N-CSR 1 ncsrdec2003.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-08110 SPECIAL SITUATIONS FUND III, L.P. (Exact name of registrant as specified in charter) 153 EAST 53RD STREET, 55TH FLOOR, NEW YORK, NEW YORK 10022 (Address of principal executive offices) (Zip code) Allen B. Levithan, Esq. c/o Lowenstein Sandler PC 65 Livingston Avenue Roseland, New Jersey 07068 (Name and address of agent for service) Registrant?s telephone number, including area code (212) 207-6500 Date of fiscal year end: DECEMBER 31, 2003 Date of reporting period: DECEMBER 31, 2003 Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ? 3507. Item 1. Reports to Stockholders. December 31, 2003 __________________________________ Special Situations Annual Fund III, L.P. Report December 31, 2003 Special Situations Fund III, L.P. Annual Report SPECIAL SITUATIONS FUND III, L.P. INDEX TO ANNUAL REPORT DECEMBER 31, 2003 _____________________________________________________________________________ ___ __ PAGE Independent Auditors Report 1 Statement of Financial Condition 2 Portfolio of Investments 3 Statement of Operations 10 Statements of Changes in Partners Capital 11 Notes to the Financial Statements 12 INDEPENDENT AUDITORS' REPORT ---------------------------- TO THE PARTNERS OF SPECIAL SITUATIONS FUND III, L.P.: We have audited the accompanying statement of financial condition of Special Situations Fund III, L.P., including the portfolio of investments, as of December 31, 2003, the related statement of operations for the year then ended and the statements of changes in partners' capital for each of the two years in the period then ended. These financial statements are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 2003, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Special Situations Fund III, L.P. at December 31, 2003, the results of its operations for the year then ended and the changes in its partners' capital for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. ANCHIN, BLOCK & ANCHIN LLP New York, New York February 6, 2004 1 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) STATEMENT OF FINANCIAL CONDITION DECEMBER 31, 2003 ASSETS Investments, at fair value (cost $206,355,498) $ 361,694,307 Cash and cash equivalents 106,255,951 Receivable for investments sold 3,816,840 Other assets 849,090 Total Assets $ 472,616,188 LIABILITIES AND PARTNERS' CAPITAL Liabilities Payable for Units repurchased $ 55,248,289 Securities sold short, at fair value (proceeds $460,164) 391,884 Payable for investments purchased 2,106,522 Administrator's fee payable 1,514,892 Consulting fee payable 1,706,859 Accrued expenses 319,785 Total Liabilities 61,288,231 Partners' Capital Limited Partners 380,390,677 Corporate General Partner 23,987,396 Individual General Partners 6,949,884 Total Partners' Capital 411,327,957 Total Liabilities and Partners' Capital $ 472,616,188 See the accompanying Notes to the Financial Statements. 2 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Shares Common Stocks Value Aerospace 0.37% 994,500 SPACEHAB, Incorporated (a) $ 1,521,585 Automotive Components 1.96% 1,869,368 Amerigon Incorporated (a) 8,079,409 Biotechnology 3.80% 215,862 Adolor Corporation 4,315,081 562,726 ArQule, Inc. 2,746,103 574,132 Corixa Corporation 3,467,757 119,500 Discovery Laboratories, Inc. 1,253,555 500,300 Paradigm Genetics, Inc. 735,441 820,628 VIVUS, Inc. 3,110,180 15,628,117 Biotechnology - Drug Delivery 1.12% 601,851 DepoMed, Inc. 4,267,124 135,000 Durect Corporation 337,500 4,604,624 CAD/CAM/CAE 1.11% 359,202 Ansoft Corporation 4,551,089 Communication Equipment - Software 1.80% 799,905 Artisoft, Inc. (a) 2,159,742 44,842 Artisoft, Inc. (Restricted) (a) 45,129 1,049,082 ION Networks, Inc. (a) 44,061 590,300 MetaSolv, Inc. 1,434,429 1,654,100 Visual Networks, Inc. (a) 3,705,184 7,388,545 Communication Products - Equipment 6.45% 2,094,583 NMS Communication Corporation (a) 13,070,196 254,900 RADVision, Ltd. (Israel) 2,908,409 1,013,613 Superconductor Technologies, Inc. 5,635,689 752,900 Telular Corporation (a) 4,916,437 26,530,731 Computer Services - Software 13.48% 625,100 CryptoLogic, Inc. (Canada) 7,444,941 400,000 Docent, Inc. 1,815,998 1,163,250 dot com Entertainment Group, Inc. (Canada) (a) 81,428 198,200 eCollege.com 3,658,772 888,832 First Virtual Communications, Inc. (a) 1,955,430 553,771 First Virtual Communications, Inc. (Restricted) (a) 991,250 1,667,200 Landacorp, Inc. (a) 4,001,280 1,134,200 Net Perceptions, Inc. 453,680 See the accompanying Notes to the Financial Statements. 