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, 2009

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
  Incorporation or Organization)
(I.R.S. Employer Identification No.)

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     ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes     x            No     ¨

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

Large accelerated filer  ¨
Accelerated filer  x
Non-accelerated filer  ¨
Smaller reporting company  ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes     ¨            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 6, 2009
Common Stock, $0.01 par value per share     
 
30,854,258 shares

 
 
 

Harris & Harris Group, Inc.
Form 10-Q, September 30, 2009

 
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
21
Financial Highlights
32
   
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
33
   
Background and Overview
33
Historical Investment Track Record
34
Age of Current Portfolio and Investment Pace
34
Commercialization of Nanotechnology by Our Portfolio Companies
36
Maturity of Current Venture Capital Portfolio
37
Current Business Environment
38
Valuation of Investments
40
Investment Objective
42
Results of Operations
42
Financial Condition
49
Liquidity
51
Capital Resources
52
Critical Accounting Policies
52
Recent Developments – Portfolio Companies
55
Recent Developments – Other
55
Forward-Looking Statements
56
   
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
56
   
Item 4.  Controls and Procedures
57
   
   
PART II.  OTHER INFORMATION
  
   
Item 1A.  Risk Factors
59
   
Item 6.  Exhibits
61
   
Signatures
62
   
Exhibit Index
63


 
 

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 accounting principles generally accepted in the United States of America (“GAAP”) 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, 2008, contained in our Annual Report on Form 10-K for the year ended December 31, 2008.

In September 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 net capital gain from investments, but any net capital gain not distributed will be subject to corporate income tax and the excise tax described below.  We will be subject to a four percent excise tax to the extent we fail to distribute at least 98 percent of our annual net ordinary income and 98 percent of our capital gain net 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 9, 2009, we received SEC certification for 2008, permitting us to qualify for RIC treatment for 2008 (as we had for the years 1999 through 2007) pursuant to Section 851(e) of the Code.  Although the SEC certification for 2008 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 2008, we qualified for RIC treatment even without certification.  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 net capital gain, it is not clear that the Company and its shareholders have paid less in 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

ASSETS


   
September 30, 2009
    
December 31, 2008
  
   
(Unaudited)
        
Investments, in portfolio securities at value:
            
Unaffiliated companies (cost: $26,648,390 and
$24,208,281, respectively)
   $ 16,892,041     $ 12,086,503  
Non-controlled affiliated companies (cost: $60,109,424
and $60,796,720, respectively)
     48,920,403       39,650,187  
Controlled affiliated companies (cost: $6,996,458
and $6,085,000, respectively)
     4,063,766       5,228,463  
Publicly traded securities (cost: $199,432 and $0, respectively)
     173,405       0  
Total, investments in private portfolio companies and
public securities at value
                
(cost: $93,953,704 and $91,090,001, respectively)
   $ 70,049,615     $ 56,965,153  
Investments, in U.S. Treasury obligations at value
                
(cost: $66,960,793 and $52,956,288, respectively)
     66,971,440       52,983,940  
Cash and cash equivalents
     1,495,970       692,309  
Restricted funds
     1,985       191,955  
Interest receivable
     6,517       56  
Prepaid expenses
     148,653       484,567  
Other assets
     462,253       309,621  
Total assets
   $ 139,136,433     $ 111,627,601  

LIABILITIES & NET ASSETS

Payable for investments purchased
   $ 25,720,198     $ 0  
Accounts payable and accrued liabilities
     1,880,616       2,088,348  
Deferred rent
     3,413       8,140  
Total liabilities
     27,604,227       2,096,488  
                 
Net assets
   $ 111,532,206     $ 109,531,113  
                 
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
9/30/09 and 12/31/08; 27,795,498 issued at
9/30/09 and 27,688,313 issued at 12/31/08
     277,956       276,884  
Additional paid in capital (Note 8)
     184,077,904       181,251,507  
Accumulated net operating and realized loss
     (45,524,681 )     (34,494,551 )
Accumulated unrealized depreciation of investments
     (23,893,442 )     (34,097,196 )
Treasury stock, at cost (1,828,740 shares at 9/30/09 and 12/31/08)
     (3,405,531 )     (3,405,531 )
                 
Net assets
   $ 111,532,206     $ 109,531,113  
                 
Shares outstanding
     25,966,758       25,859,573  
                 
Net asset value per outstanding share
   $ 4.30     $ 4.24  

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
  
   
2009
    
2008
    
2009
    
2008
  
Investment income:
                        
Interest from:
                        
Fixed-income securities and bridge notes
   $ 99,677     $ 585,418     $ 138,862     $ 1,626,176  
Miscellaneous income
     6,000       2,500       27,088       5,669  
Total investment income
     105,677       587,918       165,950       1,631,845  
                                 
Expenses:
                                
