N-CSR 1 ssfiiincsrdec07.htm SSF III NCSR DEC 07 ssfiiincsrdec07.htm
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)
 
527 MADISON AVENUE, SUITE 2600, 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) 319-6670
 
Date of fiscal year end:
DECEMBER 31, 2007
 
Date of reporting period:
DECEMBER 31, 2007
 

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, 2007
Special Situations Fund III, L.P.
Annual Report












SPECIAL SITUATIONS FUND III, L.P.

INDEX TO THE ANNUAL REPORT

DECEMBER 31, 2007
_________________________________________________________________________________





PAGE
Report of Independent Registered Public Accounting Firm                                                                                     1


Statement of Financial Condition                                                                                                                                   2


Portfolio of Investments                                                                                                                                                  3


Statement of Operations                                                                                                                                               14


Statements of Changes in Partners’ Capital                                                                                                              15

 
Notes to the Financial Statements                                                                                                                              16








 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2007, and the related statement of operations for the year then ended and changes in partners' capital for the years ended December 31, 2007 and 2006, and the financial highlights (Note 9) for the years ended December 31, 2007, 2006 and 2005.  These financial statements and financial highlights are the responsibility of the Fund’s management.  Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits.  The financial highlights (Note 9) for 2003 and 2004 for Special Situations Fund III, L.P. were audited by other auditors whose report dated February 1, 2005, expressed an unqualified opinion on the financial highlights for 2003 through 2004.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights 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 at December 31, 2007, 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 and financial highlights (Note 9) referred to above, present fairly, in all material respects, the financial position of Special Situations Fund III, L.P. as of December 31, 2007, and the results of its operations for the year then ended, and the changes in its partners' capital for the years ended December 31, 2007 and 2006, and the financial highlights for the years ended December 31, 2007, 2006 and 2005, in conformity with accounting principles generally accepted in the United States of America.


WEISER LLP

New York, N. Y.
February 27, 2008



 
SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
       
STATEMENT OF FINANCIAL CONDITION
   
       
DECEMBER 31, 2007
   
       
       
 
       
       
       
ASSETS
     
       
Investments, at fair value (cost $35,240,356)
$
36,153,275
Cash and cash equivalents
 
 5,475,349
Receivable for investments sold
 
    669,789
Other assets
 
      29,190
       
Total Assets
$
42,327,603
       
LIABILITIES AND PARTNERS' CAPITAL
   
       
Liabilities
     
       
Payable for Units repurchased
$
2,038,140
Securities sold short, at fair value (proceeds $1,302,666)
 
   899,160
Payable for investments purchased
 
   417,133
Administrator's fee payable
 
     79,914
Accrued expenses
 
   168,595
       
Total Liabilities
 
3,602,942
       
Partners' Capital
   
       
Limited Partners
 
33,303,994
Corporate General Partner
 
  4,980,130
Individual General Partners
 
     440,537
       
Total Partners' Capital
 
38,724,661
       
Total Liabilities and Partners' Capital
$
42,327,603
       
       
       
       
       
       
       
       
       
See the accompanying Notes to the Financial Statements.
   
       
 
  2
   

 
 

 


SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
 Shares
 
Common Stocks
 Value
 
   
Automotive Components 1.58%
   
33,556
 
Rush Enterprises, Inc. - Class A
$
         610,057
         
   
Biotechnology 5.12%
   
89,575
 
Combinatorx, Inc.
 
         397,713
59,429
 
Medivation, Inc.
 
         855,778
35,587
 
Metabasis Therapeutics, Inc.
 
         109,252
22,952
 
Opexa Therapeutics, Inc.
 
           55,085
40,000
 
Sangamo BioSciences, Inc.
 
         523,600
134,278
 
Tapestry Pharmaceuticals, Inc.
 
           40,283
       
      1,981,711
         
   
Building Materials 0.32%
   
9,056
 
Comfort Systems USA, Inc.
 
         115,736
300
 
WFI Industries, Ltd. (Canada)
 
             7,828
       
         123,564
         
   
Business Services 0.00%
   
15,600
 
UTIX Group, Inc.
 
             1,560
         
   
Capital Equipment 0.82%
   
29,790
 
Mfri, Inc.
 
         317,859
         
   
Casino - Services 0.79%
   
109,560
 
Full House Resorts, Inc.
 
         306,768
         
   
Chemicals 1.60%
   
42,717
 
KMG Chemicals, Inc.
 
         617,688
         
   
Communication Equipment - Software 2.08%
   
1,424,157
 
ION Networks, Inc.
 
           85,450
53,573
 
PC-Tel, Inc.
 
         367,511
9,991
 
RIT Technologies, Ltd. (Israel)
 
             3,996
513,175
 
Vertical Communications, Inc.
 
         348,959
       
         805,916
         
   
Communication Products - Equipment 0.99%
   
89,893
 
Centillium Communications, Inc.
 
         103,377
173,207
 
NMS Communications Corporation
 
         280,595
       
         383,972
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  3
   

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Shares
 
Common Stocks (Continued)
 Value
         

   
Computer Services - Software 15.26%
   
58,633
 
Acorn Factor, Inc.
$
         348,866
100,147
 
ClickSoftware Technologies, Ltd. (Israel)
 
         404,594
58,200
 
Constant Contact, Inc.
 
      1,251,300
18,760
 
CryptoLogic, Inc. (Canada)
 
         329,238
302,600
 
Excapsa Software, Inc. (Canada) (Illiquid)
 
           69,144
44,658
 
Interplay Entertainment Corporation
 
             3,573
385,342
 
Interplay Entertainment Corporation (Restricted)
 
                  -
36,698
 
LocatePlus Holdings Corporation (Restricted)
 
             1,468
843,946
 
Motive, Inc.
 
      1,181,524
121,127
 
Openwave Systems, Inc.
 
         314,930
53,003
 
Phoenix Technologies, Ltd.
 
         682,679
110,505
 
Primal Solutions, Inc.
 
             3,868
7,277
 
Radware, Ltd. (Israel)
 
         112,066
93,175
 
SumTotal Systems, Inc.
 
         442,581
33,891
 
SupportSoft, Inc.
 
         150,815
36,983
 
Trident Microsystems, Inc.
 
         242,608
57,021
 
Unify Corporation
 
         370,634
       
      5,909,888
         
   
Computer Systems 1.56%
   
76,108
 
Adept Technology, Inc.
 