3 PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Shares Common Stocks (Continued) Value Computer Services - Software (Continued) 2,719,012 ON Technology Corporation (a) $ 10,767,288 773,059 ONYX Software Corporation (a) 3,092,236 42,000 Phoenix Technologies, Ltd. 339,360 1,000,994 Quovadx, Inc. 4,904,871 774,050 SupportSoft, Inc. 10,186,498 621,290 Witness Systems, Inc. 5,759,358 55,452,390 Computer Systems 2.33% 51,100 3D Systems Corporation 518,665 3,333,400 Adept Technology, Inc. (Restricted) (a) 3,000,060 406,527 Pinnacle Systems, Inc. 3,467,675 168,155 SeaChange International, Inc. 2,589,587 9,575,987 Consumer Products 1.41% 1,686,500 Meade Instruments Corp. (a) 5,818,425 Electronic Components 4.74% 1,189,524 AMX Corporation (a) 9,480,506 307,894 American Technology Corporation 1,469,270 182,800 Frequency Electronics, Inc. 2,650,600 243,200 Peerless Systems Corporation 629,888 2,152,800 Tvia, Inc. (a) 5,252,832 19,483,096 Electronic Equipment 0.78% 1,624,600 Iteris Holdings, Inc. (a) 3,200,462 Electronic Semiconductor 0.59% 1,263,200 PSi Technologies Holdings, Inc. (Philippines) (a) 2,437,976 Energy - Oil & Gas 1.75% 179,900 Core Laboratories, N.V. 3,002,531 349,000 Willbros Group, Inc. 4,194,980 7,197,511 Energy - Technology 2.00% 509,459 Catalytica Energy Systems, Inc. 1,782,597 799,600 Quantum Fuel Systems Technologies Worldwide, Inc. 6,428,784 8,211,381 Financial Services - Miscellaneous 1.05% 126,350 ASTA Funding, Inc. 4,327,488 Gold Mining 0.86% 2,334,500 MK Gold Company (a) 3,548,440 See the accompanying Notes to the Financial Statements. 4 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Shares Common Stocks (Continued) Value Healthcare Services 0.83% 250,398 I-many, Inc. $ 250,398 202,046 U.S. Physical Therapy, Inc. 3,178,184 3,428,582 Healthcare - Specialized Products & Services 0.25% 254,700 BioSphere Medical, Inc. 1,006,065 Insurance 0.00% 200 Renaissance Acceptance Group, Inc. - Information Services 0.45% 1,107,371 EDGAR Online, Inc. (a) 1,849,310 Media 2.00% 1,950,946 Audible, Inc. (a) 8,232,992 Medical Devices & Equipment 13.05% 937,500 ATS Medical, Inc. 3,796,875 1,400,127 Applied Imaging Corporation (a) 2,114,192 1,497,084 Aradigm Corporation 2,560,014 386,440 Given Imaging, Ltd. (Israel) 6,936,598 357,600 Invivo Corporation 7,838,592 417,182 Laserscope, Inc. 6,503,867 923,998 LifeCell Corporation (a) 5,728,788 724,925 Micro Therapeutics, Inc. 2,341,508 596,428 Orthovita, Inc. 1,914,534 573 PharmaNetics, Inc. 1,076 1,636,364 Physiometrix, Inc. (Restricted) (a) 2,700,000 65,567 Precision Optics Corporation, Inc. 137,690 569,968 Sonic Innovations, Inc. 3,676,294 950,460 World Heart Corporation (Canada) (a) 7,413,587 53,663,615 Medical - Drugs 1.14% 267,500 Advancis Pharmaceutical Corporation 2,006,250 242,725 CollaGenex Pharmaceuticals, Inc. 2,701,529 4,707,779 Medical Instruments 1.20% 290,000 Intuitive Surgical, Inc. 4,956,100 Online Services 1.68% 1,732,150 The Knot, Inc. (a) 6,928,600 Paper - Packaging 0.00% 593,749 Chase Packaging Corporation - Pharmaceutical Products 0.81% 213,267 Axcan Pharma, Inc. (Canada) 3,337,629 See the accompanying Notes to the Financial Statements. 5 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Shares Common Stocks (Continued) Value Restaurant 0.89% 490,000 Champps Entertainment, Inc. $ 3,650,500 Retail 4.48% 161,300 1-800 CONTACTS, INC. 3,387,300 55,000 Conn's, Inc. 885,500 1,365,311 EZCORP, Inc. (a) 11,618,797 424,146 Gaiam, Inc. 2,523,669 18,415,266 Semiconductor Equipment 3.59% 1,189,299 Nova Measuring Instruments, Ltd. (Israel) (a) 6,993,078 1,364,815 Trikon Technologies, Inc. (Great Britain) 7,765,797 14,758,875 Services 1.11% 439,385 Collectors Universe, Inc. (a) 4,560,816 Specialized Services 1.73% 885,400 NIC, Inc. 7,109,762 Technology - Miscellaneous 1.54% 252,700 Culp, Inc. 2,754,430 1,555,400 Pinnacor, Inc. 3,594,529 6,348,959 Telecom Equipment 0.47% 1,665,454 Peco II, Inc. (a) 1,915,272 Therapeutics 1.40% 260,000 Dyax Corp. 2,119,000 492,000 Pharmacyclics, Inc. 3,645,720 5,764,720 Total Common Stocks 82.22% 338,192,098 Fair Shares Preferred Stocks Value Communication Equipment - Software 0.92% 1,140,000 Artisoft, Inc. (a) $ 3,762,000 Electronic Instruments 0.20% 825 Metretek Technologies, Inc. 8% (a) 825,000 Total Preferred Stocks 1.12% 4,587,000 See the accompanying Notes to the Financial Statements. 