Venture Capital for Tiny Technology

 

FIRST QUARTER REPORT 2006

 

FELLOW SHAREHOLDERS:

 

We have been investing quite actively in the year to date. During the first quarter ended March 31, 2006, we invested a total of $9,412,746 in privately held companies working at the nanoscale. Two of these investments were initial deals, in which our Company invested a total of $5,300,000. Two of these investments were follow-on deals, in which our Company invested a total of $4,112,764. Additionally, since the close of the first quarter, our Company has invested $4,809,950 in new and follow-on deals in companies working at the nanoscale. In summary, in 2006 to date, we have invested a total of $14,222,714 in tiny-technology companies, versus a total of $16,251,339 in all of 2005.

 

As the table below delineates, not only have we been investing in more tiny-technology companies, but also, as our net assets have increased, the average amount of our investments has been growing, and we have been able to act more frequently as a lead investor.

 

Investments in Tiny Technology Since 2001

(To Date)

2001 2002 2003 2004 2005 2006 Total

 

Dollar Investments in Tiny Technology $489,999 $6,240,118 $3,812,600 $14,926,749 $16,251,339 $14,222,714 $56,693,519

 

Number of New Investments 1 7 5 8 4 4 29

 

Number of Follow-On Investments 0 1 5 21 12 4 43

 

Average Dollar Amount - New $489,999 $784,303 $587,156 $921,050 $1,575,000 $2,387,637 NA

 

Average Dollar Amount - Follow On NA $750,000 $175,364 $359,921 $829,278 $1,168,042 NA

 

Number of Rounds Led 0 1 0 2 0 5 8

 

Net Assets at Year End $24,334,770 $27,256,046 $40,682,738 $74,744,749 $117,987,742 NA NA

 

As the table above also depicts, our tiny-technology portfolio is quite young. All but one of our tiny-technology investments, Questech Corporation, have been made since August of 2001. (We originally invested in Questech in 1994. Today, Questech is a nicely profitable, rapidly growing manufacturer of decorative tiles; its line of metal tiles is enabled by a patented microscale process.) We have held the other 25 tiny-technology investments still in our portfolio for slightly less than two years on average since our initial investments in them.

 

The future is almost always different from the past, and most of the investments that we have closed out were not in tiny technology. But for lack of better data, it is interesting to look back at the ages of our successful venture capital investments when we sold them. Altogether, we have completed 18 profitable venture capital investments, including four PIPES (private investments in public equities). As we currently have no PIPES in our portfolio, the more relevant data is the time between our initial investments in privately held companies and their completions of initial public offerings (IPOs) or acquisitions.

 

Historically, eight of our portfolio companies completed IPOs, including one that we eventually sold at a loss. Focusing just on the seven profitable IPOs, the average time that elapsed from our initial investment to IPO was 4.26 years. Focusing just on the seven successful non-PIPE investments in which our exit was an acquisition, the average time that elapsed from our initial investment to acquisition was 3.7 years.

 

The shortest time from initial investment to IPO was 1.39 years, in a low-tech company that was relatively mature at the time of our initial investment. Two other IPOs took place a little over three years after our initial investment. NeuroMetrix took the longest time from initial investment to IPO, a little over eight years. Six of the seven successful non-PIPE investments in which the exit was an acquisition took less than four years, with the shortest taking 2.59 years.

 

Thus, our portfolio of 25 tiny-technology investments made since August 2001 is on average roughly two years younger than the average age of our 14 successful non-PIPE private-equity investments when they either completed IPOs or were acquired. Only four of the 25 now in our portfolio are approximately four years old. Moreover, of the 31 investments in tiny-technology companies that we have made since August of 2001, we have realized losses so far on only four of them -- half of the eight initial investments that we made in 2001 and 2002. Of the 44 private-equity investments that we have sold, on an all-inclusive basis encompassing tiny and non-tiny technology and PIPES as well as investments in privately held companies, we lost money on 26 (59 percent) and made money on 18 (41 percent). We have many advantages now that we did not have in the past, including a much larger deal flow. As a result, our current portfolio may contain a lower percentage of money-losing investments than we have experienced in the past. But it is too early to know what our loss experience will be, and we certainly should expect to realize some more losses over time from our current portfolio.

 

If the future is anything like the past, a reasonable expectation for our current portfolio as it matures would be for it to exhibit the "J-curve" pattern common to early stage venture capital: i.e., more write downs and write offs followed by some successful exits through acquisitions and IPOs. Successful exits of course cannot be guaranteed. But the asymmetrical potential of early stage venture capital invested in companies with proprietary technology means that it does not take many winners to give a very satisfactory return on overall investment. Indeed, in the 44 deals that we have sold, we invested a total of $51,144,319 and received back a total of $143,614,382. (The average holding period on the 146 tranches of investments in these 44 deals was 2.85 years.)