         605,059
         
   
Consumer Products 0.08%
   
138,952
 
Varsity Group, Inc.
 
           29,180
         
   
Diagnostics 0.24%
   
102,792
 
Curagen Corporation
 
           94,569
         
   
Electronic Components 1.51%
   
137,082
 
American Technology Corporation
 
         346,817
11,561
 
Frequency Electronics, Inc.
 
         110,870
73,125
 
Interlink Electronics, Inc.
 
         124,313
58,116
 
Tvia, Inc.
 
             1,860
       
         583,860
         
   
Electronic - Display 0.00%
   
993,474
 
E Ink Corporation (Illiquid)
 
                  -
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  4
   

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Shares
 
Common Stocks (Continued)
 Value
         
   
Electronic Equipment 2.01%
   
198,705
 
Iteris, Inc.
$
         776,937
         
   
Electronic Instruments 3.31%
   
43,731
 
Image Sensing Systems, Inc.
 
         760,045
38,723
 
PowerSecure International, Inc.
 
         522,760
       
      1,282,805
         
   
Electronic Semiconductor 1.27%
   
136,897
 
Kopin Corporation
 
         432,594
79,830
 
PSi Technologies Holdings, Inc. (Philippines)
 
           60,671
       
         493,265
         
   
Energy - Services 0.59%
   
36,158
 
Renegy Holdings, Inc.
 
         226,711
         
   
Energy - Technology 1.94%
   
460,277
 
Capstone Turbine Corporation
 
         750,252
         
   
Environmental Services 1.83%
   
1,200,600
 
PDG Environmental, Inc.
 
         708,354
         
   
Financial Services - Miscellaneous 0.70%
   
43,556
 
MicroFinancial Incorporated
 
         271,354
         
   
Food 0.50%
   
14,932
 
Zhongpin, Inc. (China)
 
         194,414
         
   
Healthcare - Specialized Products & Services 1.80%
   
108,025
 
Alpha Pro Tech Ltd.
 
         180,402
33,366
 
Alphatec Holdings, Inc.
 
         168,165
34,901
 
American Dental Partners, Inc.
 
         350,057
       
         698,624
         
   
Housing - Construction 0.63%
   
73,590
 
Modtech Holdings, Inc.
 
           65,495
33,060
 
U.S. Home Systems, Inc.
 
         176,871
       
         242,366
         
   
Information Services 1.43%
   
438,015
 
Pfsweb, Inc.
 
         551,899
         
   
Insurance 2.41%
   
100,000
 
AmCOMP, Inc.
 
         935,000
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  5
   

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Shares
 
Common Stocks (Continued)
 Value
         

   
Internet Commerce 0.16%
   
54,375
 
Youbet.com, Inc.
$
           60,900
         
   
Medical Devices & Equipment 7.37%
   
50,602
 
Natus Medical Incorporated
 
         979,148
111,147
 
Orthovita, Inc.
 
         387,903
104,522
 
Precision Optics Corporation, Inc.
 
           14,738
19,028
 
Regeneration Technologies, Inc.
 
         165,163
99,218
 
Sonic Innovations, Inc.
 
         765,963
175,068
 
World Heart Corporation (Canada)
 
         542,712
       
      2,855,627
         
   
Medical Instruments 0.05%
   
27,790
 
Caprius, Inc.
 
           18,897
         
   
Oil Equipment 0.00%
   
650
 
Beluga Composites Corporation
 
                  -
         
   
Online Services 0.71%
   
17,230
 
The Knot, Inc.
 
         274,646
         
   
Optical Recognition Equipment 0.09%
   
15,000
 
VeriChip Corporation
 
           33,150
         
   
Paper - Packaging 0.02%
   
47,850
 
Chase Packaging Corporation
 
             9,570
         
   
Practice Management 0.85%
   
28,738
 
IntegraMed America, Inc.
 
         330,487
         
   
Restaurant 0.62%
   
54,903
 
Buca, Inc.
 
           49,413
59,952
 
Monterey Gourmet Foods, Inc.
 
         191,846
       
         241,259
         
   
Retail 0.40%
   
66,477
 
Bakers Footwear Group, Inc.
 
         152,897
33,737
 
Odimo Incorporated
 
             3,711
       
         156,608
         
   
Semiconductor 3.84%
   
62,668
 
CEVA, Inc.
 
         762,669
232,900
 
NeoMagic Corporation
 
         724,319
       
      1,486,988
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  6
   

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Shares
 
Common Stocks (Continued)
 Value
         

   
Semiconductor Equipment 4.43%
   
55,321
 
HI/FN, Inc.
$
         316,436
27,152
 
Integral Vision, Inc.
 
             1,900
109,215
 
Nova Measuring Instruments, Ltd. (Israel)
 
         282,867
56,274
 
Tegal Corporation
 
         225,096
72,924
 
Ultra Clean Holdings, Inc.
 
         889,673
       
      1,715,972
         
   
Services 3.55%
   
49,337
 
Collectors Universe, Inc.
 
         608,819
50,000
 
Internet Brands, Inc.
 
         351,500
40,920
 
OPNET Technologies, Inc.
 
         416,035
       
      1,376,354
         
   
Specialty Pharmaceuticals 0.38%
   
37,500
 
Barrier Therapeutics, Inc.
 
         147,750
         
   
Technology - Miscellaneous 5.21%
   
108,445
 
iPass, Inc.
 
         440,287
119,140
 
Intermap Technologies Corp. (Canada)
 
      1,255,485
68,910
 
Vuance, Ltd. (Israel)
 
         323,190
       
      2,018,962
         
   
Telecom Equipment 1.19%
   
55,571
 
COMARCO, Inc.
 
         307,308
189,908
 
Peco II, Inc.
 
         151,926
       
         459,234
         
   
Telecom Services 2.19%
   
69,605
 
Multiband Corporation
 
         187,238
69,810
 
WPCS International Incorporated
 
         660,403
       
         847,641
         
   
Telecommunications 0.54%
   
343,304
 
Emrise Corporation
 
         209,415
         
   
Therapeutics 2.80%
   
302,859
 
Anadys Pharmaceuticals, Inc.
 
         487,603
125,000
 
Pharmacopeia Drug Discovery, Inc.
 
