris Group, Inc. and Harris & Harris Group, Inc. *Exhibits attached. 55 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HARRIS & HARRIS GROUP, INC. Date: March 19, 199921, 2000 By:/s/ ------------------------ /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 19, 199921, 2000 - -------------------------------------------- Chief Compliance Officer and Charles E. Harris Chief Executive Officer /s/ Mel P. Melsheimer President, Chief Operating March 19, 199921, 2000 - -------------------------------------------- Officer and Chief Financial Officer Mel P. Melsheimer Officer /s/ Rachel M. Pernia Vice President, Controller, March 19, 199921, 2000 - --------------------------------------------- Treasurer and Principal Rachel M. Pernia Accounting Officer 4556 /s/ C. Wayne Bardin Director March 20, 19992000 - ------------------------------------------- C. Wayne Bardin /s/ Phillip A. Bauman Director March 18, 19992000 - -------------------------------------------- Phillip A. Bauman /s/ G. Morgan Browne Director March 18, 199917, 2000 - -------------------------------------------- G. Morgan Browne /s/ Harry E. Ekblom Director March 19, 199918, 2000 - -------------------------------------------- Harry E. Ekblom /s/ Dugald A. Fletcher Director March 19, 199917, 2000 - --------------------------------------------- Dugald A. Fletcher /s/ Glenn E. Mayer Director March 18, 199917, 2000 - ----------------------- Glenn E. Mayer /s/ James E. Roberts Director March 19, 1999 - ----------------------- William R. Polk /s/ Director March 18, 199917, 2000 - ----------------------- James E. Roberts 4657 EXHIBIT INDEX The following exhibits are filed with this report in accordance with Rule 12b-32 under the Securities Exchange Act of 1934. Exhibit No. Description 10.19 Deferred Compensation Agreement Between Harris & Harris Group, Inc. and Charles E. Harris. 10.20 Trust Under Harris & Harris Group, Inc. Deferred Compensation Agreement. 10.21 Note due January 26, 2001; Form of Warrant to Purchase 25,263 Shares of Harris & Harris Group, Inc. common stock. 10.22 Harris & Harris Group, Inc. Employee Profit-Sharing Plan. 11.0 Computation of Per Share Earnings is set forth under Item 8. 23 Consent of Arthur Andersen LLP. 27.0 Financial Data Schedule. 47