6 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Principal Fair Amount Corporate Bonds Value Computer Services - Software 0.00% 2,100,000 Titus Interactive 2%, due 7/1/05 (France) $ - Computer Services 0.45% $1,875,000 3D Systems Corp. 6%, due 11/30/13 (Restricted) 1,875,000 Medical Devices & Equipment 0.58% 2,400,000 Micro Therapeutics, Inc. 7%, due 12/4/04 (Restricted) 2,400,000 Retail 0.44% 1,800,000 Bakers Footwear Group 7%, due 4/4/07 1,800,000 Telecom Services 0.03% 113,085 GoAmerica, Inc. 10%, due 4/18/04 (Restricted) 113,085 Total Corporate Bonds 1.50% 6,188,085 Fair Warrants Warrants Value Automotive Components 0.54% 869,750 Amerigon Incorporated 2/25/07 (a) $ 2,226,560 Biotechnology 0.08% 413,400 Alliance Pharmaceutical Corp. 10/30/06 82,680 43,000 Discovery Laboratories, Inc. 9/19/10 238,650 321,330 Biotechnology - Drug Delivery 0.26% 210,648 DepoMed, Inc. 4/21/08 1,091,157 Communication Equipment - Software 0.08% 1,140,000 Artisoft, Inc. 9/30/06 (a) 307,800 44,842 Artisoft, Inc. 12/16/08 (Restricted) (a) - 586,600 ION Networks, Inc. 2/14/07 (a) 5,866 313,666 Communication Products - Equipment 0.28% 57,861 Superconductor Technologies, Inc. 3/10/07 101,835 427,500 Superconductor Technologies, Inc. 9/26/07 1,034,550 1,136,385 Computer Services - Software 0.12% 413,309 Attunity, Ltd. A 10/24/05 (Israel) 239,719 137,769 Attunity, Ltd. B 10/24/05 (Israel) 49,597 375,000 Burst.com, Inc. 1/27/05 63,750 1,250,000 First Virtual Communications, Inc. 4/12/07 (a) 150,000 276,885 First Virtual Communications, Inc. 11/12/08 (Restricted) (a) - 862,500 Interplay Entertainment Corp. 3/29/06 8,625 511,691 Computer Systems 0.00% 1,666,700 Adept Technology, Inc. 11/18/08 (Restricted) (a) - Data Security 0.00% 509,500 Datakey, Inc. 2/20/06 (Restricted) - Electronic Components 0.02% 85,227 American Technology Corporation 7/10/07 80,113 See the accompanying Notes to the Financial Statements. 7 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Warrants Warrants (Continued) Value Electronic Equipment 0.36% 708,350 Iteris Holdings, Inc. A 8/16/07 (a) $ 786,269 708,350 Iteris Holdings, Inc. B 8/16/07 (a) 680,016 1,466,285 Electronic Instruments 0.00% 82,500 Metretek Technologies, Inc. 12/9/04 (a) 9,075 Energy - Miscellaneous 0.00% 180,000 Boots & Coots International Well Control 5/14/04 (Restricted) - Energy - Technology 0.00% 132,667 Arotech Corporation 6/30/08 - 58,075 Arotech Corporation 12/31/08 (Restricted) - - Information Services 0.00% 150,000 EDGAR Online, Inc. 1/8/06 (a) 37,500 Medical Devices & Equipment 1.25% 268,600 Applied Imaging Corporation 7/29/06 (a) 59,092 208,333 Aradigm Corporation 11/10/07 95,833 398,733 Aradigm Corporation 3/10/07 354,872 301,050 Cardima, Inc. 2/25/05 45,158 218,750 LifeCell Corporation 7/10/06 955,938 114,286 Orthovita, Inc. 6/26/08 67,429 26,250 PharmaNetics, Inc. 2/25/05 788 818,182 Physiometrix, Inc. A 12/5/08 (Restricted) (a) 818 818,182 Physiometrix, Inc. B 12/5/08 (Restricted) (a) 818 47,476 SpectRx, Inc. 6/13/06 23,738 6,653,226 World Heart Corporation 9/22/08 3,526,210 5,130,694 Medical Information Systems 0.00% 2,200,000 LifeRate Systems, Inc. 11/14/07 (a) - Retail 0.00% 96,450 Gemstar-TV Guide International, Inc. A 11/2/04 - 47,143 Gemstar-TV Guide International, Inc. B 12/21/05 - 90,000 PawnMart, Inc. B 3/11/04 - - Semiconductor Equipment 0.07% 206,250 Trikon Technologies, Inc. 10/22/07 (a) 294,938 Telecom Services 0.00% 150,780 GoAmerica, Inc. 12/19/08 (Restricted) - Telecommunications 0.03% 79,800 Q Comm International, Inc. 6/24/08 107,730 Total Warrants 3.09% 12,727,124 TOTAL INVESTMENTS 87.93% $ 361,694,307 See the accompanying Notes to the Financial Statements. SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) PORTFOLIO OF INVESTMENTS DECEMBER 31, 2003 Fair Shares Securities Sold Short Value Biotechnology 0.10% 67,800 CryoLife, Inc. $ 391,884 TOTAL SECURITIES SOLD SHORT 0.10% $ 391,884 (a) Affiliated issuer under the Investment Company Act of 1940, inasmuch as the Fund owns more than 5% of the voting securities of the issuer. All percentages are relative to Partners' Capital. See the accompanying Notes to the Financial Statements. 9 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003 REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments $ 87,120,315 Net change in unrealized appreciation 154,083,581 Total Realized and Unrealized Gain on Investments $ 241,203,896 INVESTMENT INCOME Income Interest 544,873 Dividends (net of withholding taxes of $2,813) 355,388 Securities lending fees 510,313 Total Investment Income 1,410,574 Investment Expenses Consulting fee 1,786,738 Dividends on securities sold short 31,971 Total Investment Expenses 1,818,709 Operating Expenses Administrator's fee 2,453,020 Professional fees 519,768 Independent General Partners' fees 105,000 Other 212,156 Total Operating Expenses 3,289,944 Net Investment Loss (3,698,079) NET INCOME $ 237,505,817 See the accompanying Notes to the Financial Statements. 