Item 1. Business.
Business. Established in 1983 as an outgrowth of an on-line accounting and bankcard data processing system developed for Columbus Bank and Trust Company(R), Total System Services, Inc.(sm) ("TSYS(R)") is now one of the world's largest credit, debit and private-label card processing companies. Based in Columbus, Georgia, and traded on the New York Stock Exchange under the symbol "TSS," TSYS provides a comprehensive on-line system of data processing services marketed as THE TOTAL SYSTEM(sm), servicing issuing and acquiring institutions throughout the United States, Puerto Rico, Canada and Mexico, representing more than 63 million cardholder and over 600,000 merchant accounts. TSYS provides card production, domestic and international clearing, statement preparation, customer service support, merchant accounting, merchant services and management support. Synovus Financial Corp.(R), a $7.9 billion asset, multi-financial services company, owns 80.8 percent of TSYS.
TSYS has four wholly-owned subsidiaries: (1) Columbus Depot Equipment Company(sm) ("CDEC(sm)"), which sells and leases computer related equipment associated with TSYS' bankcard data processing services and bank data processing services provided by an affiliate; (2) Mailtek, Inc.(sm) ("Mailtek"), which provides full-service direct mail production services and offers data processing, list management, laser printing, computer output microfiche, card embossing, encoding and mailing services; (3) Lincoln Marketing, Inc.(sm) ("LMI"), which provides correspondence, fulfillment, telemarketing, data processing and mailing services; and (4) Columbus Productions, Inc.(sm) ("CPI"), which provides full-service commercial printing and related services. TSYS also holds a 49% equity interest in a Mexican company named Total System Services de Mexico, S.A. de C.V.("TSM"), which provides credit card related processing services to Mexican banks.
Service Marks. TSYS owns a family of service marks containing the name Total System, and the federally registered service marks TSYS and TS2, to which TSYS believes strong customer identification attaches. TSYS also owns service marks associated with its subsidiaries. Management does not believe the loss of such marks would have a material impact on the business of TSYS.
Major Customers. A significant amount of TSYS' revenues are derived from certain major customers who are processed under long-term contracts. For the year ended December 31, 1995, AT&T Universal Card Services Corp. and NationsBank accounted for 21.4% and 12.4%, respectively, of TSYS' total revenues. As a result, the loss of one of TSYS' major customers could have a material adverse effect on TSYS' results of operations.
- ------------------------------------ Synovus Financial Corp., Synovus, Columbus Bank and Trust Company and CB&T are federally registered service marks of Synovus Financial Corp. Total System Services, Inc., "THE TOTAL SYSTEM," Columbus Depot Equipment Company, CDEC, Lincoln Marketing, Inc., Mailtek, Inc. and Columbus Productions, Inc. are service marks of Total System Services, Inc. TSYS and TS2 are federally registered service marks of Total System Services, Inc.
Competition. TSYS encounters vigorous competition in providing bankcard data processing services from several different sources. The national market in third party bankcard data processors is presently being provided by approximately five vendors. TSYS believes that it is the second largest third party bankcard processor in the United States. In addition, TSYS competes against software vendors which provide their products to institutions which process in-house. TSYS is presently encountering, and in the future anticipates continuing to encounter, substantial competition from bankcard associations, data processing and bankcard computer service firms and other such third party vendors located throughout the United States.
TSYS' major competitor in the bankcard data processing industry is First Data Resources, Inc., a wholly-owned subsidiary of First Data Corporation, which is headquartered in Omaha, Nebraska, and provides bankcard data processing services, including authorization and data entry services. The principal methods of competition between TSYS and First Data Resources are price and the type and quality of services provided. In addition, there are a number of other companies which have the necessary financial resources and the technological ability to develop or acquire products and, in the future, to provide services similar to those being offered by TSYS.
Regulation and Examination. TSYS is subject to being examined, and is indirectly regulated, by the Office of the Comptroller of the Currency, the Federal Reserve Board ("Board"), the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the National Credit Union Administration, and the various state financial regulatory agencies which supervise and regulate the banks, savings institutions and credit unions for which TSYS provides bankcard data processing services. Matters reviewed and examined by these federal and state financial institution regulatory agencies have included TSYS' internal controls in connection with its present performance of bankcard data processing services, and the agreements pursuant to which TSYS provides such services.
On January 4, 1990, the Federal Reserve Bank of Atlanta approved Synovus' indirect retention of its ownership of TSYS through Columbus Bank and Trust Company ("CB&T") and TSYS is now subject to direct regulation by the Board. TSYS was formed with the prior written approval of, and is subject to regulation and examination by, the Department of Banking and Finance of the State of Georgia as a subsidiary of CB&T and is authorized to engage in only those activities which CB&T itself is authorized to engage in directly, which includes the bankcard and other data processing services presently being provided by TSYS. As TSYS and its subsidiaries operate as subsidiaries of CB&T, they are subject to regulation by the Federal Deposit Insurance Corporation.
Employees. On December 31, 1995, TSYS had 2,269 full-time employees.
See the "Financial Review" Section on pages 18 through 25 and Note 1, Note 4 and Note 9 of Notes to Consolidated Financial Statements on pages 30 through 32, 33 and 34, and 37 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.
Item 2.