         596,250
       
      1,083,853
         
   
Toys 0.01%
   
978
 
Corgi International, Ltd. (China) (ADR)
 
             2,172
         
   
Transportation 0.00%
   
113
 
Velocity Express Corporation
 
                346
         
   
Vitamins 1.72%
   
71,682
 
Omega Protein Corporation
 
         665,926
         
   
Total Common Stocks 86.51% (cost $33,843,227)
 
    33,499,389
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  7
   

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Shares
 
Preferred Stocks
 Value
         
 
   
Business Services 0.06%
   
24
 
UTIX Group, Inc. convertible
$
           18,462
57,698
 
UTIX Group, Inc. convertible (Restricted)
 
             5,885
       
           24,347
         
   
Communications Equipment - Software 0.26%
   
4
 
Vertical Communications, Inc. convertible
 
             4,808
96
 
Vertical Communications, Inc. convertible (Restricted)
 
           96,253
       
         101,061
         
   
Data Security 0.66%
   
100,739
 
Verdasys, Inc. Series B convertible (Illiquid)
 
         254,668
         
   
Electronic - Display 0.93%
   
549,484
 
E Ink Corporation Series A (Illiquid)
 
         241,773
904,490
 
E Ink Corporation Series B (Illiquid)
 
         118,194
       
         359,967
         
   
Food 1.44%
   
42,750
 
Zhongpin, Inc. convertible (China)
 
         556,605
         
   
Medical Instruments 0.18%
   
1,612
 
Caprius, Inc. convertible
 
           21,294
468
 
Caprius, Inc. convertible (Restricted)
 
           47,080
       
           68,374
         
   
Total Preferred Stocks 3.53% (cost $1,045,111)
 
      1,365,022
         
Principal
   
 Fair
Amount
 
Corporate Debt
 Value
         
   
Computer Services - Software 0.32%
   
 $         869
 
Primal Solutions, Inc. 4.9%, due 3/31/08
$
                869
 $    11,000
 
Primal Solutions, Inc. 5% convertible, due 3/31/08
 
           11,000
 $    39,503
 
Unify Corporation 11.25% convertible, due 10/31/10
 
           51,354
 $    16,867
 
Unify Corporation 11.25% convertible, due 10/31/11
 
           21,927
 $    40,000
 
Unify Corporation  Revolving Credit 10.5%, due 10/31/10
 
           40,000
       
         125,150
         
   
Consumer Products 0.31%
   
 $  120,886
 
Rockford Corporation 4.5% convertible, due 6/11/09
 
         120,886
         
   
Electronic Components 0.20%
   
 $    78,000
 
Interlink Electronics, Inc. 8% convertible, due 7/19/10 (Restricted)
           78,000
         
   
Technology - Miscellaneous 0.09%
   
 $    10,947
 
Vuance, Ltd. 8% convertible, due 11/19/09 (Israel)
 
           12,079
 $    22,053
 
Vuance, Ltd. 8% convertible, due 11/19/09 (Israel) (Restricted)
 
           22,053
       
           34,132
         
   
Total Corporate Debt 0.92% (cost $339,256)
 
         358,168
         
         
         See the accompanying Notes to the Financial Statements.
   
         
         
 
  8
   


 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Warrants
 
Warrants
 Value
         

   
Biotechnology 0.08%
   
96,038
 
La Jolla Pharmaceutical Company 12/14/10
$
           11,524
3,847
 
Metabasis Therapeutics, Inc. 9/30/10
 
                731
142,000
 
Opexa Therapeutics, Inc. 4/13/11
 
             8,520
100,000
 
Tapestry Pharmaceuticals, Inc. 4/6/11
 
           10,000
       
           30,775
         
   
Building Materials 0.12%
   
200,000
 
American Mold Guard, Inc. Class A 4/26/11
 
           22,000
200,000
 
American Mold Guard, Inc. Class B 4/26/11
 
           26,000
       
           48,000
         
   
Business Services 0.01%
   
1,500,000
 
UTIX Group, Inc. 1/13/11
 
             4,650
1,731
 
UTIX Group, Inc. 11/9/11 (Restricted)
 
                   -
6,924
 
UTIX Group, Inc. 9/28/12 (Restricted)
 
                   -
6,924
 
UTIX Group, Inc. 11/15/12 (Restricted)
 
                   -
       
             4,650
         
   
Communication Equipment - Software 0.11%
   
3,614
 
Vertical Communications, Inc. 12/16/08 (Restricted)
 
                   -
9,523
 
Vertical Communications, Inc. 9/28/15
 
             6,380
94,340
 
Vertical Communications, Inc. 12/1/16
 
           36,793
       
           43,173
         
   
Computer Services - Software 0.26%
   
805,910
 
LocatePlus Holding Corporation 7/8/10 (Restricted)
 
                   -
55,000
 
Primal Solutions, Inc. 3/31/11
 
                825
74,914
 
Unify Corporation 4/26/09
 
           41,952
53,600
 
Unify Corporation 10/31/12
 
           56,816
       
           99,593
         
   
Computer Systems 0.14%
   
134,321
 
Adept Technology, Inc. 11/18/08
 
           52,385
         
   
Consumer Products 0.00%
   
5,713
 
Rockford Corporation 6/11/09
 
                628
         
   
Electronic Components 0.05%
   
14,450
 
American Technology Corporation 7/18/09
 
             2,745
32,422
 
American Technology Corporation 8/6/10
 
           17,508
30,952
 
Interlink Electronics, Inc. 7/19/12 (Restricted)
 
                   -
       
           20,253
         
   
Electronic Equipment 0.04%
   
11,246
 
Iteris, Inc. B 9/28/11
 
           15,969
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  9
   


 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
 Fair
Warrants
 
Warrants (Continued)
 Value
         

   
Energy - Technology 0.35%
   
10,692
 
Arotech Corporation 6/30/08
$
                   -
4,680
 
Arotech Corporation 12/31/08
 
                   -
175,438
 
Capstone Turbine Corporation 1/23/12
 
         117,543
80,000
 
Quantum Fuel Systems Technologies Worldwide, Inc. 12/22/12
 
             8,800
34,146
 
Quantum Fuel Systems Technologies Worldwide, Inc. 4/27/14
 
             7,512
       
         133,855
         
   
Food 0.57%
   
25,683
 
Zhongpin, Inc. 1/30/11
 
         222,062
         
   
Medical Devices & Equipment 0.00%
   
9,210
 
Orthovita, Inc. 6/26/08
 
             1,566
536,190
 
World Heart Corporation 9/22/08 (Canada)
 
