UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

Form 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________
 
Commission file number: 0-11576

HARRIS & HARRIS GROUP, INC. 
(Exact Name of Registrant as Specified in Its Charter)
 
New York
  
13-3119827
(State or Other Jurisdiction of
  
(I.R.S. Employer Identification No.)
Incorporation or Organization)
    
     
111 West 57th Street, New York, New York
  
10019
(Address of Principal Executive Offices)
  
(Zip Code)

(212) 582-0900
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No x 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
Class
  
Outstanding at November 8, 2007
Common Stock, $0.01 par value per share
  
23,309,148 shares


Harris & Harris Group, Inc.
Form 10-Q, September 30, 2007

   
Page Number
PART I. FINANCIAL INFORMATION
    
     
Item 1. Consolidated Financial Statements
  
1
     
Consolidated Statements of Assets and Liabilities
  
2
     
Consolidated Statements of Operations
  
3
     
Consolidated Statements of Cash Flows
  
4
     
Consolidated Statements of Changes in Net Assets
  
5
     
Consolidated Schedule of Investments
  
6
     
Notes to Consolidated Financial Statements
  
18
     
Financial Highlights
  
27
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
  
28
     
Background and Overview
  
28
     
Results of Operations
  
31
     
Financial Condition
  
35
     
Liquidity
  
37
     
Capital Resources
  
37
     
Critical Accounting Policies
  
38
     
Recent Developments - Portfolio Companies
  
39
     
Forward Looking Statements
  
40
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
40
     
Item 4. Controls and Procedures
  
42
     
PART II. OTHER INFORMATION
    
     
Item 1A. Risk Factors
  
43
     
Item 6. Exhibits
  
43
     
Signatures
  
45
     
Exhibit Index
  
46


PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

The information furnished in the accompanying consolidated financial statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim period presented.

Harris & Harris Group, Inc.® (the "Company," "us," "our" and "we"), is an internally managed venture capital company that has elected to operate as a business development company under the Investment Company Act of 1940 (the "1940 Act"). Certain information and disclosures normally included in the consolidated financial statements in accordance with Generally Accepted Accounting Principles have been condensed or omitted as permitted by Regulation S-X and Regulation S-K. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2006, contained in our Annual Report on Form 10-K for the year ended December 31, 2006.

On September 25, 1997, our Board of Directors approved a proposal to seek qualification as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code (the "Code"). At that time, we were taxable under Subchapter C of the Code (a "C Corporation"). We filed for the 1999 tax year to elect treatment as a RIC. In order to qualify as a RIC, we must, in general, (1) annually, derive at least 90 percent of our gross income from dividends, interest, gains from the sale of securities and similar sources; (2) quarterly, meet certain investment diversification requirements; and (3) annually, distribute at least 90 percent of our investment company taxable income as a dividend. In addition to the requirement that we must annually distribute at least 90 percent of our investment company taxable income, we may either distribute or retain our taxable net capital gains from investments, but any net capital gains not distributed could be subject to corporate level tax. Further, we could be subject to a four percent excise tax to the extent we fail to distribute at least 98 percent of our annual investment company taxable income and would be subject to income tax to the extent we fail to distribute 100 percent of our investment company taxable income.

Because of the specialized nature of our investment portfolio, we generally can satisfy the diversification requirements under Subchapter M of the Code if we receive a certification from the Securities and Exchange Commission (“SEC”) that we are "principally engaged in the furnishing of capital to other corporations which are principally engaged in the development or exploitation of inventions, technological improvements, new processes, or products not previously generally available."  
 
On June 20, 2007, we received SEC certification for 2006, permitting us to qualify for RIC treatment for 2006 (as we had for the years 1999 through 2005) pursuant to Section 851(e) of the Code. Although the SEC certification for 2006 was issued, there can be no assurance that we will qualify for or receive such certification for subsequent years (to the extent we need additional certification as a result of changes in our portfolio) or that we will actually qualify for Subchapter M treatment in subsequent years. In addition, under certain circumstances, even if we qualified for Subchapter M treatment in a given year, we might take action in a subsequent year to ensure that we would be taxed in that subsequent year as a C Corporation, rather than as a RIC. Because Subchapter M does not permit deduction of operating expenses against long-term capital gains, it is not clear that the Company and its shareholders have paid less taxes since 1999 than they would have paid had the Company remained a C Corporation.
 
1
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES 

   
 September 30, 2007
  
December 31, 2006
  
   
 (Unaudited)
      
           
ASSETS
          
           
Investments, at value (Cost: $143,074,052 at 9/30/07,
          
$121,331,398 at 12/31/06)
   $ 132,946,492  
$
112,323,978
  
Cash and cash equivalents
     288,397    
2,071,788
  
Restricted funds
     2,533,929    
2,149,785
  
Receivable from broker
     0    
819,905
  
Interest receivable
     499,079    
625,372
  
Prepaid expenses
     142,459    
10,945
  
Other assets
     286,123    
326,817
  
Total assets
   $ 136,696,479  
$
118,328,590
  
               
LIABILITIES & NET ASSETS
              
               
Accounts payable and accrued liabilities
   $ 4,237,657  
$
4,115,300
  
Accrued profit sharing (Note 5)
     0    
261,661
  
Deferred rent
     16,225    
21,326
  
Total liabilities
     4,253,882    
4,398,287
  
               
Net assets
   $ 132,442,597  
$
113,930,303
  
               
Net assets are comprised of:
              
Preferred stock, $0.10 par value,
              
2,000,000 shares authorized; none issued
   $ 0  
$
0
  
Common stock, $0.01 par value, 45,000,000 shares authorized at
              
9/30/07 and 12/31/06; 25,100,598 issued at 9/30/07 and
              
22,843,757 issued at 12/31/06
     251,006    
228,438
  
Additional paid-in capital (Note 7)
     158,170,494    
129,801,201
  
Accumulated net realized loss
     (12,507,339 )  
(3,747,912
)
Accumulated unrealized depreciation of investments
     (10,127,560 )  
(9,007,420
)
Unrecognized net gain on retirement benefit plans
     61,527    
61,527
  
Treasury stock, at cost (1,828,740 shares at 9/30/07
              
and 12/31/06)
     (3,405,531 )  
(3,405,531
)
               
Net assets
   $ 132,442,597  
$
113,930,303
  
               
Shares outstanding
     23,271,858    
21,015,017
  
               
Net asset value per outstanding share
   $ 5.69  
$
5.42
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
2
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
Three Months Ended Sept. 30
  
Nine Months Ended Sept. 30
  
   
2007
  
2006
  
2007
  
2006
  
Investment income:
                  
Interest from:
                  
Fixed-income securities
  
$
743,375
  
$
719,619
  
$
2,033,574
  
$
2,302,246
  
Miscellaneous income
    
39
    
0
    
39
    
7,500
  
Total investment income
    
743,414
    
719,619
    
2,033,613
    
2,309,746
  
                           
Expenses:
                          
Salaries, benefits and stock-based
                          
compensation (Note 4)
    
3,230,838
    
3,151,338
    
8,409,888
    
4,741,850
  
Administration and operations
    
311,332
    
242,930
    
1,049,375
    
971,471
  
Profit-sharing provision (Note 5)
    
0
    
51,545
    
0
    
51,545
  
Professional fees
    
155,999
    
95,742
    
673,261
    
483,567
  
Rent
    
60,314
    
59,310
    
178,634
    
177,929
  
Directors’ fees and expenses
    
80,364
    
85,287
    
333,717
    
266,089
  
Depreciation
    
16,734
    
16,201
    
47,955
    
49,097
  
Custodian fees
    
5,428
    
6,056
    
17,163
    
18,618
  
Total expenses
    
3,861,009
    
3,708,409
    
10,709,993
    
6,760,166
  
                           
Net operating loss
    
(3,117,595
)
  
