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Venture Capital for Tiny Technology

 

THIRD QUARTER REPORT 2005

 

FELLOW SHAREHOLDERS:

 

During the quarter ended September 30, 2005, we sold 3,507,500 shares of our common stock at $11.25 per share, for net proceeds of $36,526,567 after underwriting discounts and expenses. This stock offering was co-managed by ThinkEquity Partners LLC and Punk, Ziegel & Company. Primarily as a result of this successful stock offering and continued appreciation of the stock of NeuroMetrix, Inc. (Nasdaq: NURO), of which we own 1,137,570 shares, our net assets rose during the quarter from $79,513,203 to $123,376,692, and our net asset value per share rose from $4.61 to $5.94.

 

Our pace of investment in tiny technology has accelerated, in concert with increases in our capital, deal flow and investment team. From August of 2001 to the date of this Letter to Shareholders, we have invested cumulatively approximately $41,270,912 in tiny technology. Of this cumulative investment in tiny technology, we have invested approximately $15,887,078 in 2005 to date. We hold pre-emptive rights to invest in future rounds of financing by our privately held portfolio companies, and we enjoy a robust deal flow. Thus, we anticipate that not only will we have ample opportunities to put our existing liquidity to work in tiny technology, but also that we will have to generate internally and/or raise externally additional capital to take full advantage of our investment opportunities.

 


As we trace the cumulative cost of our tiny technology investments since August of 2001, and we fit exponential and power law equations to this cumulative cost and use these equations to extrapolate our hypothetical cumulative investments in tiny technology, we see that we would have to invest cumulatively approximately another $200 to $700 million to stay on this curve for the next five years.

We suspect that it may be necessary for us to put to work that sort of capital in order to maintain our leadership position amongst venture capital investors in nanotechnology. There is only one other venture capital firm, Draper Fisher Jurvetson, that we can identify as having made approximately as many investments as we have in companies that one might label as nanotechnology-enabled companies.

 

Assuming that we continue to enjoy a robust deal flow, one of the biggest questions that we put to ourselves internally is, how will we finance our future investments? If we can earn high enough net returns on our existing investments, we could continue to finance our new investments in part by selling more shares of our own common stock from time to time and still produce an attractive rate of growth in our net asset value per share. But the optimal rate of growth in our net asset value per share would be produced if we could finance entirely through retained earnings continued rapid growth in our cumulative investment in tiny technology.

 

To achieve entirely self-financed rapid growth, we would need to experience some timely combination of acquisitions and initial public offerings of companies in our portfolio. For example, when we decide to sell our shares of NeuroMetrix, if we decide not to distribute the capital gains to shareholders, we will pay federal income taxes at the corporate rate of 35 percent on the long-term capital gains and retain the net after-tax proceeds of the sales. (At its current price of $35.66 per share as of November 11, 2005, our holding in NeuroMetrix has a market value of $40,565,746, versus our cost of $4,411,374.) When we retain rather than distribute our capital gains, so long as we continue to qualify for tax purposes as a regulated investment company under Subchapter M, our shareholders also receive cash flow from the net tax credits that you are eligible to receive as a result of our paying, in effect, taxes on your behalf. (Please see pages 12-15 of our 2004 Annual Report on Form 10-K for detail.)

 

If our retained earnings do not prove sufficient to finance the investments that we need to make in order to maintain our leadership position in venture capital for nanotechnology, we will however seek outside capital as we deem appropriate. We think that it is even more important to try to maintain our leadership position than it is to finance all of our growth internally, if we are forced to choose between these two alternatives.

 

As always, we are appreciative that, just as we are risk seeking but patient investors, so are our shareholders. We hope that all of our shareholders are ever-mindful of the many risks of our business. Early stage venture capital is risky in general; investing in advanced technology is risky in particular; and, all else being equal, small capitalization, publicly held companies like Harris & Harris Group are riskier than large capitalization publicly held companies.

Charles E. Harris Douglas W. Jamison

Chairman and Chief Executive Officer President and Chief Operating Officer

Managing Director Managing Director

Daniel V. Leff Alexei A. Andreev

Executive Vice President Executive Vice President

Managing Director Managing Director

 

November 18, 2005

 

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 September 30, 2005)

 

 

 

Shares/

 

 

 

 

Principal

Value

 

 

Investment

 

 

AlphaSimplex Group, LLC

 

 

 

 

      Limited Liability Company Interest

      --

$     125,000

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Crystal IS, Inc.

 

 

 

 

      Series A Convertible Preferred Stock

   274,100

       199,983

 

 

 

 

 

 

 

CSwitch, Inc.

 

 

 

 

      Series A Convertible Preferred Stock

1,000,000

    1,000,000

 

 

 

 

 

 

 

eLite Optoelectronics Inc.

 

 

 

 

      Series B Convertible Preferred Stock

1,861,504

    1,000,000

 

 

 

 

 

 

 

Experion Systems, Inc.

 

 

 

 

      Series A Convertible Preferred Stock

   187,500

                  0

 

 

      Series B Convertible Preferred Stock

     22,500

                  0

 

 

      Series C Convertible Preferred Stock

   222,184

                  0

 

 

      Series D Convertible Preferred Stock

     64,501

0

 

 

 

 

        0

 

 

Exponential Business Development Company

 

 

 

 

      Limited Partnership Interest

         --

                  0

 

 

 

 

 

 

 

Heartware, Inc.

 

 

 

 

      Series A-2 Non-Voting Preferred Stock

     47,620

                  0

 

 

 

 

 

 

 

Kereos, Inc.

 

 

 

 

      Series B Convertible Preferred Stock

   349,092

       960,000

 

 

 

 

 

 

 

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

 

 

 

 

    4,500,000

 

 

NanoGram Corporation

 

 

 

 

      Series I Convertible Preferred Stock

     63,210

         21,672

 

 

      Series II Convertible Preferred Stock

1,250,904

    1,000,723

 

 

 

 

   1,022,395

 

 

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

 

 

Nanopharma Corp.

 

 

 

 

      Series A Convertible Preferred Stock

   684,516

       136,903

 

 

      Secured Convertible Bridge Note with 25 % Warrants

$733,000

       733,000

 

 

 

 

       869,903

 

 

Nanosys, Inc.

 

 

 

 

      Series C Convertible Preferred Stock

   803,428

    1,500,000

 

 

 

 

 

 

 

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

 

 

NeuroMetrix, Inc.

 

 

 

 

      Common Stock

1,137,570

  33,865,459

 

 

 

 

 

 

 

Nextreme Thermal Solutions, Inc.

 

 

 

 

      Series A Convertible Preferred Stock

   500,000

       500,000

 

 

 

 

 

 

 

Optiva, Inc.

 

 

 

 

      Series C Convertible Preferred Stock

1,249,999

                  0

 

 

      Secured Convertible Bridge Note with 50% Preferred

      Stock Warrant coverage

 

 $150,000

 

         75,000

 

 

 

 

         75,000

 

 

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 11/16/05

       1,250

                  0

 

 

      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.

 

 

 

 

      Convertible Promissory Note

 $310,000

       310,000

 

 

 

 

 

 

 

Starfire Systems, Inc.

 

 

 

 

      Common Stock

   375,000

       150,000

 

 

      Series A-1 Convertible Preferred Stock

   600,000

       600,000

 

 

 

 

       750,000

 

 

Zia Laser, Inc.