                   -
       
             1,566
         
   
Medical Instruments 0.04%
   
222,320
 
Caprius, Inc. 2/15/10
 
           14,451
4,477
 
Caprius, Inc. 2/16/11
 
             1,492
31,250
 
Caprius, Inc. 2/27/12 (Restricted)
 
                   -
14,750
 
Caprius, Inc. 12/5/12 (Restricted)
 
                   -
       
           15,943
         
   
Semiconductor Equipment 0.01%
   
60,250
 
Tegal Corporation 7/14/10
 
                446
270,793
 
Tegal Corporation 9/19/10
 
             2,329
       
             2,775
         
   
Technology - Miscellaneous 0.07%
   
90,990
 
Vuance, Ltd. 12/9/10 (Israel)
 
           26,387
8,250
 
Vuance, Ltd. 11/19/11 (Israel)
 
             1,403
       
           27,790
         
   
Telecom Services 0.53%
   
12,152
 
GoAmerica, Inc. 12/19/08
 
                  16
705,171
 
WPCS International Incorporated 11/16/09
 
         204,499
       
         204,515
         
   
Telecommunications 0.00%
   
6,431
 
Q Comm International, Inc. 6/24/08
 
64
         
   
Therapeutics 0.02%
   
12,868
 
Critical Therapeutics, Inc. 6/6/10
 
515
47,506
 
Memory Pharmaceuticals Corp. 9/22/10
 
             6,185
       
6,700
         
   
Total Warrants 2.40% (cost $12,762)
 
930,696
         
   
TOTAL INVESTMENTS 93.36% (cost $35,240,356)
 $
36,153,275
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  10
   
 
 
 
 

 

SPECIAL SITUATIONS FUND III, L.P.
   
(A Limited Partnership)
   
         
PORTFOLIO OF INVESTMENTS
   
         
DECEMBER 31, 2007
   
         
     
Fair
Shares
 
Securities Sold Short
Value
         

   
Medical Instruments 2.32%
   
155,564
 
Thermage, Inc.
 $
899,160
         
   
TOTAL SECURITIES SOLD SHORT 2.32% (proceeds $1,302,666)
 $
899,160
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         
 
All percentages are relative to Partners' Capital.
   
         
 
All securities are non-income producing except for Collectors Universe, Inc.,
 
COMARCO, Inc., Comfort Systems USA, Inc., CryptoLogic, Inc.,
   
 
Frequency Electronics, Inc., Interlink Electronics, Inc., KMG Chemicals, Inc.,
 
MicroFinancial Incorporated, Primal Solutions, Inc., Rockford Corporation,
 
Unify Corporation, Velocity Express Corporation, Vertical Communications,
 
Inc., Vuance, Ltd. and WFI Industries, Ltd.
   
         
         
         
         
         
         
         
         
See the accompanying Notes to the Financial Statements.
   
         
 
 
  11
   

 
 

 


SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)
PORTFOLIO OF INVESTMENTS
DECEMBER 31, 2007

 
 
Industry Concentration
Total                    
% of Partners' Capital
Automotive Components
$ 610,057
1.58
Biotechnology
2,012,486
5.20
Building Materials
171,564
0.44
Business Services
30,557
0.08
Capital Equipment
317,859
0.82
Casino - Services
306,768
0.79
Chemicals
617,688
1.60
Communication Equipment - Software
950,150
2.45
Communication Products - Equipment
383,972
0.99
Computer Services - Software
6,134,631
15.84
Computer Systems
657,444
1.70
Consumer Products
150,694
0.39
Data Security
254,668
0.66
Diagnostics
94,569
0.24
Electronic Components
682 113
1.76
Electronic - Display
359,967
0.93
Electronic Equipment
792,906
2.05
Electronic Instruments
1,282,805
3.31
Electronic Semiconductor
493,265
1.27
Energy - Services
226,711
0.59
Energy - Technology
884,107
2.28
Environmental Services
708,354
1.83
Financial Services
271,354
0.70
Food
973,081
2.51
Healthcare - Specialized Products & Services
698,624
1.80
Housing - Construction
242,366
0.63
Information Services
551,899
1.43
Insurance
935,000
2.41
Internet Commerce
60,900
0.16
Medical Devices & Equipment
2,857,193
7.38
Medical Instruments
(795,946)
(2.05)
Oil Equipment
            -
0.00
Online Services
       274,646
0.71
Optical Recognition Equipment
         33,150
0.09
Paper - Packaging
           9,570
0.02
Practice Management
       330,487
0.85
Restaurant
       241,259
0.62
    
See the accompanying Notes to the Financial Statements.
   
   
  12
   
                    
 
 
 
 

 
 
SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)
PORTFOLIO OF INVESTMENTS
DECEMBER 31, 2007

                                                                                                                                                                                   % of
                                                                                                                                                                                      Partners'
Industry Concentration (Continued)
Total
Capital
Retail
$ 156,608
0.40
Semiconductor
1,486,988
3.84
Semiconductor Equipment
1,718,747
4.44
Services
1,376,354
3.55
Specialty Pharmaceuticals
147,750
0.38
Technology - Miscellaneous
2,080,884
5.37
Telecom Equipment
459,234
1.19
Telecom Services
1,052,156
2.72
Telecommunications
209,479
0.54
Therapeutics
1,090,553
2.82
Toys
2,172
0.01
Transportation
346
0.00
Vitamins
665,926
1.72
TOTAL PORTFOLIO
$ 35,254,115
91.04%
 
See the accompanying Notes to the Financial Statements.
 



 
SPECIAL SITUATIONS FUND III, L.P.
         
(A Limited Partnership)
         
               
STATEMENT OF OPERATIONS
         
               
FOR THE YEAR ENDED DECEMBER 31, 2007
         
               
               
               
 
               
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
     
 
Net realized gain on investments
$
4,780,565
     
 
Net change in unrealized appreciation
 
(5,642,636)
     
   
Net Realized and Unrealized Gain (Loss) on Investments
     
$
(862,071)
               
INVESTMENT INCOME (LOSS)
         
 
Investment Income
         
   
Interest
 
198,546
     
   
Dividends (net of withholding taxes of $1,467)
 
126,365
     
   
Securities lending fees
 
5,492
     
   
Total Investment Income
 
330,403
     
               
 
Operating Expenses
         
   
Administrator's fee
 
334,454
     
   
Professional fees
 
130,215
     
   
Independent General Partners' fees
 
80,000
     
   
Custody fee and other
 
48,642
     
   
Total Operating Expenses
 
593,311
     
               
   
Net Investment Loss
       
(262,908)
               
NET LOSS
     
$
(1,124,979)
               
               
               
               
               
               
               
               
               
               
               
               
See the accompanying Notes to the Financial Statements.
         