(2,988,790
)
  
(8,676,380
)
  
(4,450,420
)
                           
Net realized gain (loss) from investments:
                          
Realized gain from investments
    
14,828
    
6,420
    
5,941
    
19,873
  
Income tax expense (benefit) (Note 6)
    
4,083
    
(242,352
)
  
88,988
    
(222,815
)
Net realized gain (loss) from
                          
investments
    
10,745
    
248,772
    
(83,047
)
  
242,688
  
                           
Net decrease (increase) in unrealized
                          
depreciation on investments:
                          
Change on investments held
    
3,711,087
    
151,926
    
(1,120,140
)
  
(1,317,347
)
Net decrease (increase) in unrealized
                          
depreciation on investments
    
3,711,087
    
151,926
    
(1,120,140
)
  
(1,317,347
)
                           
Net realized and unrealized gain (loss)
                          
from investments
    
3,721,832
    
400,698
    
(1,203,187
)
  
(1,074,659
)
                           
Net increase (decrease) in net assets
                          
resulting from operations
  
$
604,237
  
$
(2,588,092
)
$
(9,879,567
)
$
(5,525,079
)
                           
Per average basic and diluted outstanding share
  
$
0.03
  
$
(0.12
)
$
 (0.45 )
$
 (0.27 )
                           
Average outstanding shares
    
23,235,023
    
20,756,345
    
22,084,893
    
20,756,345
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
3

HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) 
   
Nine Months Ended
  
Nine Months Ended
  
   
September 30, 2007
  
September 30, 2006
  
           
Cash flows used in operating activities:
          
Net decrease in net assets resulting from operations
  
$
(9,879,567
)
$
(5,525,079
)
Adjustments to reconcile net decrease in net
              
assets resulting from operations to net cash
              
used in operating activities:
              
Net realized and unrealized loss on investments
    
1,114,199
    
1,297,473
  
Depreciation and amortization
    
31,425
    
(351,229
)
Stock-based compensation expense
    
5,725,031
    
2,585,680
  
 
              
Changes in assets and liabilities:
              
Restricted funds
    
(384,144
)
  
(282,806
)
Receivable from portfolio company
    
(5,000
)
  
75,000
  
Receivable from broker
    
819,905
    
0
  
Interest receivable
    
126,292
    
(317,199
)
Income tax receivable
    
7,209
    
(159,199
)
Prepaid expenses
    
(131,514
)
  
(138,258
)
Other assets
    
25,630
    
0
  
Accounts payable and accrued liabilities
    
122,356
    
268,980
  
Accrued profit sharing
    
(261,661
)
  
(1,845,527
)
Deferred rent
    
(5,101
)
  
(7,976
)
Current income tax liability
    
0
    
(9,438,827
)
               
Net cash used in operating activities
    
(2,694,940
)
  
(13,838,967
)
               
Cash flows from investing activities:
              
Purchase of short-term investments and marketable securities
    
(60,744,292
)
  
(56,380,294
)
Sale of short-term investments and marketable securities
    
56,454,594
    
96,174,284
  
Investment in private placements and loans
    
(17,480,885
)
  
(20,252,341
)
Proceeds from sale of investments
    
51,669
    
28,295
  
Purchase of fixed assets
    
(36,367
)
  
(11,762
)
               
Net cash (used in) provided by investing activities
    
(21,755,281
)
  
19,558,182
  
               
Cash flows from financing activities:
              
Proceeds from stock option exercises (Note 4)
    
9,673,662
    
0
  
Proceeds from stock offering (Note 7)
    
12,993,168
    
0
  
               
Net cash provided by financing activities
    
22,666,830
    
0
  
               
Net (decrease) increase in cash and cash equivalents:
              
Cash and cash equivalents at beginning of the period
    
2,071,788
    
1,213,289
  
Cash and cash equivalents at end of the period
    
288,397
    
6,932,504
  
               
Net (decrease) increase in cash and cash equivalents
  
$
(1,783,391
)
$
5,719,215
  
               
Supplemental disclosures of cash flow information:
              
Income taxes paid
  
$
87,920
  
$
9,354,653
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
4
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

   
Nine Months Ended
  
Year Ended
  
   
September 30, 2007
  
December 31, 2006
  
   
(Unaudited)
      
           
Changes in net assets from operations:
          
           
Net operating loss
  
$
(8,676,380
)
$
(7,612,935
)
Net realized (loss) gain on investments
    
(83,047
)
  
258,693
  
Net increase in unrealized depreciation
              
on investments held
    
(1,120,140
)
  
(4,418,870
)
               
Net decrease in net assets resulting
              
from operations
    
(9,879,567
)
  
(11,773,112
)
               
Changes in net assets from capital
              
stock transactions:
              
               
Issuance of common stock on offering
    
13,000
    
0
  
Issuance of common stock upon the
              
exercise of stock options
    
9,568
    
2,587
  
Additional paid-in capital on common
              
stock issued
    
22,644,262
    
2,612,603
  
Stock-based compensation expense
    
5,725,031
    
5,038,956
  
               
Net increase in net assets resulting from
              
capital stock transactions
    
28,391,861
    
7,654,146
  
               
Changes in net assets from adoption
              
of SFAS No. 158
    
0
    
61,527
  
               
Net increase (decrease) in net assets
    
18,512,294
    
(4,057,439
)
               
Net assets:
              
               
Beginning of the period
    
113,930,303
    
117,987,742
  
               
End of the period
  
$
132,442,597
  
$
113,930,303
  
 
The accompanying notes are an integral part of these consolidated financial statements.

5
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)

   
Method of
  
Shares/
      
   
Valuation (1)
  
Principal
  
Value
  
               
               
Investments in Unaffiliated Companies (2)(3) - 15.98% of
                    
net assets at value
                    
                     
Private Placement Portfolio (Illiquid) - 15.98% of net assets
                    
at value
                    
                     
AlphaSimplex Group, LLC (4)(5) -- Investment management company
            
headed by Dr. Andrew W. Lo, holder of the Harris & Harris Group
            
Chair at MIT
                    
Limited Liability Company Interest
    
(B
)
  
1
  
$
125,000
  
                     
BioVex Group, Inc. (4)(6)(7)(8) - Developing novel biologics
                    
for treatment of cancer and infectious disease
                    
Series E Convertible Preferred Stock
    
(A
)
  
2,799,552
    
2,500,000
  
                     
Exponential Business Development Company (4)(6) -- Venture
                    
capital partnership focused on early stage companies
                    
Limited Partnership Interest
    
(B
)
  
1
    
1,973
  
                     
Molecular Imprints, Inc. (4)(6) -- Manufacturing nanoimprint
                    
lithography capital equipment
                    
Series B Convertible Preferred Stock
    
(B
)
  
1,333,333
    
2,000,000
  
Series C Convertible Preferred Stock
    
(B
)
  
1,250,000
    
2,500,000
  
Warrants at $2.00 expiring 12/31/11
    
(B
)
  
125,000
    
0
  
                 
4,500,000
  
                     
Nanosys, Inc. (4)(6)(8) -- Developing zero and one-dimensional
                    
inorganic nanometer-scale materials and devices
                    
Series C Convertible Preferred Stock
    
(C
)
  
803,428
    
2,370,113
  
Series D Convertible Preferred Stock
    
(C
)
  
1,016,950
    
3,000,003
  
                 
5,370,116
  
                     
Nantero, Inc. (4)(6)(8) -- Developing a high-density, nonvolatile,
                    
random access memory chip, enabled by carbon nanotubes
                    
Series A Convertible Preferred Stock
    
(C
)
  
345,070
    
1,046,908
  
Series B Convertible Preferred Stock
    
(C
)
  
207,051
    
628,172
  
Series C Convertible Preferred Stock
    
(C
)
  
188,315
    
571,329
  
                 
2,246,409
  

The accompanying notes are an integral part of these consolidated financial statements.
 