Item 2. Properties.
TSYS owns its 73,000 square foot South Center located at 1000 Fifth Avenue, Columbus, Georgia 31901, and owns its 60,000 square foot Annex Building located at 420 10th Street, Columbus, Georgia 31901. TSYS also owns a warehouse facility, various other tracts of real estate located near or adjacent to its South Center and Annex Building which are used for parking and/or future expansion needs, and leases additional office space in Columbus, Georgia, Atlanta, Georgia, and Jacksonville, Florida.
The approximately 32,000 square foot Columbus Depot, located at 1200 Sixth Avenue, Columbus, Georgia 31901, which is owned by TSYS and is on the National Register of Historic Places, houses TSYS' executive offices and several corporate divisions.
TSYS also owns a 210,000 square foot production center which is located on a 40.4 acre tract of land in north Columbus, Georgia. Primarily a production center, this facility houses TSYS' primary data processing computer operations, statement preparation, mail handling, microfiche production and purchasing, as well as other related operations.
TSM owns a 52,000 square foot structure in Toluca, Mexico which has offices, a communication node and facilities for statement production, report printing and card embossing.
During 1995, TSYS purchased a 110,000 square foot building on a 23-acre site in Columbus, Georgia, to accommodate current and future office space needs.
On March 7, 1996, TSYS announced its plans to purchase approximately 50 acres in downtown Columbus, Georgia, on which it will begin building a campus-like complex for its corporate headquarters in early 1997.
All properties owned and leased by TSYS are in good repair and suitable condition for the purposes for which they are used.
In addition to its real property, TSYS owns and/or leases a substantial amount of computer equipment.
See Note 1, Note 2, Note 3, Note 5 and Note 9 of Notes to Consolidated Financial Statements on pages 30 through 32, pages 33 and 34, and page 37 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.
Item 3.

Item 3. Legal Proceedings.
See Note 9 of Notes to Consolidated Financial Statements on page 37 of TSYS' Annual Report to Shareholders which is specifically incorporated herein by reference.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The "Quarterly Financial Data, Stock Price, Dividend Information" Section which is set forth on page 39 of TSYS' 1995 Annual Report to Shareholders is specifically incorporated herein by reference.
Item 6.

Item 6. Selected Financial Data.
The "Selected Financial Data" Section which is set forth on page 17 of TSYS' 1995 Annual Report to Shareholders is specifically incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The "Financial Review" Section which is set forth on pages 18 through 25 of TSYS' 1995 Annual Report to Shareholders, which includes the information encompassed within "Management's Discussion and Analysis of Financial Condition and Results of Operations," is specifically incorporated herein by reference.
Item 8.

Item 8. Financial Statements and Supplementary Data.
The "Quarterly Financial Data, Stock Price, Dividend Information" Section, which is set forth on page 39, and the "Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Shareholders' Equity, Consolidated Statements of Cash Flows, Notes to Consolidated Financial Statements and Report of Independent Auditors" Sections, which are set forth on pages 26 through 38 of TSYS' 1995 Annual Report to Shareholders are specifically incorporated herein by reference.
Item 9.

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
The "ELECTION OF DIRECTORS - Information Concerning Number and Classification of Directors and Nominees" Section which is set forth on pages 2 and 3, the "ELECTION OF DIRECTORS - Information Concerning Directors and Nominees for Class I Directors - General Information" Section which is set forth on pages 3 and 4, the "ELECTION OF DIRECTORS - Executive Officers" Section which is set forth on pages 6 and 7, and the "COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT" Section which is set forth on pages 19 and 20 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held
on April 15, 1996 are specifically incorporated herein by reference.
Item 11.

Item 11. Executive Compensation.
The "EXECUTIVE COMPENSATION - Summary Compensation Table; Stock Option Exercises and Grants; Compensation of Directors; Change in Control Arrangements; and Compensation Committee Interlocks and Insider Participation" Sections which are set forth on pages 9 through 12, and page 15 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
The "ELECTION OF DIRECTORS - Information Concerning Directors and Nominees for Class I Directors - TSYS Common Stock Ownership of Directors and Management" Section which is set forth on page 5, the "RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Beneficial Ownership of TSYS Common Stock by CB&T" Section which is set forth on page 16, and the "RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - - Synovus Common Stock Ownership of Directors and Management" Section which is set forth on pages 16 and 17 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.
Item 13.