 

The next few years should be eventful both for nanotechnology in general and for our current portfolio. Because it takes time to build up an inventory of companies that are mature enough to sell profitably through acquisitions and IPOs, it has not been a problem for us that the market for venture-backed IPOs has been very subdued since the crash of 2000. Our portfolio of tiny technology investments would not previously have been in a position to take full advantage of a robust IPO window. Moreover, the tepid IPO market has helped to keep the wholesale prices that we pay when we invest fairly reasonable. But, in time, we will need a reawakening IPO market.

 

An ideal scenario for us would be for some of our portfolio companies to be ready for IPOs at the same time that another robust market for venture-backed IPOs materialized. As always, we thank our fellow shareholders for your understanding of and patience with the cycles of venture capital and the capital markets and your continued support of our Company's endeavor to remain in the vanguard of venture capital for the commercialization of nanotechnology.

 

 

Charles E. Harris

Douglas W. Jamison

Daniel V. Leff

Alexei A. Andreev

Chairman and Chief Executive Officer

President and Chief Operating Officer

Executive Vice President

Executive Vice President

Managing Director

Managing Director

Managing Director

Managing Director

 

May 19, 2006

 

This letter may contain statements of a forward-looking nature relating to future events. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect the Company's current beliefs, and a number of important factors could cause actual results to differ materially from those expressed in this press release. Please see the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission, for a more detailed discussion of the risks and uncertainties associated with the Company's business, including but not limited to the risks and uncertainties associated with venture capital investing and other significant factors that could affect the Company's actual results. Except as otherwise required by Federal securities laws, Harris & Harris Group, Inc., undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. The reference to the website www.TinyTechVC.com has been provided as a convenience, and the information contained on such website is not incorporated by reference into this letter.


 



Unaudited Schedule of Investments*

 

(As of March 31, 2006)

 

 

Shares/

 

 

 

Principal

Value

 

Investment

 

AlphaSimplex Group, LLC

 

 

      Limited Liability Company Interest

      --

$        4,058

 

 

 

BridgeLux, Inc.

 

 

      Series B Convertible Preferred Stock

1,861,504

    1,000,000

 

 

 

Cambrios Technologies Corporation

 

 

      Series B Convertible Preferred Stock

1,294,025

    1,294,025

 

 

 

Chlorogen, Inc.

 

 

      Series A Convertible Preferred Stock

4,478,038

       785,000

      Series B Convertible Preferred Stock

2,077,930

       364,261

 

 

    1,149,261

Crystal IS, Inc.

 

 

      Series A Convertible Preferred Stock

   274,100

       199,983

 

 

 

CSwitch, Inc.

 

 

      Series A Convertible Preferred Stock

1,000,000

       500,000

      Series B Convertible Preferred Stock

5,700,000

    2,850,000

 

 

    3,350,000

 

 

 

Evolved Nanomaterial Sciences, Inc.

 

 

      Series A Convertible Preferred Stock

5,870,021

    2,800,000

 

 

 

Exponential Business Development Company

 

 

       Limited Partnership Interest

      --

                  0

 

 

 

Kereos, Inc.

 

 

      Series B Convertible Preferred Stock

   349,092

       960,000

 

 

 

Kovio, Inc.

 

 

      Series C Convertible Preferred Stock

2,500,000

    3,000,000

 

 

 

Mersana Therapeutics, Inc.

 

 

      Series A Convertible Preferred Stock

     68,452

       136,904

      Series B Convertible Preferred Stock

   616,500

    1,233,000

      Warrants at $2.00 expiring 10/21/10

     91,625

                  0

 

 

    1,369,904

Metabolon, Inc.

 

 

      Series B Convertible Preferred Stock

2,173,913

    2,500,000

 

 

 

Molecular Imprints, Inc.

 

 

      Series B Convertible Preferred Stock

1,333,333

    2,000,000

      Series C Convertible Preferred Stock

1,250,000

    2,500,000

      Warrants at $2.00 expiring 12/31/11

   125,000

                  0

 

 

    4,500,000

NanoGram Corporation

 

 

      Series I Convertible Preferred Stock

     63,210

         64,259

      Series II Convertible Preferred Stock

1,250,904

    1,271,670

      Series III Convertible Preferred Stock

1,242,144

   1,262,764

 

 

   2,598,693

Nanomix, Inc.