6

HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited) 

   
Method of
  
Shares/
      
   
Valuation (1)
  
Principal
  
Value
  
               
Investments in Unaffiliated Companies (2)(3) - 15.98% of
                    
net assets at value (cont.)
                    
                     
Private Placement Portfolio (Illiquid) - 15.98% of net assets
                    
at value (cont.)
                    
                     
NeoPhotonics Corporation (4)(6) -- Developing and manufacturing
            
optical devices and components
                    
Common Stock
    
(B
)
  
716,195
  
$
133,141
  
Series 1 Convertible Preferred Stock
    
(B
)
  
1,831,256
    
1,831,256
  
Series 2 Convertible Preferred Stock
    
(B
)
  
741,898
    
741,898
  
Series 3 Convertible Preferred Stock
    
(B
)
  
2,750,000
    
2,750,000
  
Warrants at $0.15 expiring 01/26/10
    
(B
)
  
16,364
    
164
  
Warrants at $0.15 expiring 12/05/10
    
(B
)
  
14,063
    
140
  
                 
5,456,599
  
                     
Polatis, Inc. (4)(6)(8)(9) -- Developing MEMS-based optical
                    
networking components
                    
Series A-1 Convertible Preferred Stock
    
(B
)
  
16,775
    
0
  
Series A-2 Convertible Preferred Stock
    
(B
)
  
71,611
    
132,653
  
Series A-4 Convertible Preferred Stock
    
(B
)
  
4,774
    
8,768
  
Series A-5 Convertible Preferred Stock
    
(B
)
  
9,311
    
76,523
  
                 
217,944
  
                     
Starfire Systems, Inc. (4)(6)(8) -- Producing ceramic-forming polymers
            
Common Stock
    
(B
)
  
375,000
    
150,000
  
Series A-1 Convertible Preferred Stock
    
(C
)
  
600,000
    
600,000
  
                 
750,000
  
                     
                     
Total Unaffiliated Private Placement Portfolio (cost: $21,387,846)
      
$
21,168,041
  
                     
Total Investments in Unaffiliated Companies (cost: $21,387,846)
      
$
21,168,041
  

The accompanying notes are an integral part of these consolidated financial statements.
 
7
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)

   
Method of
  
Shares/
      
   
Valuation (1)
  
Principal
  
Value
  
Investments in Non-Controlled Affiliated Companies (2)(10) -
                    
33.07% of net assets at value
                    
                     
Private Placement Portfolio (Illiquid) - 33.07% of net assets
                    
at value
                    
                     
Adesto Technologies Corporation (4)(6)(7)(8) -- Developing
                    
semiconductor-related products enabled at the nanoscale
                    
Series A Convertible Preferred Stock
    
(A
)
  
3,416,149
  
$
1,147,826
  
                     
Ancora Pharmaceuticals Inc. (4)(6)(7)(8) - Developing synthetic
                    
carbohydrates for pharmaceutical markets and for internal
                    
drug development programs
                    
Series B Convertible Preferred Stock
    
(A
)
  
909,091
    
800,000
  
Warrants at $1.06 expiring 05/01/08
    
(B
)
  
754,717
    
0
  
                 
800,000
  
                     
BridgeLux, Inc. (4)(6)(11) -- Manufacturing high-power light
                    
emitting diodes
                    
Series B Convertible Preferred Stock
    
(C
)
  
1,861,504
    
1,328,369
  
Series C Convertible Preferred Stock
    
(C
)
  
2,130,699
    
1,520,466
  
Warrants at $0.7136 expiring 02/02/2017
    
(B
)
  
98,340
    
0
  
Warrants at $0.7136 expiring 04/26/2017
    
(B
)
  
65,560
    
0
  
                 
2,848,835
  
                     
Cambrios Technologies Corporation (4)(6)(8) -- Developing
                    
nanowire-enabled electronic materials for the display industry
                    
Series B Convertible Preferred Stock
    
(C
)
  
1,294,025
    
1,294,025
  
Series C Convertible Preferred Stock
    
(C
)
  
1,300,000
    
1,300,000
  
                 
2,594,025
  
                     
Chlorogen, Inc. (4)(6)(8) -- Developed patented chloroplast
                    
technology to produce plant-made proteins
                    
Series A Convertible Preferred Stock
    
(B
)
  
4,478,038
    
0
  
Series B Convertible Preferred Stock
    
(B
)
  
2,077,930
    
0
  
Secured Convertible Bridge Note (including interest)
    
(B
)
$
176,811
    
0
  
 
                
0
  
                     
Crystal IS, Inc. (4)(6)(8) -- Developing single-crystal
                    
aluminum nitride substrates for optoelectronic devices
                    
Series A Convertible Preferred Stock
    
(C
)
  
391,571
    
305,425
  
Series A-1 Convertible Preferred Stock
    
(C
)
  
1,300,376
    
1,014,294
  
Warrants at $0.78 expiring 05/05/2013
    
(B
)
  
15,231
    
0
  
Warrants at $0.78 expiring 05/12/2013
    
(B
)
  
2,350
    
0
  
Warrants at $0.78 expiring 08/08/2013
    
(B
)
  
4,396
    
0
  
                 
1,319,719
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
8
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)
 
   
Method of
Valuation (1)
  
 Shares/ 
Principal
  
Value
  
Investments in Non-Controlled Affiliated Companies (2)(10) - 33.07% of net assets at value (cont.)
                
                 
Private Placement Portfolio (Illiquid) - 33.07% of net assets at value (cont.)
                
                 
CSwitch, Inc. (4)(6)(8) -- Developing next-generation, system-on- a-chip solutions for communications-based platforms
                
Series A-1 Convertible Preferred Stock
  
(B)
    
6,863,118
$
3,431,559
  
Secured Convertible Bridge Note (including interest)
  
(A)
  
$
529,852
    
531,129
  
   
 
          
3,962,688
  
                   
D-Wave Systems, Inc. (4)(6)(8)(12) -- Developing high- performance quantum computing systems
                  
Series B Convertible Preferred Stock
  
(A)
    
2,000,000
    
2,008,240
  
Warrants at $0.85 expiring 10/19/07
  
(B)
    
1,800,000
    
0
  
   
 
          
2,008,240
  
   
 
              
Ensemble Discovery Corporation (4)(6)(7)(8) - Developing DNA Programmed Chemistry for the discovery of new classes of therapeutics and bioassays
  
 
              
Series B Convertible Preferred Stock
  
(A)
    
1,449,275
    
2,000,000
  
   
 
              
                   
Innovalight, Inc. (4)(6)(8) - Developing renewable energy products enabled by silicon-based nanomaterials
  
 
              
Series B Convertible Preferred Stock
  
(B)
    
16,666,666
    
5,718,216
  
   
 
              
   
 
              
Kereos, Inc. (4)(6)(8) -- Developing emulsion-based imaging agents and targeted therapeutics to image and treat cancer and cardiovascular disease
  
 
              
Series B Convertible Preferred Stock
  
(B)
    
545,456
    
1,500,000
  
   
 
              
   
 
              
Kovio, Inc. (4)(6)(8) -- Developing semiconductor products using printed electronics and thin-film technologies
  
 
              
Series C Convertible Preferred Stock
  
(C)
    
2,500,000
    
3,125,000
  
Series D Convertible Preferred Stock
  
(C)
    
800,000
    
1,000,000
  
   
 
          
4,125,000
  
   
 
              
Lifco, Inc. (4)(6)(7)(8) -- Developing energy solutions using nanostructured materials
  
 
              
Series A Convertible Preferred Stock
  
(A)
    
1,208,262
    
946,528
  

The accompanying notes are an integral part of these consolidated financial statements.