Item 13. Certain Relationships and Related Transactions.
The "EXECUTIVE COMPENSATION - Compensation Committee Interlocks and Insider Participation" Section which is set forth on page 15, "EXECUTIVE COMPENSATION - Transactions with Management" Section which is set forth on pages 15 and 16, the "RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Beneficial Ownership of TSYS Common Stock by CB&T" Section which is set forth on page 16, the "RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES Interlocking Directorates of TSYS, Synovus and CB&T" Section which is set forth on page 16, and the "RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T, AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Bankcard Data Processing Services Provided to CB&T and Certain of Synovus' Subsidiaries; Other Agreements Between TSYS, Synovus, CB&T and Certain of Synovus' Subsidiaries" Section which is set forth on pages 18 and 19 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.
See also Note 2 and Note 5 of Notes to Consolidated Financial Statements on pages 32, and 33 and 34 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1. Financial Statements
The following Consolidated Financial Statements of TSYS are specifically incorporated by reference from pages 26 through 38 of TSYS' 1995 Annual Report to Shareholders to Item 8, Part II, Financial Statements and Supplementary Data.
Consolidated Balance Sheets - December 31, 1995 and 1994.
Consolidated Statements of Income - Years Ended December 31, 1995, 1994 and 1993.
Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1995, 1994 and 1993.
Consolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993.
Notes to Consolidated Financial Statements.
Report of Independent Auditors.
2. Index to Financial Statement Schedules
The following report of independent auditors and consolidated financial statement schedule of Total System Services, Inc. are included:
Report of Independent Auditors.
Schedule II - Valuation and Qualifying Accounts - Years Ended December 31, 1995, 1994 and 1993.
All other schedules are omitted because they are inapplicable or the required information is included in the Notes to Consolidated Financial Statements.
3. Exhibits
Exhibit Number Description
3.1 Articles of Incorporation of Total System Services, Inc. ("TSYS"), as amended, incorporated by reference to Exhibit 3.1 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1990, as filed with the Commission on March 19, 1991.
3.2 Bylaws of TSYS.
10. EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
10.1 Director Stock Purchase Plan of TSYS, incorporated by reference to Exhibit 10.1 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.2 Group "Y" Key Executive Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.2 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.3 1985 Key Employee Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.3 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.4 1990 Key Employee Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.4 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.5 Total System Services, Inc. 1992 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.5 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.6 Excess Benefit Agreement of TSYS, incorporated by reference to Exhibit 10.6 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.7 Wage Continuation Agreement of TSYS, incorporated by reference to Exhibit 10.7 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.8 Incentive Bonus Plan of Synovus Financial Corp. in which executive officers of TSYS participate, incorporated by reference to Exhibit 10.8 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.9 Agreement in connection with use of aircraft, incorporated
by reference to Exhibit 10.9 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.
10.10 Split Dollar Insurance Agreement of TSYS, incorporated by reference to Exhibit 10.10 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1993, as filed with the Commission on March 22, 1994.
10.11 Synovus Financial Corp. 1994 Long-Term Incentive Plan in which executive officers of TSYS participate, incorporated by reference to Exhibit 10.11 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as filed with the Commission on March 9, 1995.
10.12 Synovus Financial Corp. Executive Bonus Plan in which executive officers of TSYS participate.
10.13 Change of Control Agreements for executive officers of TSYS.
11.1 Statement re Computation of Per Share Earnings.
13.1 Certain specified pages of TSYS' 1995 Annual Report to Shareholders, which are specifically incorporated herein by reference.
20.1 Proxy Statement for the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996, certain pages of which are specifically incorporated herein by reference.
21.1 Subsidiaries of Total System Services, Inc.
23.1 Independent Auditors' Consent.
24.1 Powers of Attorney contained on the signature pages of the 1995 Annual Report on Form 10-K.
27.1 Financial Data Schedule (for SEC use only).
99.1 Annual Report on Form 11-K for the Total System Services, Inc. Employee Stock Purchase Plan for the year ended December 31, 1995 (to be filed as an amendment hereto within 120 days of the end of the period covered by this report.)
99.2 Annual Report on Form 11-K for the Total System Services,
Inc. Director Stock Purchase Plan for the year ended December 31, 1995 (to be filed as an amendment hereto within 120 days of the end of the period covered by this report.)
(b) Reports on Form 8-K
On October 20, 1995, TSYS filed a Form 8-K with the Commission in connection with the renewal of a long-term credit card processing contract with NationsBank.
filings\TSYS\TSYS96.10K
Report of Independent Auditors
The Board of Directors Total System Services, Inc.
Under date of January 26, 1996, we reported on the consolidated balance sheets of Total System Services, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the Total System Services, Inc. 1995 Annual Report to Shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the Total System Services, Inc. Annual Report on Form 10-K for the year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule in Item 14(a)2. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Atlanta, Georgia January 26, 1996
Total System Services, Inc. Schedule II Valuation and Qualifying Accounts
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, Total System Services, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC. (Registrant)
March 19, 1996 By:/s/ Richard W. Ussery --------------------- Richard W. Ussery, Chairman and Principal Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James H. Blanchard, Richard W. Ussery and Philip W. Tomlinson each of them, his true and lawful attorney(s)-in-fact and agent(s), with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this report and to file the same, with all exhibits and schedules thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney(s)-in-fact and agent(s) full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney(s)-in-fact and agent(s), or their substitute(s), may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated.
/s/James H. Blanchard Date: March 19, 1996 - ----------------------------------------------- James H. Blanchard, Director and Chairman of the Executive Committee
/s/Richard W. Ussery Date: March 19, 1996 - ----------------------------------------------- Richard W. Ussery, Chairman of the Board and Principal Executive Officer
/s/Philip W. Tomlinson Date: March 19, 1996 - ----------------------------------------------- Philip W. Tomlinson, President and Director
/s/James B. Lipham Date: March 19, 1996 - ----------------------------------------------- James B. Lipham, Executive Vice President, Treasurer, Principal Accounting and Financial Officer
/s/William A. Pruett Date: March 19, 1996 - ----------------------------------------------- William A. Pruett, Exective Vice President
/s/M. Troy Woods Date: March 19, 1996 - ----------------------------------------------- M. Troy Woods, Executive Vice President
/s/G. Sanders Griffith, III Date: March 19, 1996 - ----------------------------------------------- G. Sanders Griffith, III, General Counsel and Secretary
/s/Griffin B. Bell Date: March 19, 1996 - ----------------------------------------------- Griffin B. Bell, Director
/s/ Richard Y. Bradley Date: March 19, 1996 - ----------------------------------------------- Richard Y. Bradley, Director
/s/Salvador Diaz-Verson, Jr. Date: March 19, 1996 - ----------------------------------------------- Salvador Diaz-Verson, Jr., Director
/s/Kenneth E. Evans Date: March 19, 1996 - ----------------------------------------------- Kenneth E. Evans, Director
/s/Gardiner W. Garrard, Jr. Date: March 19, 1996 - ----------------------------------------------- Gardiner W. Garrard, Jr., Director
/s/ John P. Illges Date: March 19, 1996 - ----------------------------------------------- John P. Illges, III, Director
/s/Mason H. Lampton Date: March 19, 1996 - ----------------------------------------------- Mason H. Lampton, Director
/s/W. Walter Miller, Jr. Date: March 19, 1996 - ----------------------------------------------- W. Walter Miller, Jr., Director
/s/H. Lynn Page Date: March 19, 1996 - ----------------------------------------------- H. Lynn Page, Director
/s/William B. Turner Date: March 19, 1996 - ----------------------------------------------- William B. Turner, Director
/s/George C. Woodruff, Jr. Date: March 19, 1996 - ----------------------------------------------- George C. Woodruff, Jr., Director
/s/James D. Yancey Date: March 19, 1996 - ----------------------------------------------- James D. Yancey, Director