               
 
 
  14
         

 
 

 

 
SPECIAL SITUATIONS FUND III, L.P.
         
(A Limited Partnership)
         
               
STATEMENT OF CHANGES OF PARTNERS' CAPITAL
         
               
     
 
                                       
           
Per Limited
   
 Corporate
 
 Individual
     
           
Partners'
 
Limited
 
 General
 
 General
     
           
Unit
 
Partners
 
 Partner
 
 Partners
 
 Total
                                       
YEAR ENDED
                             
 
DECEMBER 31, 2006:
                             
                                       
BALANCE,
                             
 
DECEMBER 31, 2005
       
$
   485,061,719
 
 $
    37,123,511
 
 $
  4,508,046
 
 $
  526,693,276
                                       
   
Exchanges
         
  (446,896,503)
   
  (34,198,683)
   
 (4,101,826)
   
 (485,197,012)
                                       
   
Capital transfers
         
                (658)
   
                658
   
             -
   
                 -
                                       
   
Allocation of net income:
                           
                                       
     
Corporate General
                             
                                       
       
Partner - Performance
         
                  -
   
      1,310,584
   
             -
   
      1,310,584
                                       
     
Partners
         
       4,762,068
   
         426,834
   
       53,432
   
      5,242,334
                                       
   
Repurchases
         
      (3,893,110)
   
                -
   
             -
   
     (3,893,110)
                                       
BALANCE,
                             
 
DECEMBER 31, 2006
 
$
25,000
   
     39,033,516
   
      4,662,904
   
     459,652
   
    44,156,072
                                       
SIX MONTHS ENDED
                             
 
JUNE 30, 2007:
                             
                                       
   
Capital transfers
         
                 376
   
              (376)
   
             -
   
                 -
                                       
   
Allocation of net income:
                           
                                       
     
Corporate General
                             
                                       
       
Partner - Performance
         
                  -
   
         561,129
   
             -
   
         561,129
                                       
     
Partners
 
$
1,271
   
       1,984,146
   
         237,003
   
       23,365
   
      2,244,514
                                       
   
Repurchases
         
      (2,350,292)
   
                -
   
             -
   
     (2,350,292)
                                       
BALANCE,
                             
 
JUNE 30, 2007
 
$
25,000
   
     38,667,746
   
      5,460,660
   
     483,017
   
    44,611,423
                                       
SIX MONTHS ENDED
                             
 
DECEMBER 31, 2007:
                             
                                       
   
Capital contributions
         
            82,000
   
                -
   
             -
   
           82,000
                                       
   
Capital transfers
         
                 313
   
              (313)
   
             -
   
                 -
                                       
   
Allocation of net loss
 
$
(2,199)
   
      (3,407,925)
   
       (480,217)
   
      (42,480)
   
     (3,930,622)
                                       
   
Repurchases
         
      (2,038,140)
   
                -
   
             -
   
     (2,038,140)
                                       
BALANCE,
                             
 
DECEMBER 31, 2007
 
$
25,000
 
$
     33,303,994
 
 $
      4,980,130
 
 $
     440,537
 
 $
    38,724,661
                                       
 
See Note 4 for changes in Units outstanding.
                 
                                       
                                       
See the accompanying Notes to the Financial Statements.
                 
                                       
 
                 
  15
                 
 
 
 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 1 -          GENERAL:

Organization:

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 “1940 Act”).  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 Fund’s outstanding Units.  The Fund has five Individual General Partners of which four are independent, as defined in the 1940 Act.

The Corporate General Partner and Investment Adviser is MGP Advisers Limited Partnership (“MGP”), of which the General Partner is AWM Investment Company, Inc. (“AWM”).  MGP has appointed AWM as agent and nominee, with the rights, power and authority to act on behalf of MGP with respect to the execution of trades and related matters concerning the Fund.  Austin W. Marxe, an Individual General Partner of the Fund and a limited partner of MGP owns directly and indirectly a controlling interest in MGP and AWM.  Mr. Marxe is primarily responsible for managing the Fund’s 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.

Exchange Tender and Safe Harbor Amendments:

On December 31, 2005, a “grandfather” provision under the Internal Revenue Code, which had the effect of allowing the Fund to satisfy a “private placement safe harbor,” expired.  This provision had allowed the Fund to be treated as a partnership for federal income tax purposes rather than as a publicly traded partnership, which is generally taxed as a corporation.  The Fund is seeking to satisfy a different safe harbor, which in general, limits the semi-annual repurchase offers to a maximum of 5% of Units outstanding per semi-annual period (or 10% per year) and increases the repurchase request deadline from 14 days to 60 days prior to the repurchase pricing date (the “Safe Harbor Amendments”).  These changes have the effect of reducing the liquidity of a partner’s investment in the Fund.

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 1 -          GENERAL (CONTINUED):

Exchange Tender and Safe Harbor Amendments (Continued):

A Special Meeting of Partners was held on November 16, 2005 to vote to (1) amend the Fund’s Agreement to give the Individual General Partners authority to make offers for special redemptions of Units (the “Redemption Authority Amendment”) and (2) consent to a proposed offer to be made by the Individual General Partners for Limited Partners who are “Qualified Purchasers” (as defined in the 1940 Act) to exchange their Units in the Fund for units of Special Situations Fund III QP, L.P., a Delaware limited partnership recently formed to be a companion fund to the Fund (the “Exchange Tender Offer Proposal”).  These issues passed with majority consent.  The Fund was granted exemptive relief from the Securities and Exchange Commission (the “Commission”) to permit the one-time Exchange Tender Offer at December 31, 2005.

In the Exchange Tender Offer, a limited partner who is a Qualified Purchaser had the option to: (i) accept the one-time exchange tender offer, (ii) accept the cash repurchase offer in whole or in part or (iii) remain invested in the Fund (with the expectation that the Fund will adopt the Safe Harbor Amendments).  A limited partner who is not a Qualified Purchaser had the option to:  (i) accept the cash repurchase offer in whole or in part or (ii) remain invested in the Fund (with the expectation that the Fund will adopt the Safe Harbor Amendments).