9
 

HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)
 
   
Method of
Valuation (1)
  
Shares/ 
Principal
  
Value
  
Investments in Non-Controlled Affiliated Companies (2)(10) - 33.07% of net assets at value (cont.)
              
               
Private Placement Portfolio (Illiquid) - 33.07% of net assets at value (cont.)
              
               
Mersana Therapeutics, Inc. (4)(6)(8)(13) -- Developing advanced polymers for drug delivery
              
Series A Convertible Preferred Stock
  
(B)
  
68,451
  
$
136,902
  
Series B Convertible Preferred Stock
  
(B)
  
866,500
    
1,733,000
  
Warrants at $2.00 expiring 10/21/10
  
(B)
  
91,625
    
0
  
   
 
        
1,869,902
  
   
 
            
Metabolon, Inc. (4)(6)(8) - Discovering biomarkers through the use of metabolomics
  
 
            
Series B Convertible Preferred Stock
  
(B)
 
2,173,913
    
2,500,000
  
   
 
            
NanoGram Corporation (4)(6)(8) -- Developing a broad suite of intellectual property utilizing nanoscale materials
  
 
            
Series I Convertible Preferred Stock
  
(B)
 
63,210
    
64,259
  
Series II Convertible Preferred Stock
  
(B)
 
1,250,904
    
1,271,670
  
Series III Convertible Preferred Stock
  
(B)
 
1,242,144
    
1,262,764
  
   
 
        
2,598,693
  
   
 
            
Nanomix, Inc. (4)(6)(8) -- Producing nanoelectronic sensors that integrate carbon nanotube electronics with silicon microstructures
  
 
            
Series C Convertible Preferred Stock
  
(B)
 
977,918
    
57,905
  
Series D Convertible Preferred Stock
  
(B)
 
6,802,398
    
402,789
  
   
 
        
460,694
  
NanoOpto Corporation (4)(6)(8)(14) -- Manufactured discrete and integrated optical communications sub-components on a chip by utilizing nano manufacturing and nano coating technology
  
 
            
Series A-1 Convertible Preferred Stock
  
(B)
 
267,857
    
0
  
Series B Convertible Preferred Stock
  
(B)
 
3,819,935
    
0
  
Series C Convertible Preferred Stock
  
(B)
 
1,932,789
    
0
  
Series D Convertible Preferred Stock
  
(B)
 
1,397,218
    
0
  
Warrants at $0.4359 expiring 03/15/10
  
(B)
 
193,279
    
0
  
Secured Convertible Bridge Note (including interest)
  
(B)
$
268,654
    
0
  
   
 
        
0
  
 
The accompanying notes are an integral part of these consolidated financial statements.

10
 

HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)
 
   
Method of
Valuation (1)
  
Shares/ 
Principal
  
Value
  
Investments in Non-Controlled Affiliated Companies (2)(10) - 33.07% of net assets at value (cont.)
              
               
Private Placement Portfolio (Illiquid) - 33.07% of net assets at value (cont.)
              
               
Nextreme Thermal Solutions, Inc. (4)(6)(8) -- Developing thin-film thermoelectric devices for cooling and energy conversion
              
Series A Convertible Preferred Stock
  
(B)
  
1,750,000
    
1,750,000
  
                 
Questech Corporation (4)(6) -- Manufacturing and marketing proprietary metal and stone decorative tiles
  
 
            
Common Stock
  
(B)
  
655,454
  
$
747,217
  
Warrants at $1.50 expiring 11/21/07
  
(B)
  
3,750
    
0
  
Warrants at $1.50 expiring 11/19/08
  
(B)
  
5,000
    
0
  
Warrants at $1.50 expiring 11/19/09
  
(B)
  
5,000
    
0
  
   
 
        
747,217
  
   
 
            
Solazyme, Inc. (4)(6)(8) -- Developing energy-harvesting machinery of photosynthetic microbes to produce industrial and pharmaceutical molecules
  
 
            
Series A Convertible Preferred Stock
  
(B)
  
988,204
    
385,400
  
Series B Convertible Preferred Stock
  
(B)
  
495,246
    
500,000
  
   
 
        
885,400
  
   
 
            
Xradia, Inc. (4)(6) - Designing, manufacturing and selling ultra high resolution 3D
x-ray microscopes and fluorescence imaging systems
  
 
            
Series D Convertible Preferred Stock
  
(A)
  
3,121,099
    
4,000,000
  
   
 
            
Zia Laser, Inc. (4)(6)(8)(15) -- Developed quantum dot semiconductor lasers
  
 
            
Series C Convertible Preferred Stock
  
(B)
  
1,500,000
    
15,000
  
   
 
            
Total Non-Controlled Private Placement Portfolio (cost: $51,290,257)
  
 
      
$
43,797,983
  
   
 
            
Total Investments in Non-Controlled Affiliated Companies (cost: $51,290,257)
          
$
43,797,983
  

The accompanying notes are an integral part of these consolidated financial statements.

11
 

HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)
 
   
Method of
Valuation (1)
  
Shares/ 
Principal
  
Value
  
Investments in Controlled Affiliated Companies (2)(16) - 3.25% of net assets at value
              
               
Private Placement Portfolio (Illiquid) - 3.25% of net assets at value
              
               
Evolved Nanomaterial Sciences, Inc. (4)(6)(8)(17) -- Developed nanoscale-enhanced approaches for the resolution of chiral molecules
              
Series A Convertible Preferred Stock
  
(B)
  
5,870,021
  
$
0
  
   
 
            
SiOnyx, Inc. (4)(6)(8) -- Developing silicon-based optoelectronic products enabled by its proprietary "Black Silicon"
  
 
            
Series A Convertible Preferred Stock
  
(C)
  
233,499
    
135,686
  
Series A-1 Convertible Preferred Stock
  
(C)
  
2,966,667
    
1,723,930
  
Series A-2 Convertible Preferred Stock
  
(C)
  
4,207,537
    
2,445,000
  
   
 
        
4,304,616
  
   
 
            
Total Controlled Private Placement Portfolio (cost: $6,885,000)
  
 
      
$
4,304,616
  
   
 
            
Total Investments in Controlled Affiliated Companies (cost: $6,885,000)
  
 
      
$
4,304,616
  
   
 
            
Total Private Placement Portfolio (cost: $79,563,103)
  
 
      
$
69,270,640
  
   
 
            
U.S. Government and Agency Securities - 48.08% of net assets at value
                
U.S. Treasury Bill -- due date 11/23/07
  
(J)
  
380,000
  
$
377,971
  
U.S. Treasury Bill -- due date 02/21/08
  
(J)
  
6,500,000
  
 
6,399,835
  
U.S. Treasury Notes -- due date 02/15/08, coupon 3.375%
  
(H)
  
15,005,000
    
14,962,836
  
U.S. Treasury Notes -- due date 05/15/08, coupon 3.75%
  
(H)
  
9,000,000
    
8,976,780
  
U.S. Treasury Notes -- due date 09/15/08, coupon 3.125%
  
(H)
  
5,000,000
    
4,956,650
  
U.S. Treasury Notes -- due date 01/15/09, coupon 3.25%
  
(H)
  