Item 1. Business.
(a) General Development of Business
AMERICAN INCOME 3 LIMITED PARTNERSHIP (the "Partnership") was organized as a limited partnership under the Massachusetts Uniform Limited Partnership Act (the "Uniform Act") on December 30, 1983 for the purpose of acquiring and leasing to third parties a diversified portfolio of capital equipment. Partners' capital initially consisted of contributions of $1,000 from the General Partner (AFG Leasing Associates) and $99 from the Initial Limited Partner. The sole General Partner of the Partnership is wholly-owned by American Finance Group ("AFG" or the "Manager") a Massachusetts partnership. On December 17, 1985, the Partnership issued 80,885 limited partnership units (the "Units") to 1,663 investors, including four Units purchased by the Initial Limited Partner. The General Partner contributed $50,000 in consideration of its general partner interest.
(b) Financial Information About Industry Segments
The Partnership was engaged in only one industry segment: the business of acquiring capital equipment and leasing the equipment to creditworthy lessees on a full payout or operating lease basis. (Full payout leases are those in which aggregate noncancellable rents equal or exceed the Purchase Price of the leased equipment. Operating leases are those in which the aggregate noncancellable rental payments are less than the Purchase Price of the leased equipment.) Industry segment data is not applicable.
(c) Narrative Description of Business
The Partnership was organized to acquire a diversified portfolio of capital equipment subject to various full payout and operating leases and to lease the equipment to third parties as income-producing investments. More specifically, the Partnership's primary investment objectives were to acquire and lease equipment which would:
1. Generate quarterly cash distributions; and
2. Maintain substantial residual value for ultimate sale.
The Partnership has the additional objective of providing certain federal income tax benefits.
The Closing Date of the Offering of Units of the Partnership was December 17, 1985. The initial purchase of equipment and the associated lease commitments occurred on December 17, 1985. The Partnership completed the disposition of its equipment portfolio in 1994 and dissolution of the Partnership occurred on December 29, 1995.
The Partnership had no employees; however, it entered into a Management Agreement with the Manager coincident with the commencement of operations. The Manager's role, among other things, was to (i) evaluate, select, negotiate, and consummate the acquisition of equipment, (ii) manage the leasing, re-leasing, financing, and refinancing of equipment, and (iii) arrange the resale of equipment. The Manager was compensated for such services as described in the Partnership's Amended and Restated Agreement and Certificate of Limited Partnership (the "Restated Agreement, as amended"), Item 13, herein and in Note 4 to the financial statements, included in Item 14, herein.
The Partnership's investment in equipment was subject to various risks, including physical deterioration, technological obsolescence and defaults by lessees. A principal business risk of owning and leasing equipment is the possibility that aggregate lease revenue and equipment sale proceeds will be insufficient to provide an acceptable rate of return on invested capital after payment of all debt service costs and operating expenses. Consequently, the success of the Partnership was largely dependent upon the ability of the General Partner and its Affiliates to forecast technological advances, the ability of the lessees to fulfill their lease obligations and the quality and marketability of the equipment at the time of sale. Revenue from major individual lessees which accounted for 10% or more of lease revenue during the years ended December 31, 1995, 1994 and 1993 is incorporated herein by reference to Note 2 to the financial statements in the 1995 Annual Report. Refer to Item 14(a)(3) for lease agreements filed with the Securities and Exchange Commission.
AFG is a successor to the business of American Finance Group, Inc., a Massachusetts corporation engaged since its inception in 1980 in various aspects of the equipment leasing business. In 1990, certain members of AFG's management, principally Geoffrey A. MacDonald, Chief Executive Officer and co-founder of AFG, established AFG Holdings (Massachusetts) Limited Partnership ("Holdings Massachusetts") to acquire ownership and control of AFG. Holdings Massachusetts effected this event by acquiring all of the equity interests of AFG's two partners, AFG Holdings Illinois Limited Partnership ("Holdings Illinois") and AFG Corporation. Holdings Massachusetts incurred significant indebtedness to finance this acquisition, a significant portion of which was scheduled to mature in 1995.
On December 16, 1994, the senior lender to Holdings Massachusetts (the "Senior Lender") assumed control of its security interests in Holdings Illinois and AFG Corporation and sold all such interests to GDE Acquisitions Limited Partnership, a Massachusetts limited partnership owned and controlled entirely by Gary D. Engle, President and member of the Executive Committee of AFG. As a result of this transaction, GDE Acquisitions Limited Partnership acquired all of the assets, rights and obligations of AFG from the Senior Lender and assumed control of AFG. Geoffrey A. MacDonald remains as Chief Executive Officer of AFG and member of its Executive Committee.
(d) Financial Information About Foreign and Domestic Operations and Export Sales
Not applicable.
Item 2.

Item 3. Legal Proceedings.
There are no material pending legal proceedings to which the Partnership is a party or which involve any of its equipment or leases.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.