10 (A Limited Partnership) STATEMENTS OF CHANGES IN PARTNERS' CAPITAL Per Limited Corporate Individual Partners' Limited General General Unit Partners Partner Partners Total YEAR ENDED DECEMBER 31, 2002: BALANCE, DECEMBER 31, 2001 $ 248,351,589 $ 13,199,827 $ 5,848,579 $ 267,399,995 Capital contributions 26,387,250 - - 26,387,250 Allocation of net loss (51,601,615) (2,508,613) (1,111,516) (55,221,744) Repurchases (9,124,838) - - (9,124,838) BALANCE, DECEMBER 31, 2002 $ 25,000 214,012,386 10,691,214 4,737,063 229,440,663 SIX MONTHS ENDED JUNE 30, 2003: Capital contributions 2,300,000 - 5,000 2,305,000 Allocation of net income: Corporate General Partner - Performance - 3,966,266 - 3,966,266 Partners $ 7,669 66,352,729 3,279,476 1,454,605 71,086,810 Repurchases (6,621,234) - - (6,621,234) BALANCE, JUNE 30, 2003 $ 25,000 276,043,881 17,936,956 6,196,668 300,177,505 SIX MONTHS ENDED DECEMBER 31, 2003: Capital contributions 3,946,000 - - 3,946,000 Transfers - (73,684) 73,684 - Allocation of net income: Corporate General Partner - Performance - 32,490,548 - 32,490,548 Partners $ 10,683 119,649,085 7,633,576 2,679,532 129,962,193 Repurchases (19,248,289) (34,000,000) (2,000,000) (55,248,289) BALANCE, DECEMBER 31, 2003 $ 25,000 $ 380,390,677 $ 23,987,396 $ 6,949,884 $ 411,327,957 See the accompanying Notes to the Financial Statements. 11 NOTE 1 - GENERAL: Special Situations Fund III, L.P. (the Fund) was organized under the Delaware Revised Uniform Limited Partnership Act on October 18, 1993, and commenced investment operations on January 1, 1994. The Fund is a closed-end interval fund registered under the Investment Company Act of 1940. The Fund shall have perpetual existence unless sooner dissolved as provided for in the Agreement of Limited Partnership (the Agreement). The Agreement provides for not less than three Individual General Partners and a Corporate General Partner. The General Partners, as a group, must own not less than one percent (1%) of the Funds outstanding Units. The Corporate General Partner and Investment Adviser is MGP Advisers Limited Partnership (MGP), of which the General Partner is AWM Investment Company, Inc. (AWM). Austin W. Marxe, an Individual General Partner of the Fund and a limited partner of MGP owns directly and indirectly a majority of MGP and AWM. Mr. Marxe is primarily responsible for managing the Funds investments and performing certain administrative services on its behalf. The Fund seeks long-term capital appreciation by investing primarily in equity securities and securities with equity features of publicly traded companies which possess a technological, market or product niche, which may be, for various reasons, undervalued, or with prospects of going private or being acquired. NOTE 2 - ACCOUNTING POLICIES: Securities traded on a securities exchange or on the NASDAQ System are valued at the last reported sales price on the last business day of the reporting period. Securities for which no sale occurred on such day are valued at the average of the highest bid and lowest asked prices on the last trading day. Securities for which market quotations are not available are valued at fair value as determined in good faith by the Individual General Partners. Securities transactions are recorded on trade date. Realized gains and losses on sales of securities are determined using the specific identification cost method. Dividend income is recorded on the ex-dividend date, and interest income is recorded on the accrual basis. Cash and cash equivalents consist principally of cash balances in a brokerage account. NOTE 2 - ACCOUNTING POLICIES (CONTINUED): The Fund entered into an agreement to lend portfolio securities to a qualified borrower in order to earn additional income. The terms of the lending agreement require that loans are secured by cash or securities with an aggregate market value at least equal to a percentage of the market value of the loaned securities agreed upon by the borrower and the Fund (which shall be not less than 100% of the market value of the loaned securities), computed on a daily basis. If the borrower defaults on its obligation to return the securities loaned because of insolvency or other reasons, the Fund could experience delays and costs in recovering the securities loaned or in gaining access to collateral. At December 31, 2003, the value of the loaned securities and corresponding collateral (U.S. Treasury obligations) received was $4,735,210 and $4,829,977, respectively. The Fund entered into a consulting agreement (agreement) whereby the consultant will perform management and financial advisory services to companies (covered investments) in which the Fund invests. As compensation, the consultant earns ten percent of the appreciation on each covered investment for the agreed upon period. Of this amount, one half is currently payable and the remainder is deferred until a final payment date, as further defined in the agreement. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 3 - ALLOCATION OF ACCOUNTING PROFITS AND LOSSES: Net income is allocated; first, to MGP to the extent of any previous net losses allocated to MGP in excess of the other partners capital balances; next, to the partners in proportion to the number of Units held by each to the extent of net losses previously allocated to them; and, thereafter, 80% to the partners in proportion to the number of Units held by each and 20% performance allocation to MGP. If there is a loss for an accounting period, the performance allocation to MGP will not apply to future periods until the loss has been recovered. For purposes of the performance allocation, net income for the six months ended June 30, 2003 was reduced by the loss carryover from December 31, 2002 of $55,221,744. Net losses are allocated to the partners in proportion to the number of Units held by each, provided, however, that losses in excess of an Individual General Partners or a Limited Partners capital balance will be allocated to MGP. NOTE 4 - PARTNER CAPITAL ACCOUNT TRANSACTIONS: All net income allocated to partners will be reinvested. In order to maintain a $25,000 price per Unit, the number of Units held by each partner at the close of each fiscal period (generally June 30 and December 31, commencing December 31, 1994), is adjusted to equal the partners capital account divided by $25,000. As of the close of each fiscal period, the Fund will offer to repurchase at least 10% and no more than 25% of the outstanding Units. The repurchase request deadline will generally be June 16 and December 17, of each year. The Fund has the right to sell additional Units at the beginning of each fiscal period. Changes in Units outstanding are as follows: Corporate Individual Limited General General Partners Partner Partners Total Balance, December 31, 2001 9,934.0635 527.9932 233.9431 10,695.9998 Additional Units sold 1,055.4900 - - 1,055.4900 Semi-annual adjustments of Units (2,064.0645) (100.3446) (44.4606) (2,208.8697) Repurchases (364.9935) - - (364.9935) Balance, December 31, 2002 8,560.4955 427.6486 189.4825 9,177.6266 Additional Units sold 92.0000 - 0.2000 92.2000 Semi-annual adjustments of Units 2,654.1092 289.8297 58.1842 3,002.1231 Repurchases (264.8494) - - (264.8494) Balance, June 30, 2003 11,041.7553 717.4783 247.8667 12,007.1003 Additional Units sold 157.8400 - - 157.8400 Transfers - (2.9474) 2.9474 - Semi-annual adjustments of Units 4,785.9634 1,604.9649 107.1813 6,498.1096 Repurchases (769.9316) (1,360.0000) (80.0000) (2,209.9316) Balance, December 31, 2003 15,215.6271 959.4958 277.9954 16,453.1183 NOTE 5 - PURCHASES AND SALES OF SECURITIES: Purchases and sales of securities for the year ended December 31, 2003 aggregated $144,757,470 and $249,049,873, respectively. NOTE 6 - INCOME TAXES: No provision for income taxes has been made in the accompanying financial statements as each partner is individually responsible for reporting income or loss based upon the partners respective share of the Funds income and expenses reported for income tax purposes. NOTE 7 - RELATED PARTY TRANSACTIONS: AWM is the administrator of the Fund. The administrators fee is computed monthly at an annual rate of 0.75% of the average net assets. The Fund pays each Independent General Partner an annual fee of $20,000. NOTE 8 - SUPPLEMENTARY FINANCIAL INFORMATION: Year Ended December 31, 2003 2002 2001 2000 1999 Ratio of investment expenses to average net assets 0.57% 0.03% 0.00% 0.00% 0.00% Ratio of operating expenses to average net assets 1.03% 0.94% 0.89% 0.85% 1.03% Ratio of total expenses to average net assets 1.60% 0.97% 0.89% 0.85% 1.03% Ratio of net income (loss) to average net assets 74.23% (22.16)% 16.62% 15.19% 68.01% Portfolio turnover rate 52.43% 60.28% 91.33% 102.49% 140.88% NOTE 9 - RETURN ON PARTNER INVESTMENT: At December 31, 2003, the value of a $25,000 investment made at each respective subscription