 

 

      Series C Convertible Preferred Stock

9,779,181

    2,500,000

 

 

 

NanoOpto Corporation

 

 

      Series A-1 Convertible Preferred Stock

   267,857

         32,490

      Series B Convertible Preferred Stock

3,819,935

    1,110,073

      Series C Convertible Preferred Stock

1,932,789

       842,503

      Warrants at $0.4359 expiring 03/15/10

   193,279

                  0

 

 

    1,985,066

Nanosys, Inc.

 

 

      Series C Convertible Preferred Stock

   803,428

    2,370,113

      Series D Convertible Preferred Stock

1,016,950

    3,000,003

 

 

   5,370,116

 

 

 

Nantero, Inc.

 

 

      Series A Convertible Preferred Stock

   345,070

    1,046,908

      Series B Convertible Preferred Stock

   207,051

       628,172

      Series C Convertible Preferred Stock

   188,315

       571,329

 

 

    2,246,409

NeoPhotonics Corporation

 

 

      Common Stock

   716,195

         67,736

      Series 1 Convertible Preferred Stock

1,831,256

    2,014,677

      Series 2 Convertible Preferred Stock

   741,898

       878,120

      Warrants at $0.15 expiring 01/26/10

     16,364

              164

      Warrants at $0.15 expiring 12/05/10

     14,063

              140

 

 

    2,960,837

Nextreme Thermal Solutions, Inc.

 

 

      Series A Convertible Preferred Stock

   500,000

       500,000

 

 

 

Polatis, Inc.

 

 

      Series A-1 Convertible Preferred Stock

     16,775

        47,828

      Series A-2 Convertible Preferred Stock

     71,611

      204,172

 

 

       252,000

Questech Corporation

 

 

      Common Stock

   646,954

       724,588

      Warrants at $1.50 expiring 08/03/06

       8,500

                  0

      Warrants at $1.50 expiring 11/21/07

       3,750

                  0

      Warrants at $1.50 expiring 11/19/08

       5,000

                  0

      Warrants at $1.50 expiring 11/19/09

       5,000

                  0

 

 

       724,588

Solazyme, Inc.

 

 

      Series A Convertible Preferred Stock

   988,204

       385,400

 

 

 

Starfire Systems, Inc.

 

 

      Common Stock

   375,000

       150,000

      Series A-1 Convertible Preferred Stock

   600,000

       600,000

 

 

       750,000

Zia Laser, Inc.

 

 

      Series C Convertible Preferred Stock

1,500,000

                  0

Total

 

$42,400,340

 


 

 



HARRIS & HARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES*

ASSETS

March 31, 2006 December 31, 2005

(Unaudited)

 

Investments, at value (Cost: $119,208,625 at 3/31/06, $134,026,747 at 12/31/05)...... $ 113,731,480 $ 129,438,197

Cash and cash equivalents................................................................................................ 4,470,822 1,213,289

Restricted funds............................................................................................................... 1,901,078 1,730,434

Receivable from portfolio company................................................................................ 0 75,000

Interest receivable........................................................................................................... 565,259 248,563

Prepaid expenses............................................................................................................. 452,030 2,993

Other assets.................................................................................................................... 218,654 229,644

Total assets................................................................................................................... $ 121,339,323 $ 132,938,120

 

 

LIABILITIES & NET ASSETS

 

Accounts payable and accrued liabilities........................................................................... $ 3,410,979 $ 3,174,183

Accrued profit sharing..................................................................................................... 210,786 2,107,858

Deferred rent.................................................................................................................. 29,302 31,003

Current taxes payable...................................................................................................... 1,354,504 1,514,967

Taxes payable on behalf of shareholders......................................................................... 0 8,122,367

Total liabilities............................................................................................................ 5,005,571 14,950,378

 

 

Net assets...................................................................................................................... $ 116,333,752 $ 117,987,742

 

 

Net assets are comprised of:

Preferred stock, $0.10 par value, 2,000,000 shares authorized; none issued..................... $ 0 $ 0

Common stock, $0.01 par value, 30,000,000 shares authorized; 22,585,085 issued

at 3/31/06 and 12/31/05.......................................................................................... 225,851 225,851

Additional paid in capital................................................................................................ 122,149,642 122,149,642

Accumulated net realized income.................................................................................... 3,016,509 3,781,905

Accumulated unrealized depreciation of investments....................................................... (5,652,719) (4,764,125)

Treasury stock, at cost (1,828,740 shares at 3/31/06 and 12/31/05)............................... (3,405,531) (3,405,531)

 

Net assets...................................................................................................................... $ 116,333,752 $ 117,987,742

 

Shares outstanding..................................................................................................... 20,756,345 20,756,345

 

Net asset value per outstanding share...................................................................... $ 5.60 $ 5.68

 

 

 


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