Item 5. Market for the Partnership's Securities and Related Security Holder Matters.
(a) Market Information
There is no public market for the resale of the Units and it is not anticipated that a public market for resale of the Units will develop.
(b) Approximate Number of Security Holders
At December 31, 1995, there were no recordholders of Units in the Partnership.
(c) Dividend History and Restrictions
Pursuant to Article VI of the Restated Agreement, as amended, the Partnership's Distributable Cash From Operations and Distributable Cash From Sales or Refinancings was determined and distributed to the Partners quarterly.
Distributions payable at December 31, 1994 were $204,255. There were no distributions payable at December 31, 1995.
"Distributable Cash From Operations" means the net cash provided by the Partnership's normal operations after general expenses and current liabilities of the Partnership are paid, reduced by any reserves for working capital and contingent liabilities to be funded from such cash, to the extent deemed reasonable by the General Partner, and increased by any portion of such reserves deemed by the General Partner not to be required for Partnership operations and reduced by all accrued and unpaid Equipment Management Fees and, after Payout, further reduced by all accrued and unpaid Subordinated Remarketing Fees. Distributable Cash From Operations does not include any Distributable Cash From Sales or Refinancings.
"Distributable Cash From Sales or Refinancings" means Cash From Sales or Refinancings as reduced by (i)(a) amounts realized from any loss or destruction of equipment which the General Partner determines shall be reinvested in similar equipment for the remainder of the original lease term of the lost or destroyed equipment, or in isolated instances, in other equipment, if the General Partner determines that investment of such proceeds will significantly improve the diversity of the Partnership's equipment portfolio, and subject in either case to satisfaction of all existing indebtedness secured by such equipment to the extent deemed necessary or appropriate by the General Partner, and (b) the proceeds from the sale of an interest in equipment pursuant to any agreement governing a joint venture which the General Partner determines will be invested in additional equipment or interests in equipment and which ultimately are so reinvested and (ii) any accrued and unpaid Equipment Management Fees and, after Payout, any accrued and unpaid Subordinated Remarketing Fees.
"Cash From Sales or Refinancings" means cash received by the Partnership from sale or refinancing transactions, as reduced by (i)(a) all debts and liabilities of the Partnership required to be paid as a result of sale or refinancing transactions, whether or not then due and payable (including any liabilities on an item of equipment sold which are not assumed by the buyer and any remarketing fees required to be paid to persons not affiliated with the General Partner, but not including any Subordinated Remarketing Fees whether or not then due and payable) and (b) any reserves for working capital and contingent liabilities funded from such cash to the extent deemed reasonable by the General Partner and (ii) increased by any portion of such reserves deemed by the General Partner not to be required for Partnership operations. In the event the Partnership accepts a note in connection with any sale or refinancing transaction, all payments subsequently received in cash by the Partnership with respect to such note shall be included in Cash From Sales or Refinancings, regardless of the treatment of such payments by the Partnership for tax or accounting purposes. If the Partnership receives purchase money obligations in payment for equipment sold, which are secured by liens on such equipment, the amount of such obligations shall not be included in Cash From Sales or Refinancings until the obligations are fully satisfied.
Each distribution of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings of the Partnership shall be made 99% to the Limited Partners and 1% to the General Partner before Payout and 85% to the Limited Partners and 15% to the General Partner after Payout.
"Payout" is defined as the first time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original capital contributions plus a cumulative annual return of 12% (compounded daily and calculated beginning with the last day of the month of the Partnership's Closing Date) on their aggregate unreturned capital contributions. For purposes of this definition, capital contributions shall be deemed to have been returned only to the extent that distributions of cash to the Limited Partners exceed the amount required to satisfy the cumulative annual return of 12% (compounded daily) on the Limited Partners' aggregate unreturned capital contributions, such calculation to be based on the aggregate unreturned capital contributions outstanding on the first day of each fiscal quarter. The Partnership did not achieve Payout.
Distributable Cash From Operations and Distributable Cash From Sales or Refinancings ("Distributions") were distributed within 60 days after the completion of each quarter, beginning with the first full fiscal quarter following the Partnership's Closing Date. The Partnership has distributed $21,002,832 to the Limited Partners and $212,150 to the General Partner since inception. Substantially all of the distributions to the Limited Partners represent a return of capital.
On October 31, 1995, the General Partner as trustee (the "Trustee") executed a Declaration of Trust establishing a Liquidating Trust (the "Trust") to satisfy any unforeseen expenses of the Partnership that may arise after the dissolution date as a result of the Partnership's equipment leasing activities. Organization of the Trust has the additional benefit of terminating the Partnership's income tax reporting obligations after 1995. The General Partner transferred $100,000 on September 29, 1995, representing a liquidating distribution, into a non-interest bearing custodian account (the "Account") of the Trust. The remainder of the Partnership's operating cash of $65,590 was transferred into the Trust Account on December 29, 1995. The transferred amount included $27,723 of accrued expenses which were paid in 1996. Amounts held in the Trust Account will be reserved for a period not to exceed seven years (or such shorter time as counsel for the Partnership advises will be sufficient to assure that all claims against the Partnership have been presented). To the extent that the balance of the Trust Account exceeds the ultimate liabilities of the Partnership, the General Partner will distribute such remaining balance to the beneficiaries of the Trust Account, which beneficiaries will consist of the General Partner and the Limited Partners in accordance with their respective percentage ownership interests in the Partnership as of the dissolution date.
Item 6.

Item 6. Selected Financial Data.
Incorporated herein by reference to the section entitled "Selected Financial Data" in the 1995 Annual Report.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Incorporated herein by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1995 Annual Report.
Item 8.

Item 8. Financial Statements and Supplementary Data.
Incorporated herein by reference to the financial statements and supplementary data included in the 1995 Annual Report.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Partnership.
(a-b) Identification of Directors and Executive Officers
The Partnership has no Directors or Officers. As indicated in Item 1 of this report, AFG Leasing Associates is the sole General Partner of the Partnership. Under the Restated Agreement, as amended, the General Partner is solely responsible for the operation of the Partnership's properties and the Limited Partners have no right to participate in the control of such operations. The names, titles and ages of the Directors and Executive Officers of the corporate General Partner of the General Partner as of March 15, 1996 were as follows:
(f) Involvement in Certain Legal Proceedings
None.
(g) Promoters and Control Persons
See Item 10 (a-b) above.
Item 11.