Salaries, benefits and stock-based compensation (Note 6)
     1,727,743       2,205,980       4,621,680       7,101,077  
Administration and operations
     225,044       252,884       746,640       838,100  
Professional fees
     190,942       138,461       558,483       478,559  
Rent
     79,617       80,358       236,678       197,960  
Directors’ fees and expenses
     79,136       79,318       252,745       263,633  
Depreciation
     12,633       13,447       38,370       41,251  
Custodian fees
     33,515       14,209       51,457       26,905  
Total expenses
     2,348,630       2,784,657       6,506,053       8,947,485  
                                 
Net operating loss
     (2,242,953 )     (2,196,739 )     (6,340,103 )     (7,315,640 )
                                 
Net realized (loss) gain from investments:
                                
Realized (loss) gain from:
                                
Unaffiliated companies
     0       0       (1,514,330 )     3,420  
Non-Controlled affiliated companies
     (3,176,125 )     (1,478,500 )     (3,176,125 )     (6,493,153 )
Controlled affiliated companies
     0       (2,893,487 )     0       (2,893,487 )
U.S. Treasury obligations/other
     0       (1,137 )     (325 )     (862 )
Realized loss from investments
     (3,176,125 )     (4,373,124 )     (4,690,780 )     (9,384,082 )
                                 
Income tax (benefit) expense (Note 7)
     (2,862 )     2,102       (753 )     48,968  
Net realized loss from investments
     (3,173,263 )     (4,375,226 )     (4,690,027 )     (9,433,050 )
                                 
Net decrease (increase) in unrealized depreciation on investments:
                                
Change as a result of investment sales
     3,180,240       4,278,500       4,691,282       9,293,153  
Change on investments held
     1,939,657       (31,739,282 )     5,512,472       (28,511,536 )
Net decrease (increase) in unrealized depreciation on investments
     5,119,897       (27,460,782 )     10,203,754       (19,218,383 )
                                 
Net decrease in net assets resulting from operations
   $ (296,319 )   $ (34,032,747 )   $ (826,376 )   $ (35,967,073 )
                                 
Per average basic and diluted outstanding share
   $ (0.01 )   $ (1.32 )   $ (0.03 )   $ (1.48 )
                                 
Average outstanding shares
     25,866,983       25,859,573       25,862,070       24,271,270  

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
September 30, 2009
    
Nine Months Ended
September 30, 2008
  
             
Cash flows used in operating activities:
            
Net decrease in net assets resulting from operations
   $ (826,376 )   $ (35,967,073 )
Adjustments to reconcile net decrease in net assets resulting
from operations to net cash used in operating activities:
                
Net realized and unrealized (gain) loss on investments
     (5,512,974 )     28,602,465  
Depreciation of fixed assets, amortization of premium or
discount on U.S. government securities, and bridge
note interest
     39,784       (160,283 )
Stock-based compensation expense
     2,425,525       4,333,892  
                 
Changes in assets and liabilities:
                
Restricted funds
     189,970       2,542,356  
Receivable from portfolio company
     0       524  
Other receivables
     (217 )     0  
Interest receivable
     2,044       213,520  
Income tax receivable
     (3,353 )     0  
Prepaid expenses
     335,914       340,152  
Other assets
     (186,116 )     1,619  
Accounts payable and accrued liabilities
     (207,732 )     (2,562,338 )
Deferred rent
     (4,727 )     (4,810 )
                 
Net cash used in operating activities
     (3,748,258 )     (2,659,976 )
                 
Cash flows from investing activities:
                
Purchase of U.S. government securities
     (112,308,457 )     (75,932,334 )
Sale of U.S. government securities
     123,988,254       79,326,692  
Investment in private placements and notes
     (7,535,874 )     (14,635,185 )
Proceeds from sale of investments
     7,365       140,257  
Purchase of fixed assets
     (1,313 )     (15,046 )
                 
Net cash provided by (used in) investing activities
     4,149,975       (11,115,616 )
                 
Cash flows from financing activities:
                
Proceeds from stock option exercises (Note 6)
     401,944       0  
Proceeds from stock offering (Note 8)
     0       14,383,497  
                 
Net cash provided by financing activities
     401,944       14,383,497  
                 
Net increase in cash and cash equivalents:
                
Cash and cash equivalents at beginning of the period
     692,309       330,009  
Cash and cash equivalents at end of the period
     1,495,970       937,914  
                 
Net increase in cash and cash equivalents
   $ 803,661     $ 607,905  
                 
Supplemental disclosures of cash flow information:
                
Income taxes paid
   $ 2,179     $ 48,427  



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, 2009
    
December 31, 2008
  
   
(Unaudited)
        
Changes in net assets from operations:
            
             
Net operating loss
   $ (6,340,103 )   $ (10,687,151 )
Net realized loss on investments
     (4,690,027 )     (8,323,634 )
Net decrease in unrealized depreciation
on investments as a result of sales
     4,691,282       8,292,072  
Net decrease (increase) in unrealized
depreciation on investments held
     5,512,472       (38,462,784 )
                 
                 
Net decrease in net assets resulting
from operations
     (826,376 )     (49,181,497 )
                 