date is as follows: Subscription Date Value January 1, 1994 $178,032 January 1, 1995 162,759 July 1, 1995 144,116 January 1, 1996 120,185 July 1, 1996 90,728 January 1, 1997 85,867 July 1, 1997 81,335 January 1, 1998 72,160 July 1, 1998 73,989 January 1, 1999 82,024 July 1, 1999 75,684 January 1, 2000 49,330 July 1, 2000 42,255 January 1, 2001 43,214 July 1, 2001 37,777 January 1, 2002 37,767 July 1, 2002 43,085 January 1, 2003 46,629 July 1, 2003 35,683 NOTE 10 - SECURITIES SOLD SHORT: The Fund is subject to certain inherent risks arising from its activities of selling securities short. The ultimate cost to the Fund to acquire these securities may exceed the liability reflected in the financial statements. In addition, the Fund is required to maintain collateral with the broker to secure these short positions. 12 1 SPECIAL SITUATIONS FUND III, L.P. (A Limited Partnership) NOTES TO THE FINANCIAL STATEMENTS 17 Item 2. Code of Ethics. The Registrant has adopted a Code of Ethics (the ?Code of Ethics?) that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the Registrant or a third party. The Registrant undertakes to provide to any person without charge, upon request, a copy of the Code of Ethics. Such request can be made to Special Situations Fund III, L.P. at (212) 207-6500, 153 East 53rd Street, 55th Floor, New York, New York 10022, Attention: Rose M. Carling. There have been no amendments to the Code of Ethics during the period covered by this report. In addition, during the period covered by this report, the Registrant has not granted any waivers, including an implicit waiver, from a provision of the Code of Ethics. Item 3. Audit Committee Financial Expert. The Registrant?s board of directors (or persons performing similar functions) has determined that Stanley S. Binder possesses the technical attributes identified in Instruction 2(b) of Item 3 to Form N-CSR to qualify as an ?audit committee financial expert,? and has designated Stanley S. Binder as the audit committee financial expert. Stanley S. Binder is an ?independent? director (or the functional equivalent thereof) pursuant to paragraph (a)(2) of Item 3 to Form N-CSR. Item 4. Principal Accountant Fees and Services. Audit Fees. The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the Registrant?s annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years are $86,800 and $65,900 for 2003 and 2002, respectively. Audit-Related Fees. There were no fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the Registrant?s financial statements and are not reported under ?Audit Fees? above. Tax Fees. The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning are $26,000 and $31,000 for 2003 and 2002, respectively. All Other Fees. There were no fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported above. The audit committee of the Registrant was organized in 2003. As of 2003, all services to be performed for the Registrant by the Registrant?s accountant must be pre-approved by the audit committee. The above referenced fees for 2003 were pre-approved by the audit committee. The aggregate fees paid by the Registrant for non-audit professional services rendered by the Registrant?s accountant to the Registrant?s investment advisor and any entity controlling, controlled by, or under common control with the Registrant?s investment adviser that provides ongoing services to the Registrant for 2003 and 2002 were $30,699 and $26,952, respectively. Item 5. Audit Committee of Listed Registrants. Not applicable. Item 6. [Reserved] Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies The Registrant has adopted the following proxy voting policies and procedures of its investment adviser, MGP Advisers Limited Partnership: PROXY VOTING POLICIES AND PROCEDURES These policies and procedures apply to the voting of proxies by MGP Advisers Limited Partnership (the ?Adviser?) for those client accounts over which the Adviser has proxy voting authority. Adviser is the investment adviser for Special Situations Fund III, L.P. GENERAL The Adviser?s proxy voting policies and procedures are designed to ensure that the Adviser complies with the requirements under Rule 206(4)-6 and Rule 204-2 promulgated under the Investment Advisers Act of 1940, as amended, and fulfills its obligations thereunder with respect to proxy voting, disclosure, and recordkeeping. The Adviser?s objective is to ensure that its proxy voting activities on behalf of its clients are conducted in a manner consistent, under all circumstances, with the best interest of the