A Special Meeting of Partners was held on March 29, 2006 to vote to (1) amend the Fund’s Agreement to limit semi-annual repurchase offers by the Fund to partners to a maximum of 5% of Units outstanding per semi-annual period (or 10% per year) and (2) increase the repurchase request deadline for electing to accept a repurchase offer from the Fund from 14 days to 60 days prior to the repurchase pricing date.  These Safe Harbor Amendments passed with majority consent.

The Fund submitted a request for an exemption from the 1940 Act to the Commission in May 2005 to allow for the repurchase request deadline to be more than 14 days from the repurchase pricing date.  Commission approval is still pending on this exemption request.  Due to the timing and uncertainty of the Commission’s response, and to ensure the continuance of the taxation of the Fund as a partnership, the Individual General Partners have requested the Limited Partners to consent to the suspension of the Fund’s mandatory semi-annual repurchase policies.  Such suspension shall be in effect until such time the exemption request is granted or the Individual General Partners deem it is in the best interest of the Fund to resume such policies.  As of June 19, 2006, the majority of the Limited Partners consented to the suspension, thereby agreeing to rely solely on the authority of the Individual General Partners to make repurchase offers in their sole discretion.  Although the Individual General Partners are not required to make semi-annual repurchase offers, it is their intention to make such offers within the guidelines that ensure the Fund will continue to be taxed as a partnership.


 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





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 generally valued at cost, which approximates fair value as determined in good faith by the Individual General Partners.  Warrant valuations determined in good faith by the General Partner utilize the Black Scholes model and take into account other factors deemed relevant.  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 held in a brokerage account.  The Fund considers all money market accounts and all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.

The Fund entered into agreements to lend portfolio securities to qualified borrowers in order to earn additional income.  The terms of each 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.  Gain or loss in the fair value of portfolio securities loaned that may occur during the term of the loan will be attributed to the Fund.  At December 31, 2007, there were no securities loaned.

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.


 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 3 -           ALLOCATION OF ACCOUNTING INCOME AND LOSSES:

The Agreement provides for allocations of profits and losses at the close of each fiscal period (see Note 4).

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 a fiscal period, the performance allocation to MGP will not apply to future periods until the loss has been recovered.  The amount of loss carryover at December 31, 2007 was $3,930,622.

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 Partner’s or a Limited Partner’s 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 partner’s capital account divided by $25,000.

As of the close of each fiscal period, the Fund will generally offer to repurchase 5% of the outstanding Units.  The repurchase request deadline had generally been June 16 and December 17, of each year, but is subject to change based on the Commission’s approval of the exemptive request discussed in Note 1.

The Fund has the right to sell additional Units at the beginning of each fiscal period.

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 4 -          PARTNER CAPITAL ACCOUNT TRANSACTIONS (CONTINUED):

Changes in Units outstanding are as follows:

   
Corporate
Individual
 
 
Limited
General
General
 
 
Partners
Partner
Partners
Total
         
Balance, December 31, 2005
19,402.4688
1,484.9404
180.3219
21,067.7311
Exchanges, January 1, 2006
(17,875.8602)
(1,367.9473)
(164.0730)
(19,407.8805)
Transfers
(0.0263) 
0.0263
             -         
-
Semi-annual adjustments of Units
190.4828
69.4967
2.1372
262.1167
Repurchases
(155.7244)
             -         
             -         
(155.7244)
Balance, December 31, 2006
1,561.3407 
186.5161 
18.3861 
1,766.2429
Transfers
0.0150
(0.0150)
             -         
-
Semi-annual adjustment of Units
79.3659
31.9252
0.9346
        112.2257
Repurchases
(94.0117)
             -         
             -         
(94.0117)
Balance, June 30, 2007
1,546.7099
218.4263
19.3207
1,784.4569
Additional Units sold
3.2800
             -         
             -         
3.2800
Transfers
0.0125
(0.0125)
             -         
-
Semi-annual adjustment of Units
(136.3170)
(19.2087)
(1.6992)
(157.2249)
Repurchases
(81.5256)
             -         
             -         
(81.5256)
Balance, December 31, 2007
1,332.1598
199.2051
17.6215
1,548.9864


NOTE 5 -           PURCHASES AND SALES OF SECURITIES:

Purchases and sales of securities for the year ended December 31, 2007 aggregated
$17,813,881 and $23,830,267 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 partner’s respective share of the Fund’s income and expenses reported for income tax purposes.


 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 7 -           RELATED PARTY TRANSACTIONS:

AWM is the administrator of the Fund.  The administrator’s 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 -          OTHER AGREEMENTS:

The Fund entered into a consulting agreement whereby the consultant will provide management and financial advisory services to companies in which the Fund invests (“covered investments”). 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 consulting agreement.


NOTE 9 -          FINANCIAL HIGHLIGHTS:
 
Year Ended December 31,
 
 
2007
2006
2005
2004
2003
Ratio of investment expenses to average net assets1
0.00%
0.00%
0.00%
0.00%
    0.57%
           
Ratio of operating expenses to average net assets
1.33%
1.65%
0.86%
0.84%
1.03%
           
Ratio of total expenses to average net assets
1.33%
1.65%
0.86%
0.84%
1.60%
           
Ratio of net income (loss) to average net assets
(2.52%)
15.21%
2.53%
23.09%
74.23%
           
 
Portfolio turnover rate
43.06%
81.20%
55.90%
63.46%
52.43%
 
1The investment expenses reflected in the above ratio include, but are not limited to, consulting fees having a direct correlation to the performance of “covered investments,” as further defined in Note 8 herein.

 
 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 10 -        RETURN ON PARTNER INVESTMENT:

At December 31, 2007, the value of a $25,000 investment made at each respective subscription date is as follows:

Subscription Date
Value
Subscription Date
Value
January 1, 1994
$  236,653
July 1, 2001
$  50,216
January 1, 1995
216,351
January 1, 2002
50,202
July 1, 1995
191,569
July 1, 2002
57,272
January 1, 1996
159,758
January 1, 2003
61,983
July 1, 1996
120,601
July 1, 2003
47,432
January 1, 1997
114,141
January 1, 2004
33,232
July 1, 1997
108,117
July 1, 2004
30,893
January 1, 1998
95,920
January 1, 2005
27,679
July 1, 1998
98,351
July 1, 2005
30,015
January 1, 1999
109,032
January 1, 2006
27,112
July 1, 1999
100,605
July 1, 2006
25,548
January 1, 2000
65,573
January 1, 2007
23,960
July 1, 2000
56,168
July 1, 2007
22,801
January 1, 2001
57,444
   


NOTE 11 -         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.