Item 11. Executive Compensation.
(a) Cash Compensation
Currently, the Partnership has no employees. However, under the terms of the Restated Agreement, as amended, the Partnership is obligated to pay all costs of personnel employed full or part-time by the Partnership, including officers or employees of the General Partner or its Affiliates. There is no plan at the present time to make any officers or employees of the General Partner or its Affiliates employees of the Partnership. The Partnership has not paid and does not propose to pay any options, warrants or rights to the officers or employees of the General Partner or its Affiliates.
(b) Compensation Pursuant to Plans
None.
(c) Other Compensation
Although the Partnership has no employees, as discussed in Item 11(a), pursuant to section 9.4 of the Restated Agreement, as amended, the Partnership incurred a monthly charge for personnel costs of the Manager for persons engaged in providing administrative services to the Partnership. A description of the remuneration paid by the Partnership to the Manager for such services is included in Item 13, herein and in Note 4 to the financial statements included in Item 14, herein.
(d) Compensation of Directors
None.
(e) Termination of Employment and Change of Control Arrangement
There exists no remuneration plan or arrangement with any partners of the General Partner or its Affiliates which results or may result from their resignation, retirement or any other termination.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
By virtue of its organization as a limited partnership, the Partnership has no outstanding securities possessing traditional voting rights. However, as provided in Section 11.2(a) of the Restated Agreement, as amended (subject to Sections 11.2(b) and 11.3), a majority interest of the Limited Partners have voting rights with respect to:
1. Amendment of the Restated Agreement;
2. Termination of the Partnership;
3. Removal of the General Partner; and
4. Approval or disapproval of the sale of all, or substantially all of the assets of the Partnership (except in the orderly liquidation of the Partnership upon its termination and dissolution).
The ownership and organization of AFG is described in Item 1 of this report.
Item 13.

Item 13. Certain Relationships and Related Transactions.
The General Partner of the Partnership is AFG Leasing Associates, an Affiliate of AFG.
(a) Transactions with Management and Others
All operating expenses incurred by the Partnership are paid by AFG on behalf of the Partnership and AFG is reimbursed at its actual cost for such expenditures. Fees and other costs incurred during each of the three years in the period ended December 31, 1995, which were paid or accrued by the Partnership to AFG or its Affiliates, are as follows:
As provided under the terms of the Management Agreement, AFG was compensated for its services to the Partnership. Such services included all aspects of acquisition and management of equipment. For acquisition services, AFG was compensated by an amount equal to 4.75% of Equipment Base Price paid by the Partnership. For management services, AFG was compensated by an amount equal to the lesser of (i) 5% of gross lease rental revenue or (ii) fees which the General Partner reasonably believed to be competitive for similar equipment. Both of these fees were subject to certain limitations defined in the Management Agreement. As Payout was not achieved, AFG received no compensation for services connected to the sale of equipment, under its subordinated remarketing agreement.
Interest expense - affiliate represents interest incurred on legal costs in connection with a state sales tax dispute involving certain equipment owned by the Partnership and other affiliated investment programs sponsored by AFG. Legal costs incurred by AFG to resolve this matter and the interest thereon was allocated to the Partnership and other affected investment programs. Administrative charges represent amounts owed to AFG, pursuant to Section 9.4 of the Restated Agreement as amended, for persons employed by AFG who are engaged in providing administrative services to the Partnership. Reimbursable operating expenses due to third parties represent costs paid by AFG on behalf of the Partnership which are reimbursed to AFG.
All equipment was acquired from AFG, one of its affiliates, including other equipment leasing programs sponsored by AFG, or from third-party sellers. The Partnership's Purchase Price was determined by the method described in Note 2, to the financial statements, included in Item 14, herein.
All rents and proceeds from the sale of equipment were paid directly to either AFG or to a lender. AFG temporarily deposited collected funds in a separate interest bearing escrow account prior to remittance to the Partnership.
(b) Certain Business Relationships
None.
(c) Indebtedness of Management to the Partnership
None.
(d) Transactions with Promoters
See Item 13(a) above.
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K) of American Income 3 Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to Partners of American Income 3 Limited Partnership.
ERNST & YOUNG LLP
Boston, Massachusetts March 12, 1996
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report has been sent to the Limited Partners. A report will be furnished to the Limited Partners subsequent to the date hereof.
No proxy statement has been or will be sent to the Limited Partners.