clients. For most matters, however, the Adviser?s policy is not to vote where it believes the outcome is not in doubt in order to avoid the unnecessary expenditure of time and the cost to review the proxy materials in detail and carry out the vote. In such circumstances the Adviser believes that the client is best served by the Adviser?s devoting its time to investment activities on the client?s behalf. PROXY VOTING POLICIES The Adviser is committed to voting proxies in a manner consistent with the best interests of its clients. While the decision whether or not to vote a proxy must be made on a case-by-case basis, the Adviser generally does not vote a proxy if it believes the proposal is not adverse to the best interests of the client or if adverse, the outcome of the vote is not in doubt. In the situations where the Adviser does vote a proxy, the Adviser generally votes proxies in accordance with the following general guidelines: Proxy Proposal Issue Adviser?s Voting Policy Routine Election of Directors For Issuance of Authorized Common Stock For Stock Repurchase Plans For Domestic Reincorporation For Director Indemnification For Require Shareholder Approval to Issue Preferred Stock For Require Shareholder Approval to Issue Golden Parachutes For Require Shareholder Approval of Poison Pill For Shareholders? Right to Call Special Meetings For Shareholders? Right to Act by Written Consent For Shareholder Ability to Remove Directors With or Without Cause For Shareholders Electing Directors to Fill Board Vacancies For Majority of Independent Directors For Board Committee Membership Exclusively of Independent Directors For 401(k) Savings Plans for Employees For Anti-greenmail Charter or By-laws Amendments For Corporate Name Change For Ratification of Auditors For Supermajority Vote Requirement Against Blank Check Preferred Against Dual Classes of Stock Against Staggered or Classified Boards Against Fair Price Requirements Against Limited Terms for Directors Against Require Director Stock Ownership Against The following proxy proposal issues are so fact sensitive that no general voting policy with respect to such issues may be established by the Adviser: Reprice Management Options Fact Sensitive Adopt/Amend Stock Option Plan Fact Sensitive Adopt/Amend Employee Stock Purchase Plan Fact Sensitive Approve Merger/Acquisition Fact Sensitive Spin-offs Fact Sensitive Corporate Restructurings Fact Sensitive Asset Sales Fact Sensitive Liquidations Fact Sensitive Adopt Poison Pill Fact Sensitive Golden Parachutes Fact Sensitive Executive/Director Compensation Fact Sensitive Social Issues Fact Sensitive Contested Election of Directors Fact Sensitive Stock Based Compensation for Directors Fact Sensitive Increase Authorized Shares Fact Sensitive Tender Offers Fact Sensitive Preemptive Rights Fact Sensitive Debt Restructuring Fact Sensitive Foreign Reincorporation Fact Sensitive PROXY VOTING PROCEDURES The general partner (or other principals) of the Adviser will have the responsibility of voting proxies received by the Adviser on behalf of its clients. The Adviser will evaluate whether to vote the proxy proposals received by the Adviser. If the proxies are voted, the proxy proposals received by the Adviser and designated above in the proxy voting policies as ?For? or ?Against? will be voted by the Adviser in accordance with the proxy voting policies, and proxy proposals received by the Adviser and designated above in the proxy voting policies as ?Fact Sensitive? (or not addressed in the proxy voting policies) will be reviewed by the Adviser on a case-by-case basis. Notwithstanding the foregoing, the Adviser may vote a proxy contrary to the proxy voting guidelines if the Adviser determines that such action is in the best interest of the client. In the event that the Adviser votes contrary to the proxy voting guidelines, the Adviser will document the basis for the Adviser?s contrary voting decision. In addition to not voting proxies where the Adviser deems the expenditure of time and cost of voting would exceed the anticipated benefit to the client, the Adviser may choose not to vote proxies in certain situations or for certain clients, such as (i) where a client has informed the Adviser that it wishes to retain the right to vote the proxy, (ii) where the proxy is received for a client account that has been terminated, or (iii) where a proxy is received by the Adviser for a security it no longer manages on behalf of a client. MATERIAL CONFLICTS OF INTEREST The Adviser may occasionally be subject to