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 12 -         INVESTMENTS IN RESTRICTED AND ILLIQUID SECURITIES:

The Fund has made investments in securities that are not freely tradable due to Securities and Exchange Commission’s regulations.  These restricted securities may not be sold except in exempt transactions or when they have become registered under the Securities Act of 1933.  Investing in restricted securities generally poses a greater risk than investing in more widely held, publicly traded companies.  Restrictions imposed on the sale of these securities and the lack of a secondary market may affect the timing and price obtained for such sales.  The following is a list of restricted and illiquid securities valued by the Fund as of December 31, 2007:

Issuer
Type of Security
Acquisition Date
Acquisition Cost
Value
Value as a % of Partners’ Capital
Excapsa Software, Inc.
Common
2/7/06
$    282,219
$   69,144
0.18%
LocatePlus Holdings Corporation
Common
7/8/05
181,673
1,468
0.00%
Caprius, Inc.
Preferred
2/28/07
25,000
25,000
0.06%
Caprius, Inc.
Preferred
12/7/07
22,080
22,080
0.06%
E Ink Corporation, Series A
Preferred
11/7/05
241,773
241,773
0.62%
E Ink Corporation, Series B
Preferred
7/17/07
33,234
33,234
0.09%
E Ink Corporation, Series B
Preferred
9/12/07
84,952
84,952
0.22%
UTIX Group, Inc.
Preferred
11/16/06
14,999
1,269
0.00%
UTIX Group, Inc.
Preferred
9/28/07
15,002
2,308
0.01%
UTIX Group, Inc.
Preferred
11/15/07
15,002
2,308
0.01%
Verdasys, Inc. Series B
Preferred
9/3/04
201,478
254,668
0.66%
Vertical Communications, Inc.
Preferred
12/1/06
96,253
96,253
0.25%
Interlink Electronics, Inc.
Corp. Debt
7/20/07
78,000
78,000
0.20%
Vuance, Ltd 8%
Corp. Debt
11/21/06
22,053
22,053
0.05%
Total restricted and illiquid securities
   
$1,313,718
$934,510
2.41%


NOTE 13 - CREDIT RISK CONCENTRATION:

Cash and cash equivalents consist principally of balances held in a brokerage account with Morgan Stanley & Co. Incorporated.  The balances are insured by the Securities Investor Protection Corporation up to $500,000, including $100,000 for free cash balances.  Net cash balances and securities in excess of these limits are protected by excess coverage provided by Morgan Stanley & Co. Incorporated, up to the full net equity value of each account including unlimited coverage for uninvested cash.

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 14 -
NEW ACCOUNTING PRONOUNCEMENTS:

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB 109, Accounting for Income Taxes”.  This Interpretation, which applies to all entities, including pass through entities such as the Fund, provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements.  It is effective for all fiscal years beginning after December 15, 2006, and is to be applied to all open tax years as of the date of effectiveness.  Management has concluded that there is no impact on the Fund’s financial statements as a result of implementing FIN 48.

On September 15, 2006, the Financial Accounting Standards Board issued Standard No. 157, "Fair Value Measurements" ("FAS 157"). FAS 157 which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years.  At this time, management believes the adoption of FAS 157 will have no material impact on the financial statements of the Fund.


NOTE 15 -         APPROVAL OF ADVISORY CONTRACT (UNAUDITED):

At a special meeting of the Independent General Partners (“IGPs”) of the Fund, the IGPs considered whether to approve the continuation of the existing Investment Advisory Agreement (the “Advisory Agreement”) between the Fund and MGP.  In addition to the materials the IGPs had reviewed throughout the course of the year, the IGPs received materials relating to the advisory agreement before the meeting and had the opportunity to ask questions and request further information in connection with its consideration.

The approval of the Advisory Agreement and the continuation of MGP as the investment adviser of the Fund is based upon the following findings as well as the specific considerations discussed below: (1) that the Advisory Agreement with MGP is in the best interest of the Fund; (2) that the services to be performed by MGP pursuant to the Advisory Agreement are services required for the operation of the Fund; (3) that MGP can provide services the nature and quality of which are at least equal to those provided by others offering the same services; and (4) that the fees for such services are fair and reasonable in light of the usual and customary charges made by others for services of the same nature and quality.

In determining whether to approve the Advisory Agreement, the IGPs considered various relevant factors, including those discussed below.


 


SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS




 
 
 
NOTE 15 -          APPROVAL OF ADVISORY CONTRACT (UNAUDITED) (CONTINUED):

Nature, Extent and Quality of Service

In considering the nature, extent and quality of service to the Fund, the IGPs reviewed the Fund’s investment objectives and strategy along with the advisory services provided to the Fund by MGP over both short- and long-term periods.  The services provided include investment research, portfolio management and trading.  The IGPs took into account the organizational depth and stability of the firm, noting that the Fund managers have considerable investment and trading experience and have managed the Fund since its inception.  Furthermore, they do not use brokerage commissions to purchase third-party research.

Investment Performance

The IGPs considered the short- and long-term performance of the Fund, including both lesser and more profitable periods and noted favorable performance over the Fund’s history as compared with relevant market indices.

Costs of Services Provided

The IGPs considered the compensation arrangement with MGP, such that the performance allocation of 20% is customary for the Fund’s peer group.  The IGPs also noted the use of a “highwater” mark in determining the profit threshold.  The IGPs reviewed the expense ratio of the Fund and determined it to be fair and reasonable as compared to the Fund’s peer group.  Although the administrative fee charged is below industry averages, overall expense ratio has increased due to the reduction in the net assets of the Fund resulting from the exchange offer.

Profits

The IGPs considered the level of MGP’s profits in managing the Fund and concluded that the profit was fair and customary based on the Fund’s peer group.