3,000,000
    
2,973,990
  
U.S. Treasury Notes -- due date 02/15/09, coupon 4.50%
  
(H)
  
5,100,000
    
5,134,680
  
U.S. Treasury Notes -- due date 04/15/09, coupon 3.125%
  
(H)
  
3,000,000
    
2,963,190
  
U.S. Treasury Notes -- due date 07/15/09, coupon 3.625%
  
(H)
  
3,000,000
    
2,982,900
  
U.S. Treasury Notes -- due date 10/15/09, coupon 3.375%
  
(H)
  
3,000,000
    
2,965,770
  
U.S. Treasury Notes -- due date 01/15/10, coupon 3.625%
  
(H)
  
3,000,000
    
2,977,020
  
U.S. Treasury Notes -- due date 04/15/10, coupon 4.00%
  
(H)
  
3,000,000
    
3,000,240
  
U.S. Treasury Notes -- due date 07/15/10, coupon 3.875%
  
(H)
  
3,000,000
    
2,991,330
  
U.S. Treasury Notes -- due date 10/15/10, coupon 4.25%
  
(H)
  
2,000,000
    
2,012,660
  
   
 
            
Total Investments in U.S. Government and Agency Securities (cost: $63,510,949)
          
$
63,675,852
  
                 
Total Investments (cost: $143,074,052)
          
$
132,946,492
  
 
The accompanying notes are an integral part of these consolidated financial statements.

12
 
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2007
(Unaudited)
 
Notes to Consolidated Schedule of Investments

(1)
See Footnote to Consolidated Schedule of Investments on page 14 for a description of the Valuation Procedures.

(2)
Investments in unaffiliated companies consist of investments in which we own less than five percent of the voting shares of the portfolio company. Investments in non-controlled affiliated companies consist of investments in which we own five percent or more, but less than 25 percent, of the voting shares of the portfolio company, or where we hold one or more seats on the portfolio company’s Board of Directors but do not control the company. Investments in controlled affiliated companies consist of investments in which we own 25 percent or more of the voting shares of the portfolio company or otherwise control the company.

(3)
The aggregate cost for federal income tax purposes of investments in unaffiliated companies is $21,387,846. The gross unrealized appreciation based on the tax cost for these securities is $1,846,158. The gross unrealized depreciation based on the tax cost for these securities is $2,065,963.

(4)
Legal restrictions on sale of investment.

(5)
On October 30, 2007, AlphaSimplex Group, LLC, was acquired by Natixis Global Asset Management.

(6)
Represents a non-income producing security. Equity investments that have not paid dividends within the last 12 months are considered to be non-income producing.

(7)
Initial investment was made during 2007.

(8)
These investments are development stage companies. A development stage company is defined as a company that is devoting substantially all of its efforts to establishing a new business, and either it has not yet commenced its planned principal operations, or it has commenced such operations but has not realized significant revenue from them.

(9)
Continuum Photonics, Inc., merged with Polatis, Ltd., to form Polatis, Inc.

(10)
The aggregate cost for federal income tax purposes of investments in non-controlled affiliated companies is $51,290,257. The gross unrealized appreciation based on the tax cost for these securities is $4,262,547. The gross unrealized depreciation based on the tax cost for these securities is $11,754,821.

(11)
BridgeLux, Inc., was previously named eLite Optoelectronics, Inc.

(12)
D-Wave Systems, Inc., is located and is doing business primarily in Canada. We invested in D-Wave Systems, Inc., through D-Wave USA, a Delaware company. Our investment is denominated in Canadian dollars and is subject to foreign currency translation. See "Note 3. Summary of Significant Accounting Policies."

(13)
Mersana Therapeutics, Inc., was previously named Nanopharma Corp.

(14)
On July 19, 2007, NanoOpto Corporation sold its assets to API Nanotronics, Inc.

(15)
On November 30, 2006, the assets of Zia Laser, Inc., were acquired by Innolume, Inc.

(16)
The aggregate cost for federal income tax purposes of investments in controlled affiliated companies is $6,885,000. The gross unrealized appreciation based on the tax cost for these securities is $219,616. The gross unrealized depreciation based on the tax cost for these securities is $2,800,000.

 (17)
On September 30, 2007, Evolved Nanomaterial Sciences, Inc., filed for Chapter 7 bankruptcy.
 
The accompanying notes are an integral part of this consolidated schedule.
 
13
 
HARRIS & HARRIS GROUP, INC.
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)
 
VALUATION PROCEDURES

Our investments can be classified into five broad categories for valuation purposes:

Equity-Related Securities;

Investments in Intellectual Property or Patents or Research and Development in Technology or Product Development;

Long-Term Fixed-Income Securities;

Short-Term Fixed-Income Investments; and

All Other Investments.

The 1940 Act requires periodic valuation of each investment in our portfolio to determine net asset value. Under the 1940 Act, unrestricted securities with readily available market quotations are to be valued at the current market value; all other assets must be valued at "fair value" as determined in good faith by or under the direction of the Board of Directors.

Our Board of Directors is responsible for (1) determining overall valuation guidelines and (2) ensuring the valuation of investments within the prescribed guidelines.

Our Valuation Committee, comprised of all of our independent Board members, is responsible for reviewing and approving the valuation of our assets within the guidelines established by the Board of Directors.

Fair value is generally defined as the amount that an investment could be sold for in an orderly disposition over a reasonable time. Generally, to increase objectivity in valuing our assets, external measures of value, such as public markets or third-party transactions, are utilized whenever possible. Valuation is not based on long-term work-out value, nor immediate liquidation value, nor incremental value for potential changes that may take place in the future.

The values assigned to these investments are based on available information and do not necessarily represent amounts that might ultimately be realized, as these amounts depend on future circumstances and cannot reasonably be determined until the individual investments are actually liquidated or become marketable.
 
14
 
Our valuation policy with respect to the five broad investment categories is as follows:

Equity-Related Securities

Equity-related securities are valued using one or more of the following basic methods of valuation:

A. Cost. The cost method is based on our original cost. This method is generally used in the early stages of a company’s development until significant positive or negative events occur subsequent to the date of the original investment that dictate a change to another valuation method. Some examples of these events are: (1) a major recapitalization; (2) a major refinancing; (3) a significant third-party transaction; (4) the development of a meaningful public market for the company’s common stock; and (5) significant positive or negative changes in a company’s business.

B. Analytical Method. The analytical method is generally used to value an investment position when there is no established public or private market in the company’s securities or when the factual information available to us dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of our Valuation Committee members, based on the data available to them. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the financial condition and operating results of the company, the long-term potential of the business of the company, the values of similar securities issued by companies in similar businesses, the proportion of the company’s securities we own and the nature of any rights to require the company to register restricted securities under applicable securities laws.

C. Private Market. The private market method uses actual, executed, historical transactions in a company’s securities by responsible third parties as a basis for valuation. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation.

D. Public Market. The public market method is used when there is an established public market for the class of the company’s securities held by us or into which our securities are convertible. We discount market value for securities that are subject to significant legal and contractual restrictions. Other securities, for which market quotations are readily available, are carried at market value as of the time of valuation. Market value for securities traded on securities exchanges or on the Nasdaq Global Market is the last reported sales price on the day of valuation. For other securities traded in the over-the-counter market and listed securities for which no sale was reported on that day, market value is the mean of the closing bid price and asked price on that day. This method is the preferred method of valuation when there is an established public market for a company’s securities, as that market provides the most objective basis for valuation.

Investments in Intellectual Property or Patents or Research and Development in Technology or Product Development

These investments are carried at fair value using the following basic methods of valuation:
 
E. Cost. The cost method is based on our original cost. This method is generally used in the early stages of commercializing or developing intellectual property or patents or research and development in technology or product development until significant positive or adverse events occur subsequent to the date of the original investment that dictate a change to another valuation method.
 