material conflicts of interest in the voting of proxies due to business or personal relationships it maintains with persons having an interest in the outcome of certain votes. The Adviser, its affiliates and/or its employees may also occasionally have business or personal relationships with the proponents of proxy proposals, participants in proxy contests, corporate directors and officers, or candidates for directorships. If at anytime, the Adviser becomes aware of a material conflict of interest relating to a particular proxy proposal, the Adviser will handle the proposal as follows: * If the proposal is designated in proxy voting policies above as ?For? or ?Against,? the proposal will be voted by the Adviser in accordance with the proxy voting policies, provided little discretion on the part of the Adviser is involved; or * If the proposal is designated in the proxy voting policies above as ?Fact Sensitive? (or not addressed in the proxy voting policies), the Adviser will either (i) disclose to the client such material conflict and vote the client?s shares in accordance with the client?s instructions or (ii) take such other action as is necessary to ensure that the Adviser?s vote (including the decision whether to vote) is based on the client?s best interest and not affected by the Adviser?s material conflict of interest. PROXY VOTING RECORDS In accordance with Rule 204-2, the Adviser will maintain the following records in connection with the Adviser?s proxy voting policies and procedures: * a copy of the proxy voting policies and procedures; * a copy of all proxy statements received regarding client?s securities; * a record of each vote the Adviser casts on behalf of a client; * written records of client requests for proxy voting information, including a copy of each written client request for information on how the Adviser voted proxies on behalf of the requesting client, and a copy of any written response by the Adviser to any (written or oral) client request for information on how the Adviser voted proxies on behalf of the requesting client; and * any documents prepared by the Adviser that were material to making a decision on how to vote, or that memorialized the basis for a voting decision. Each of the foregoing records will be maintained and preserved by the Adviser for five years from the end of the last fiscal year in which an entry was made on such record, and for the first two years of such five-year period, shall be maintained at an appropriate office of the Adviser. Notwithstanding the foregoing, the Adviser may rely on proxy statements filed on the SEC?s EDGAR system instead of keeping its own copies. In addition, the Adviser may also rely upon a third party to maintain the foregoing records, provided such third party has provided to the Adviser an undertaking to provide a copy of such records promptly upon request. DISCLOSURE TO CLIENTS A copy of the Adviser?s written proxy voting policies and procedures will be provided to clients upon written request to the Adviser. In addition, information regarding how a client?s proxies were voted by the Adviser will be provided to a client upon written request to the Adviser. Item 8. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers. Not applicable at this time. Item 9. Submission of Matters to a Vote of Security Holders. Not applicable at this time. Item 10. Controls and Procedures. (a) Based on an evaluation of the registrant's disclosure controls and procedures as of a date within 90 days of the filing date of this report, the registrant?s principal executive and principal financial officers, or persons performing similar functions, concluded that the disclosure controls and procedures are effective. (b) There were no significant changes in the registrant's internal control over financial reporting that occurred during the registrant's last fiscal half-year that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 11. Exhibits. (a)(1) NOT APPLICABLE. (a)(2) CERTIFICATIONS REQUIRED BY ITEM 11(a)(2) OF FORM N-CSR ARE FILED HEREWITH AS EX-99.CERT. (b) CERTIFICATIONS REQUIRED BY ITEM 11(b) OF FORM N-CSR ARE FILED HEREWITH AS EX-99.906CERT. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SPECIAL SITUATIONS FUND III, L.P. By: /s/Austin Marxe Austin Marxe, Principal Executive Officer Date March 9, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/Austin Marxe Austin Marxe, Principal Executive Officer Date March 9, 2004 By: /s/Rose M. Carling Rose M. Carling, Principal Financial Officer Date March 9, 2004 EX-99.906CERT