Economies of Scale

The IGPs, in considering economies of scale, reviewed whether there have been or if there is a potential for the realization of future economies of scale, and whether the Fund’s investors would benefit from such scale.  The IGPs noted that the consideration of economies of scale is not a determining factor as it relates to the approval of the Advisory Agreement with MGP.

In considering whether to approve the continuation of the advisory agreement, the IGPs did not weigh any one factor more than another. They concluded that the approval of the agreement was in the best interest of the Fund. The advisory agreement will continue for one year and is renewable by the IGPs after that for successive one year periods.

 
 

 

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS





NOTE 16 -         PROXY VOTING (UNAUDITED):

A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities is available (1) without charge, upon request, by calling (212) 319-6670 or (2) on the Securities and Exchange Commission (“SEC”) website at www.sec.gov.

The Fund’s proxy voting record for the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling (212) 319-6670 or (2) on the SEC’s website at www.sec.gov.  Information as of June 30 each year will generally be available by the following August 31.


NOTE 17 -         FORM N-Q (UNAUDITED):

The Fund files a complete Portfolio of Investments for the first and third quarters of its fiscal year with the SEC on Form N-Q within 60 days of the end of such fiscal quarter.  The Fund’s Form N-Q is available on the SEC’s website at www.sec.gov and may be reviewed and copied at the SEC’s Public Reference Room in Washington, DC.  Information on the operation of the SEC’s Public Reference Room may be obtained by calling 1-800-SEC-0330.




 
 

 

 

 

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) 319-6670, 527 Madison Avenue, Suite 2600, 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 $73,800 and $69,000 for 2007 and 2006, 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 $22,800 and $22,000 for 2007 and 2006, 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.  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 2007 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 2007 and 2006 were $12,025 and $7,175, respectively.

Item 5.                                Audit Committee of Listed Registrants.

Not applicable.

Item 6.                                Schedule of Investments

The Audited Schedule of Investments is included in the report to shareholders filed under Item 1 of the Form.

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.
Portfolio Managers of Closed-End Management Investment Companie.

As of the original filing of this report on March 7, 2007, Austin Marxe, President of AWM Investment Company, Inc, (“AWM”) since 1991 and David Greenhouse, Vice-President of AWM since 1992, are primarily responsible for the day-to-day management of the registrant’s portfolio.  AWM serves as the general partner of MGP Advisers Limited Partnership (“MGP”), the registrant’s investment adviser.  Pursuant to an agreement dated June 7, 2006 by and between the registrant, MGP and AWM, MGP appointed AWM as agent and nominee, with the rights, power and authority to execute trades and transact such other business as outlined in such agreement on behalf of the registrant.  Mr. Marxe, Mr. Greenhouse and Adam Stettner are the limited partners of MGP.  Mr. Marxe also serves as an Individual General Partner of the registrant.

Mr. Marxe, Mr. Greenhouse and Mr. Stettner also serve as members of the general partners to six other Special Situations funds (the “Affiliates”) that have performance based advisory fees, with combined total assets of $ 1,019,304,271 as of December 31, 2007.

MGP makes investments on behalf of the registrant in accordance with the stated investment objectives for the registrant.  MGP is given discretionary authority over the registrant’s investments.  When purchases of securities are made with respect to the registrant individually, the purchase is allocated solely to the account of the registrant.  At times, however, MGP, along with AWM, the investment adviser to the Affiliates may purchase the same security in an aggregate amount for the accounts of one or more of the Special Situations funds (which includes the Registrant).  When securities are purchased by the registrant in conjunction with other Special Situations funds, MGP and AWM will allocate securities amongst the registrant and the other Special Situations funds in a fair and equitable manner depending upon the facts and circumstances of each situation, taking into account the Registrant’s stated investment objectives, liquidity, other holdings of such securities and overall portfolio, and other factors considered relevant.

MGP, the registrant’s investment advisor, receives a 20% performance allocation at six month periods ending June 30 and December 31.  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.  All investment advisers of the Special Situations funds managed by Mr. Marxe, Mr. Greenhouse and Mr. Stettner receive similar 20% performance based advisory fees with loss recovery provisions.

As of December 31, 2007 Austin Marxe and David Greenhouse each own in excess of $1,000,000 of equity securities in the registrant.

 
Item 9.            Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.

 
Not applicable at this time.



Item 10.
Submission of Matters to a Vote of Security Holders.

A Special Meeting of Partners was held on November 16, 2005 to vote to (1) amend the Fund’s Agreement to give the Individual General Partners authority to make offers for special redemptions of Units (the “Redemption Authority Amendment”) and (2) consent to a proposed offer to be made by the Individual General Partners for Limited Partners who are “Qualified Purchasers” (as defined in the 1940 Act) to exchange their Units in the Fund for units of Special Situations Fund III QP, L.P., a Delaware limited partnership recently formed to be a companion fund to the Fund (the “Exchange Tender Offer Proposal”).  These issues passed with majority consent.

A Special Meeting of Partners was held on March 29, 2006 to vote to (1) amend the Fund’s Agreement to limit semi-annual repurchase offers by the Fund to partners to a maximum of 5% of Units outstanding per semi-annual period (or 10% per year) and (2) increase the repurchase request deadline for electing to accept a repurchase offer from the Fund from 14 days to 60 days prior to the repurchase pricing date.  These Safe Harbor Amendments passed with majority consent.

The Fund submitted a request for an exemption from the 1940 Act to the Commission in May 2005 to allow for the repurchase request deadline to be more than 14 days from the repurchase pricing date.  Commission approval is still pending on this exemption request.  Due to the timing and uncertainty of the Commission’s response, and to ensure the continuance of the taxation of the Fund as a partnership, the Individual General Partners have requested the Limited Partners to consent to the suspension of the Fund’s mandatory semi-annual repurchase policies.  Such suspension shall be in effect until such time the exemption request is granted or the Individual General Partners deem it is in the best interest of the Fund to resume such policies.  As of June 19, 2006, the majority of the Limited Partners consented to the suspension, thereby agreeing to rely solely on the authority of the Individual General Partners to make repurchase offers in their sole discretion.  Although the Individual General Partners are not required to make semi-annual repurchase offers, it is their intention to make such offers within the guidelines that ensure the Fund will continue to be taxed as a partnership.


Item 11.
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 12.
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 7, 2007


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 7, 2007 2007


By:              _/s/ Rose M. Carling_
Rose M. Carling, Principal Financial Officer

Date: March 7, 2007