15
 
F. Analytical Method. The analytical method is used to value an investment after analysis of the best available outside information where the factual information available to us dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of our Valuation Committee members. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the results of research and development, product development progress, commercial prospects, term of patent and projected markets.

G. Private Market. The private market method uses actual third-party investments in intellectual property or patents or research and development in technology or product development as a basis for valuation, using actual executed historical transactions by responsible third parties. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation.

As of September 30, 2007, we do not have any investments in intellectual property or patents or research and development in technologies or products.

Long-Term Fixed-Income Securities

H. Readily Marketable. Fixed-income securities for which market quotations are readily available are carried at market value as of the time of valuation using the most recent bid quotations when available.

I. Not Readily Marketable. Securities for which market quotations are not readily available are carried at fair value using one or more of the following basic methods of valuation:

Fixed-income securities are valued by independent pricing services that provide market quotations based primarily on quotations from dealers and brokers, market transactions, and other sources.

Other fixed-income securities that are not readily marketable are valued at fair value by our Valuation Committee.

Short-Term Fixed-Income Investments

J. Short-term fixed-income investments are valued at market value at the time of valuation. We value short-term debt with remaining maturity of 60 days or less at amortized cost.
 
16
 
All Other Investments

K. All other investments are reported at fair value as determined in good faith by the Valuation Committee. As of September 30, 2007, we do not have any of these investments.

The reported values of securities for which market quotations are not readily available and for other assets reflect the Valuation Committee’s judgment of fair values as of the valuation date using the outlined basic methods of valuation. They do not necessarily represent an amount of money that would be realized if we had to sell the securities in an immediate liquidation. Thus, valuations as of any particular date are not necessarily indicative of amounts that we may ultimately realize as a result of future sales or other dispositions of investments we hold.

17

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1. THE COMPANY

Harris & Harris Group, Inc. (the "Company," "us," "our" and "we"), is a venture capital company operating as a business development company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). We operate as an internally managed company whereby our officers and employees, under the general supervision of our Board of Directors, conduct our operations.

We elected to become a BDC on July 26, 1995, after receiving the necessary shareholder approvals. From September 30, 1992, until the election of BDC status, we operated as a closed-end, non-diversified investment company under the 1940 Act. Upon commencement of operations as an investment company, we revalued all of our assets and liabilities in accordance with the 1940 Act. Prior to September 30, 1992, we were registered and filed under the reporting requirements of the Securities Exchange Act of 1934 (the "1934 Act") as an operating company and, while an operating company, operated directly and through subsidiaries.

Harris & Harris Enterprises, Inc.,SM is a 100 percent wholly owned subsidiary of the Company. Harris & Harris Enterprises, Inc., is a partner in Harris Partners I, L.P.,SM and is taxed under Subchapter C of the Code (a “C Corporation”). Harris Partners I, L.P, is a limited partnership and owns our interest in AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P., are Harris & Harris Enterprises, Inc., (sole general partner) and Harris & Harris Group, Inc., (sole limited partner). Harris & Harris Enterprises, Inc., pays taxes on any non-passive investment income generated by Harris Partners I, L.P. The Company consolidates the results of its subsidiaries for financial reporting purposes.
 
NOTE 2. INTERIM FINANCIAL STATEMENTS

Our interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and in conformity with generally accepted accounting principles applicable to interim financial information. Accordingly, they do not include all information and disclosures necessary for a presentation of our financial position, results of operations and cash flows in conformity with generally accepted accounting principles in the United States of America. In the opinion of management, these financial statements reflect all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of our financial position, results of operations and cash flows for such periods. The results of operations for any interim period are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
 
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements:
 
Principles of Consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for investment companies and include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
 
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Use of Estimates. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities as of September 30, 2007 and December 31, 2006, and the reported amounts of revenues and expenses for the three months and nine months ended September 30, 2007 and 2006. The most significant estimates relate to the fair valuations of certain of our investments. Actual results could differ from these estimates.

Cash and Cash Equivalents. Cash and cash equivalents include money market instruments with maturities of less than three months.
 
Portfolio Investment Valuations. Investments are stated at "value" as defined in the 1940 Act and in the applicable regulations of the SEC. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) the fair value as determined in good faith by, or under the direction of, the Board of Directors for all other assets. (See "Valuation Procedures" in the "Footnote to Consolidated Schedule of Investments.") At September 30, 2007, our financial statements include private venture capital investments valued at $69,270,640, the fair values of which were determined in good faith by, or under the direction, of the Board of Directors. Upon sale of investments, the values that are ultimately realized may be different from what is presently estimated. The difference could be material.

Foreign Currency Translation. The accounting records of the Company are maintained in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rate of exchange of such currencies against U.S. dollars on the date of valuation. For the nine months ended September 30, 2007, included in the net decrease in unrealized depreciation on investments was a $291,796 gain resulting from foreign currency translation.

Securities Transactions. Securities transactions are accounted for on the date the securities are purchased or sold (trade date); dividend income is recorded on the ex-dividend date; and interest income is accrued as earned. The Company ceases accruing interest when securities are determined to be non-income producing and writes off any previously accrued interest. Realized gains and losses on investment transactions are determined by specific identification for financial reporting and tax reporting.

Stock-Based Compensation. The Company has a stock-based employee compensation plan. The Company accounts for the plan in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based Payment." See Note 4 for further discussion.

Income Taxes. As we intend to qualify as a RIC under Subchapter M of the Internal Revenue Code, the Company does not provide for income taxes. Our taxes are accounted for in accordance with SFAS No. 109, "Accounting for Income Taxes."
 
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However, we pay federal, state and local income taxes on behalf of our wholly owned subsidiary, Harris & Harris Enterprises, Inc., which is a C corporation. See "Note 6. Income Taxes."

In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in Income Taxes" (“FIN 48”), an interpretation of SFAS No. 109. FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007, which had no effect on the Company's financial statements. The Company recognizes interest and penalties in income tax expense. See Note 6 for further discussion.

Restricted Funds. The Company maintains a rabbi trust for the purposes of accumulating funds to satisfy the obligations incurred by us for the Supplemental Executive Retirement Plan ("SERP") under the employment agreement with Charles E. Harris.
 
Property and Equipment. Property and equipment are included in "Other Assets" and are carried at cost, less accumulated depreciation of $319,140. Depreciation is provided using the straight-line method over the estimated useful lives of the premises and equipment.

Recent Accounting Pronouncements. In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (“SFAS No. 159”). SFAS No. 159 would allow the Company an irrevocable election to measure certain financial assets and liabilities at fair value, with unrealized gains and losses on the elected items recognized in earnings at each reporting period. The fair value option may only be elected at the time of initial recognition of a financial asset or financial liability or upon the occurrence of certain specified events. The election is applied on an instrument-by-instrument basis, with a few exceptions, and is applied only to entire instruments and not to portions of instruments. SFAS No. 159 also provides expanded disclosure requirements regarding the effects of electing the fair value option on the financial statements. SFAS No. 159 is effective prospectively for fiscal years beginning after November 15, 2007. The Company is currently evaluating this Statement. However, as investments are carried at fair value, the Company does not anticipate that this Statement will have a significant impact on the consolidated financial statements.
 