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, and expects to continue to invest, 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 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 buy-out 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 Registrant was incorporated under the laws of the State of New York in August 1981. Prior to September 30, 1992, the Company was registered and filed under the reporting requirements of the Securities and Exchange Act of 1934 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 business development company subject to the provision of Sections 55 through 65 of the 1940 Act, as amended by the Small Business Incentive Act of 1980. 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.
Venture Capital Investments
The Company has invested, and expects to continue to invest, 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 investment 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 also find it necessary or appropriate to provide additional capital of its own. 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 derive income from such companies for the performance of any of the above services. Because of the speculative 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 been and will continue to be risk seeking rather than risk averse in its approach to its venture capital and other investments.
The Company may control a 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 a company. Particularly during the early stages of an investment, the Company may in effect be conducting the operations of the 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 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 and expects to continue to invest 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.
The Company expects to make speculative investments that have limited marketability and a greater risk of investment loss than less speculative issues. The Company does not seek to invest in any particular industries or categories of investments.
Intellectual Property
The Company believes there is a role for organizations 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 to do.
The Company's form of investment may include: 1) funding of research and development in the development of a technology; 2) obtaining licensing rights to intellectual property or patents; 3) outright acquisition of intellectual property or patents; and 4) formation 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, fee income, or some other form of remuneration. At some point during the commercialization of a technology, the Company's investment may be transformed into ownership of securities of a development stage or start-up company as discussed above. Investing in intellectual property is highly risky.
Illiquidity of Investments
Many of the Company's investments consist of securities acquired directly from the issuer in private transactions. They 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 or investee registers its securities and becomes a reporting company under the Securities and Exchange Act of 1934, the Company may be considered an insider by virtue of its board representation and would be restricted in sales of such company's securities.
Managerial Assistance
The Registrant believes that providing managerial assistance to its investees is critical to its business development activities. "Making available significant managerial assistance" as defined in the 1940 Act with respect to a business development company such as the Registrant means (a) any arrangement whereby a business development company, 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 business development company of a controlling influence over the management or policies of a portfolio company by a business development company acting individually or as a part of a group acting together which controls such portfolio company. The Registrant is required by the 1940 Act to make significant managerial assistance available at least with respect to investee companies that the Registrant treats as qualifying assets for purposes of the 70% test (see "Regulation"). The nature, timing, and amount of managerial assistance provided by the Registrant vary depending upon the particular requirements of each investee company.
The Registrant 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 Registrant 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 of operations. The Registrant also seeks capital for its investees from other potential investors and occasionally subordinates its own investment to those of other investors. The Registrant introduces 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 Registrant also assists with joint ventures, acquisitions and mergers.
In connection with its managerial assistance, the Registrant 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 Registrant's role will become progressively less active. However, when the Registrant owns or on a pro forma basis could acquire a substantial proportion of a more mature investee company's equity, the Registrant remains active in and will frequently initiate planning of major transactions by the investee. The Registrant's goal is 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) in an 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 will have 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.
Competition
Numerous companies and individuals are engaged in the venture capital business and such business is intensely competitive. Most 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 modified the provisions of the 1940 Act that are applicable to a BDC. 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, as modified by the Small Business Investment Incentive Act of 1980, and as qualified in its entirety by the reference to the full text of the 1940 Act and the rules thereunder by the Securities and Exchange Commission (the "SEC").
Generally, to be eligible to elect BDC status, a company must primarily engage in the business of furnishing capital and managerial expertise to companies which do not have ready access to capital through conventional financial channels. Such portfolio companies are termed "eligible portfolio companies." More specifically, in order to qualify as a BDC, a company must (i) be a domestic company, (ii) have registered a class of its securities or have filed a registration statement with the SEC pursuant to Section 12 of the Exchange Act of 1934; (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) extend significant managerial assistance to such portfolio companies; (v) have a majority of "disinterested" directors (as defined in the 1940 Act); and (vi) file (or, under certain circumstances, intend to 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 securities registered on an exchange or included in the Federal Reserve Board's over-the- counter margin list; (ii) is actively controlled by a BDC and has an affiliate of a BDC on its board of directors; or (iii) meets such other criteria as may be established by the SEC. Control under the 1940 Act is presumed to exist where a BDC owns 25% of the outstanding 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 limits the type of certain assets necessary for its operations (such as office furniture, equipment and facilities) if, at the time of acquisition, less than 70% 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 such company acquired their securities; (ii) securities of bankrupt or insolvent companies that were eligible at the time of such 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 for whom, securities can be purchased in order for the securities to be considered qualifying assets. Such restrictions include limiting purchases to transactions not involving a public offering and acquiring securities from either the portfolio company or their officers, directors or affiliates.
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% after the issuance of the debt or the preferred stock (i.e., such senior securities may not be in excess of 50% of its net assets). If the value of the Company's assets, as defined, were to increase through the issuance of additional capital stock or otherwise, the Company would be permitted under the 1940 Act to issue senior securities.
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 interests 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% or more of the Company's Common Stock present at the meeting, if the holders of more than 50% of the outstanding Common Stock are present or represented by proxy, or (ii) more than 50% of the Company's outstanding Common Stock, whichever is less.
Most of the transactions involving the Company and its affiliates (as well as affiliates of those affiliates) which were prohibited without the prior approval of the Commission under the 1940 Act prior to its amendment by the Small Business Investment Incentive Act are now permissible upon the prior approval of a majority of the Company's independent directors and a majority of the directors having no financial interest in the transactions. However, certain transactions involving certain closely affiliated persons of the Company, including its directors, officers, and employees, may still require the prior approval of the Commission. In general, (i) any person who owns, controls or holds power to vote, more than 5% of the Company's outstanding Common Stock; (ii) any director, executive officer or general partner of that person; and (iii) any person who directly or indirectly controls, is controlled by, or is under common control with, that person, must obtain the prior approval of a majority of the Company's independent directors and, in some situations, the prior approval of the Commission, before engaging in certain transactions involving the Company or any company controlled by the Company. The 1940 Act generally does not restrict transactions between the Company and its portfolio companies. While a BDC may change the nature of its business so as to cease being a BDC (and in connection therewith withdraw its election to be treated as a BDC) only if authorized to do so by a majority vote (as defined in the 1940 Act) of its outstanding voting securities, stockholder approval of changes in other fundamental investment policies of a BDC is not required (in contrast to the general 1940 Act requirement, which requires stockholder approval for a change in any fundamental investment policy). The Company is entitled to change its diversification status without stockholder approval.
Item 2.

Item 2. Properties
The Company maintains its offices at One Rockefeller Plaza, Suite 1430, New York, New York 10020, where it leases approximately 3,400 square feet of office space pursuant to a lease agreement expiring in 2003.
Item 3.