NOTE 4. STOCK-BASED COMPENSATION

On March 23, 2006, the Board of Directors of the Company voted to terminate the Employee Profit-Sharing Plan and establish the Harris & Harris Group, Inc., 2006 Equity Incentive Plan (the “Stock Plan”), subject to shareholder approval. This proposal was approved at the May 4, 2006, Annual Meeting of Shareholders. The Stock Plan provides for the grant of equity-based awards of stock options and restricted stock (subject to receipt of an exemption order described below) to our directors, officers and employees who are selected by our Compensation Committee for participation in the plan and subject to compliance with the 1940 Act.
 
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On July 11, 2006, the Company filed an application with the SEC regarding certain provisions of the Stock Plan, and on July 11, 2007, the Company responded to comments from the SEC on the application. In the event that the SEC provides the exemptive relief requested by the application, and we receive any additional stockholder approval required by the SEC, the Compensation Committee may, in the future, authorize awards under the Stock Plan to non-employee directors of the Company and authorize grants of restricted stock to employees.

A maximum of 20 percent of our total shares of our common stock issued and outstanding are available for awards under the Stock Plan. Under the Stock Plan, no more than 25 percent of the shares of stock reserved for the grant of the awards under the Stock Plan may be restricted stock awards at any time during the term of the Stock Plan. If any shares of restricted stock are awarded, such awards will reduce on a percentage basis the total number of shares of stock for which options may be awarded. If the Company does not receive exemptive relief from the SEC to issue restricted stock, all shares granted under the Stock Plan may be subject to stock options. No more than 1,000,000 shares of our common stock may be made subject to awards under the Stock Plan to any individual in any year.

On June 26, 2006, the Compensation Committee of the Board of Directors of the Company approved individual stock option awards for certain officers and employees of the Company. Both non-qualified stock options ("NQSOs") and incentive stock options ("ISOs"), subject to the limitations of Section 422 of the Internal Revenue Code, were awarded under the Stock Plan. The terms and conditions of the stock options granted were determined by the Compensation Committee and set forth in award agreements between the Company and each award recipient. Options to purchase a total of 3,958,283 shares of stock were granted with vesting periods ranging from December 2006 to June 2014 and with an exercise price of $10.11. Upon exercise, the shares will be issued from our previously authorized shares. The full Board of Directors ratified and approved the grants on August 3, 2006, on which date the Company's common stock price fluctuated between $9.76 and $10.00.

On June 27, 2007, the Compensation Committee of the Board of Directors of the Company approved a new grant of individual NQSO awards for certain officers and employees of the Company. The grant and exercise price were approved by the full Board of Directors on June 27, 2007. The terms and conditions of the stock options granted were determined by the Compensation Committee and set forth in award agreements between the Company and each award recipient entered into on that date. Options to purchase a total of 1,700,609 shares of stock were granted with vesting periods ranging from December 2007 to June 2014 and with an exercise price of $11.11, which was the closing volume weighted average price of our shares of common stock on June 27, 2007. Upon exercise, the shares would be issued from our previously authorized but unissued shares.
 
The Company accounts for the Stock Plan in accordance with the provisions of SFAS No. 123(R), “Share-Based Payment,” which requires that we determine the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, and record these amounts as an expense in the Statement of Operations over the vesting period with a corresponding increase to our additional paid-in capital. At September 30, 2007, the increase to our operating expenses was offset by the increase to our additional paid-in capital, resulting in no net impact to our net asset value. Additionally, the Company does not record the tax benefits associated with the expensing of stock options, because the Company currently intends to qualify as a RIC under Subchapter M of the Code.
 
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The amount of stock-based compensation expense recognized in the Consolidated Statements of Operations is based on the fair value of the awards the Company expects to vest, recognized over the vesting period on a straight-line basis for each award, and adjusted for actual forfeitures that occur before vesting. The forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeiture rate differs from the estimated rate.
 
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model. The stock options granted on June 27, 2007, were awarded in four different grant types, each with different contractual terms. The assumptions used in the calculation of fair value of the stock options granted on June 27, 2007, using the Black-Scholes model for each contract term were as follows:
 
       
Number
  
Expected
  
Expected
  
Expected
  
Risk-free
  
Fair
  
   
Contractual
  
of Options
  
Term
  
Volatility
  
Dividend
  
Interest
  
Value
  
Type of Award
  
Term
  
Granted
  
in Yrs
  
Factor
  
Yield
  
Rates
  
Per Share
  
                               
Non-qualified stock options
    
1.5 Years
    
380,000
    
1
    
42.6
%
  
0
%
  
4.93
%
$
2.11
  
Non-qualified stock options
    
2.5 Years
    
600,540
    
2
    
40.1
%
  
0
%
  
4.91
%
$
2.92
  
Non-qualified stock options
    
3.5 Years
    
338,403
    
3
    
44.7
%
  
0
%
  
4.93
%
$
3.94
  
Non-qualified stock options
    
9 Years
    
381,666
    
Ranging from 4.75- 6.28
    
Ranging from 57.8% to 59.9%
 
  
0
%
  
Ranging from 4.97% to 5.01%
 
  
Ranging from $5.92 to $6.85
  
Total
          
1,700,609
                                

For the three months and nine months ended September 30, 2007, the Company recognized $2,302,394 and $5,725,031 of compensation expense in the Consolidated Statements of Operations, respectively. As of September 30, 2007, there was approximately $10,137,379 of unrecognized compensation cost related to unvested stock option awards. This cost is expected to be recognized over a weighted-average period of approximately 1.6 years.

For the three months ended September 30, 2007, a total of 129,934 options were exercised for total proceeds to the Company of $1,313,633. For the nine months ended September 30, 2007, a total of 956,841 options were exercised for total proceeds to the Company of $9,673,662. 

For the three months and nine months ended September 30, 2007, the calculation of the net decrease in net assets resulting from operations per share excludes the stock options because such options were anti-dilutive. The options may be dilutive in future periods in which there is a net increase in net assets resulting from operations, in the event that there is a significant increase in the average stock price in the stock market or significant decreases in the amount of unrecognized compensation cost.
 
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A summary of the changes in outstanding stock options is as follows:
 
               
Weighted
      
       
Weighted
  
Weighted
  
Average
      
       
Average
  
Average
  
Remaining
  
Aggregate
  
       
Exercise
  
Grant Date
  
Contractual
  
Intrinsic
  
   
Shares
  
Price
  
Fair Value
  
Term (Yrs)
  
Value
  
                       
Options Outstanding at January 1, 2007
    
3,699,611
 
$
10.11
  
$
4.43
              
Granted
   
1,700,609
  
$
11.11
  
$
3.68
    
3.68
        
Exercised
    
(956,841
)
$
10.11
  
$
1.94
              
Forfeited or Expired
    
- .
                          
Options Outstanding at September 30, 2007
    
4,443,379
 
$
10.49
  
$
4.68
    
4.58
  
$
1,453,668
  
Options Exercisable at September 30, 2007
    
1,062,195
 
$
10.11
  
$
5.34
    
5.42
  
$
562,963
  
Options Exercisable and Expected to be
Exercisable at September 30, 2007
   
4,060,974
  
$
10.52
  
$
4.63
    
4.56
  
$
1,259,697
  

The aggregate intrinsic value in the table above with respect to options outstanding, exercisable and expected to be exercisable, is calculated as the difference between the Company's closing stock price of $10.64 on the last trading day of the third quarter of 2007 and the exercise price, multiplied by the number of in-the-money options. This represents the total pre-tax intrinsic value that would have been received by the option holders had all options been fully vested and all option holders exercised their awards on September 30, 2007.

For the nine months ended September 30, 2007, the aggregate intrinsic value of the 956,841 options exercised was $1,674,126.