Item 4. Submission of Matters to a Vote of Security Holders
On Friday, October 20, 1995, Registrant held its Annual Meeting of Shareholders, for the following purposes: 1) to elect directors of the Company; 2) to consider and act upon a proposal to authorize options to be automatically granted to non-employee Directors under the 1988 Stock Option Plan; 3) to ratify, confirm and approve the Board of Directors' selection of Arthur Andersen LLP as the Company's independent public accountant for its fiscal year ending December 31, 1995. All of the nominees at the October 20, 1995 annual meeting were elected directors by an affirmative vote of at least 89% of the total shares outstanding. With respect to purpose number two, described as proposal "to consider and act upon a proposal to authorize options to be automatically granted to non-employee Directors under the 1988 Stock Option Plan" in the Registrant's 1995 Proxy Statement, the affirmative votes cast were 8,528,138, the negative votes cast were 514,787 and those abstaining were 109,405, effecting passage. With respect to purpose number three, described as proposal "to ratify, confirm and approve the Board of Directors' selection of Arthur Andersen LLP" as the Company's independent public accountant for its fiscal year ending December 31, 1995, the affirmative votes cast were 9,140,065, the negative votes cast were 31,050 and those abstaining were 55,050, effecting passage.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information set forth under the caption "Shareholder Information- Shareholders and Market Prices" on page 36 of the 1995 Annual Report is herein incorporated by reference.
Item 6.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Pages 31 through 35 of the Company's 1995 Annual Report are herein incorporated by reference.
Item 8.

Item 8. Financial Statements and Supplementary Data
Pages 12 through 30 of the Company's 1995 Annual Report are herein incorporated by reference. See also Item 14 of the Form 10K - "Exhibits, Financial Statement Schedules and Reports of Form 8K"
Item 9.

Item 9. Changes in and Disagreements With Accountants of Accounting and Financial Disclosure
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
The information set forth under the caption "Election of Directors" on page 3 and "Executive Officers" on page 8 in the Company's definitive Proxy Statement for Annual Meeting of Shareholders to be held April 11, 1996, filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, on or about March 4, 1996 (the "1996 Proxy Statement") is herein incorporated by reference.
Item 11.

Item 11. Executive Compensation
The information set forth under the caption "Summary Compensation Table" on page 11 in the 1996 Proxy Statement is herein incorporated by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the caption "Security ownership of Directors, Nominees, and Officers and other principal holders of the Corporations's voting securities" on page 7 in the 1996 Proxy Statement is herein incorporated by reference.
Item 13.

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, 1995.
Item 14.

Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a) (1)The following financial statements included on pages 12 through 30 of the Company's 1995 Annual Report are herein incorporated by reference:
(A) Statement of Assets and Liabilities as of December 31, 1995 and 1994 Statement of Operations for the years ended December 31, 1995, 1994 and 1993 Statement of Changes in Net Assets for the years ended December 31, 1995, 1994, and 1993 Statement of Cash Flows for the years ended December 31, 1995, 1994, and 1993
(B) Notes to Financial Statements
(C) Financial Highlights (selected per share data and ratio)
(a)(2)The following financial statement schedules are submitted herewith:
Schedule I - Marketable Securities - Other Investments
The information set forth under the captions "Schedule of Investments" and "Footnote to Schedule of Investments" on pages 16 through 23 of the 1995 Annual Report are herein incorporated by reference.
Schedules other than those listed above have been omitted because they are not applicable or the required information is presented in the financial statements and/or related notes.
(a)(3)Exhibits. The exhibits which are filed with this Form 10-K or incorporated herein by reference are set forth in the Exhibit Index on page 13.
(b) Reports on Form 8-K. The Registrant did not file any reports of Form 8-K during the last quarter of 1995.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HARRIS & HARRIS GROUP, INC.
Date: March 28, 1996 By: /s/___________________ 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 Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
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.)
Exhibit No. Description - ----------- -----------
3.1(a) * Restated Certificate of Incorporation of the Registrant, as amended, incorporated by reference to Exhibit 3 (a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.
3.1(b) * Restated By-laws of the Registrant.
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.
8.1 * Harris & Harris Group, Inc. 1988 Stock Option Plan, as amended and restated.
9.1 * Harris & Harris Group, Inc. Custodian Agreement with JP Morgan
10.1 Employment Agreement by and between the Registrant and Charles E. Harris dated August 15, 1990, incorporated by reference to Exhibit 10 (r) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.
10.2 Amendment No.1 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of June 30, 1992, incorporated by reference to Exhibit 10.2 to the Company's Registration Statement in Form N-2 filed on October 29, 1992.
10.3 Amendment No.2 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of January 6, 1993, incorporated by reference to Exhibit 10.22 to the Company's Registration Statement in Form N-2 filed on December 3, 1993.
10.4 * Amendment No.3 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of June 30, 1994.
10.5 Severance Compensation Agreement by and between the Registrant and Charles E. Harris dated August 15, 1990, incorporated by reference to exhibit 10 (s) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.
10.6 Employment Agreement by and between the Registrant and C. Richard Childress dated August 15, 1990, incorporated by reference to exhibit 10 (t) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.
10.7 Amendment No. 1 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of June 30, 1992 incorporated by reference to Exhibit 10.2 to the Company's Registration Statement in Form N-2 filed on October 29, 1992.
10.8 Amendment No.2 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of January 6, 1993, incorporated by reference to Exhibit 10.22 to the Company's Registration Statement in Form N-2 filed on December 3, 1993.
10.9 * Amendment No.3 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of June 30, 1994.
10.10 Severance Compensation Agreement by and between the Registrant and C. Richard Childress dated August 15, 1990, incorporated by reference to Exhibit 10 (u) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.
10.11 Warrant issued by the Registrant to Charles E. Harris dated September 23, 1985 as clarified and restated on May 1, 1989, incorporated by reference to Exhibit 10 (n) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.
10.12 Warrant issued by the Registrant to C. Richard Childress dated September 23, 1985 as clarified and restated on May 1, 1989, incorporated by reference to Exhibit 10 (o) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.
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.
10.14 * Form of Indemnification Agreement which has been established with all directors and executive officers of the Company.
10.15 * Definitive Proxy Statment for the Annual Meeting of Shareholders to be held on April 11, 1996
13 * Annual Report to shareholders for year ended December 31, 1995
24 * Consent of Arthur Andersen LLP