Unless earlier terminated by our Board of Directors, the Stock Plan will expire on May 4, 2016. The expiration of the Stock Plan will not by itself adversely affect the rights of plan participants under awards that are outstanding at the time the Stock Plan expires. Our Board of Directors may terminate, modify or suspend the plan at any time, provided that no modification of the plan will be effective unless and until any required shareholder approval has been obtained. The Compensation Committee may terminate, modify or amend any outstanding award under the Stock Plan at any time, provided that in such event, the award holder may exercise any vested options prior to such termination of the Stock Plan or award.
 
NOTE 5. EMPLOYEE PROFIT-SHARING PLAN

Prior to the adoption of the Stock Plan, the Company operated the Amended and Restated Harris & Harris Group, Inc. Employee Profit-Sharing Plan (the "2002 Plan"). Effective May 4, 2006, the 2002 Plan was terminated.
 
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The 2002 Plan (and its predecessor) provided for profit sharing by our officers and employees equal to 20 percent of our "qualifying income" for that plan year.
 
As soon as practicable following the year-end, the Compensation Committee determined whether, and if so how much, qualifying income existed for a plan year. Approximately 90 percent of the amount determined by the Compensation Committee was then paid out to plan participants pursuant to the distribution percentages set forth in the 2002 Plan. The remaining payment was paid out after we finalized our tax returns for that plan year.

At September 30, 2007, and December 31, 2006, we accrued $0 and $261,661, respectively, for profit sharing. On March 1, 2006, the Company paid $1,897,072 to plan participants (employees and former employees), which represented approximately 90 percent of the total estimated profit-sharing payment for 2005. The balance of $261,661 was paid on January 31, 2007, upon finalization of our tax returns.
 
NOTE 6. INCOME TAXES

We filed for the 1999 tax year to elect treatment as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code of 1986 (the "Code") and qualified for the same treatment for the years 2000 through 2006. On June 20, 2007, we received SEC certification for 2006 pursuant to Section 851(e) of the Code. However, there can be no assurance that we will qualify as a RIC for 2007 or subsequent years. In addition, under certain circumstances, even if we qualified for Subchapter M treatment for a given year, we might take action in a subsequent year to ensure that we would be taxed in that subsequent year as a C Corporation, rather than as a RIC. As a RIC, we must, among other things, distribute at least 90 percent of our investment company taxable income and may either distribute or retain our realized net capital gains on investments.

Provided that a proper election is made, a corporation taxable under Subchapter C of the Code or a C Corporation that elects to qualify as a RIC continues to be taxable as a C Corporation on any gains realized within 10 years of its qualification as a RIC (the "Inclusion Period") from sales of assets that were held by the corporation on the effective date of the RIC election ("C Corporation Assets"), to the extent of any gain built into the assets on such date ("Built-In Gain"). If the corporation fails to make a proper election, it is taxable on its Built-In Gain as of the effective date of its RIC election. We had Built-In Gains at the time of our qualification as a RIC and made the election to be taxed on any Built-In Gain realized during the Inclusion Period.

We adopted FIN 48 as of January 1, 2007, the beginning of our fiscal year. As of January 1, 2007, we had unrecognized tax benefits of $0 and did not record any cumulative effect adjustment to net assets as a result of adopting FIN 48.
 
For federal tax purposes, the Company’s 2004 through 2006 tax years remain open for examination by the tax authorities under the normal three year statute of limitations. Generally, for state tax purposes, the Company’s 2004 through 2006 tax years remain open for examination by the tax authorities under a four year statute of limitations.
 
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For the nine months ended September 30, 2007, we paid $74,454 in federal income tax interest and penalties related to the Built-In Gains recognized in the Company's 2005 tax year, which is included in income tax expense. During the third quarter of 2007, we paid $851 in federal, state and local income taxes. At September 30, 2007, we had $0 accrued for federal, state and local taxes payable by the Company.

We pay federal, state and local taxes on behalf of our wholly owned subsidiary, Harris & Harris Enterprises, Inc., which is taxed as a C Corporation. For the three months ended September 30, 2007, our income tax expense for Harris & Harris Enterprises, Inc., was $3,232. For the three months ended September 30, 2006, our income tax benefit for Harris & Harris Enterprises, Inc., was $7,571. For the nine months ended September 30, 2007, and 2006, our income tax expense for Harris & Harris Enterprises, Inc., was $3,232 and $9,475, respectively.

Continued qualification as a RIC requires us to satisfy certain investment asset diversification requirements in future years. Our ability to satisfy those requirements may not be controllable by us. There can be no assurance that we will qualify as a RIC in subsequent years.
 
NOTE 7. CAPITAL TRANSACTIONS

On November 29, 2006, we filed a registration statement with the SEC on Form N-2 to register 4,000,000 shares of our common stock. On December 11, 2006, and on April 23, 2007, we filed amended registration statements with the SEC. On May 11, 2007, the SEC declared the registration statement effective. The common stock may be sold at prices and on terms to be set forth in one or more supplements to the prospectus from time to time.

On June 25, 2007, we completed the sale of 1,300,000 shares of our common stock for gross proceeds of $14,027,000; net proceeds of this offering, after placement agent fees and offering costs of $1,033,832, were $12,993,168.
 
NOTE 8. CHANGE IN NET ASSETS PER SHARE

The following table sets forth the computation of basic and diluted per share net increases in net assets resulting from operations for the three and nine months ended September 30, 2007, and September 30, 2006, respectively.
 
   
 For the Three Months Ended
September 30
  
 For the Nine Months Ended
September 30
  
   
2007
  
2006
  
2007
  
2006
  
Numerator for increase (decrease) in net assets per share
  
$
604,237
  
$
(2,588,092
)
$
(9,879,567
)
$
(5,525,079
)
Denominator for basic and diluted weighted average shares
    
23,235,023
    
20,756,345
    
22,084,893
    
20,756,345
  
Basic and diluted net increase (decrease) in net assets per share resulting from operations
  
$
0.03
  
$
(0.12
)
$
(0.45
)
$
(0.27
)
 
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NOTE 9. SUBSEQUENT EVENTS

On October 11, 2007, we made a $1,993,568 follow-on investment in Innovalight, Inc.

On October 16, 2007, we made a $58,582 follow-on investment that has not yet been announced in a privately held tiny technology portfolio company.

On October 17, 2007, we made a $160,723 new investment that has not yet been announced in a privately held tiny technology portfolio company.

On October 24, 2007, we made a $50,000 new investment that has not yet been announced in a privately held tiny technology portfolio company.

On October 30, 2007, we received proceeds of $123,000 from the sale of the assets of AlphaSimplex Group, LLC, to Natixis Global Asset Management. 

On November 7, 2007, we made an $851,393 follow-on investment that has not yet been announced in a privately held tiny technology portfolio company.

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HARRIS & HARRIS GROUP, INC.
FINANCIAL HIGHLIGHTS
(Unaudited)
 
   
Three Months Ended Sept. 30
 
Nine Months Ended Sept. 30
 
 
 
2007
 
2006
 
2007
 
2006
  
                   
Per Share Operating Performance
                  
Net asset value per share, beginning
                          
of period
  
$
5.54
  
$
5.54
  
$
5.42
  
$
5.68
  
                           
Net operating (loss)*
    
(0.13
)
  
(0.14
)
  
(0.39
)
  
(0.22
)
Net realized income (loss)
                          
on investments*
    
0.00
    
0.01
    
(0.01
)
  
0.01
  
Net (increase) decrease in unrealized
                          
depreciation as a result of sales*
    
0.00
    
0.00
    
(0.00
)
  
0.00
  
Net decrease (increase) in unrealized
                          
depreciation on investments held*
    
0.16
    
0.01
    
(0.05
)
  
(0.06
)
Total from investment operations*
    
0.03