                 
Changes in net assets from capital
stock transactions:
                
                 
Issuance of common stock
     1,072       25,450  
Additional paid-in capital on common
stock issued
     400,872       14,358,047  
Stock-based compensation expense
     2,425,525       5,965,769  
                 
                 
Net increase in net assets resulting from
capital stock transactions
     2,827,469       20,349,266  
                 
                 
Net increase (decrease) in net assets
     2,001,093       (28,832,231 )
                 
                 
Net assets:
                
                 
Beginning of the period
     109,531,113       138,363,344  
                 
End of the period
   $ 111,532,206     $ 109,531,113  


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, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Unaffiliated Companies (2)(3)(4)– 15.3% of net assets at value
              
               
Private Placement Portfolio (Illiquid) – 15.1% of net assets at value
              
               
               
BioVex Group, Inc. (5)(6)(7)(8) -- Developing novel biologics
for treatment of cancer and infectious disease
              
Series E Convertible Preferred Stock
(M)
     2,799,552     $ 470,325  
Series F Convertible Preferred Stock
(M)
     2,011,110       388,669  
Warrants at $0.241576 expiring 11/13/15
( I )
     248,120       18,838  
                877,832  
                   
Cobalt Technologies, Inc. (5)(6)(7)(9) -- Developing processes for
making biobutanol through biomass fermentation
                  
Series C Convertible Preferred Stock
(M)
     352,112       375,000  
                   
                   
D-Wave Systems, Inc. (5)(6)(7)(10) -- Developing high-
performance quantum computing systems
                  
Series B Convertible Preferred Stock
(M)
     1,144,869       1,184,568  
Series C Convertible Preferred Stock
(M)
     450,450       466,070  
Series D Convertible Preferred Stock
(M)
     1,533,395       1,586,566  
                3,237,204  
                   
Molecular Imprints, Inc. (5)(6) -- Manufacturing nanoimprint
lithography capital equipment
                  
Series B Convertible Preferred Stock
(M)
     1,333,333       1,625,000  
Series C Convertible Preferred Stock
(M)
     1,250,000       1,523,438  
Warrants at $2.00 expiring 12/31/11
( I )
     125,000       48,750  
                3,197,188  
                   
Nanosys, Inc. (5)(6) -- Developing zero and one-dimensional
inorganic nanometer-scale materials and devices
                  
Series C Convertible Preferred Stock
(M)
     803,428       1,185,056  
Series D Convertible Preferred Stock
(M)
     1,016,950       1,500,001  
                2,685,057  


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, 2009
(Unaudited)
 
 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
               
Investments in Unaffiliated Companies (2)(3)(4)– 15.3% of net assets at value (Cont.)
              
               
Private Placement Portfolio (Illiquid) – 15.1% of net assets at value (Cont.)
              
               
               
Nantero, Inc. (5)(6)(7) -- Developing a high-density, nonvolatile,
random access memory chip, enabled by carbon nanotubes
              
Series A Convertible Preferred Stock
(M)
     345,070     $ 1,046,908  
Series B Convertible Preferred Stock
(M)
     207,051       628,172  
Series C Convertible Preferred Stock
(M)
     188,315       571,329  
                2,246,409  
                   
NeoPhotonics Corporation (5)(6) -- Developing and manufacturing
optical devices and components
Common Stock
(M)
     716,195       413,244  
Series 1 Convertible Preferred Stock
(M)
     1,831,256       1,056,634  
Series 2 Convertible Preferred Stock
(M)
     741,898       428,075  
Series 3 Convertible Preferred Stock
(M)
     2,750,000       1,586,750  
Series X Convertible Preferred Stock
(M)
     2,000       230,800  
Warrants at $0.15 expiring 01/26/10
( I )
     16,364       7,004  
Warrants at $0.15 expiring 12/05/10
( I )
     14,063       6,272  
                3,728,779  
                   
Polatis, Inc. (5)(6)(7) -- Developing MEMS-based optical
networking components
                  
Series A-1 Convertible Preferred Stock
(M)
     16,775       0  
Series A-2 Convertible Preferred Stock
(M)
     71,611       0  
Series A-4 Convertible Preferred Stock
(M)
     4,774       0  
Series A-5 Convertible Preferred Stock
(M)
     16,438       0  
                0  
                   
PolyRemedy, Inc. (5)(6)(7) -- Developing a robotic
manufacturing platform for wound treatment patches
                  
Series B-1 Convertible Preferred Stock
(M)
     287,647       93,866  
Series B-2 Convertible Preferred Stock
(M)
     676,147       121,706  
                215,572  


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, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Unaffiliated Companies (2)(3)(4)– 15.3% of net assets at value (Cont.)
              
               
Private Placement Portfolio (Illiquid) – 15.1% of net assets at value (Cont.)
              
               
               
Siluria Technologies, Inc. (5)(6)(7) -- Developing next-generation
nanomaterials
              
Series S-2 Convertible Preferred Stock
(M)
     612,061     $ 204,000  
                   
                   
                   
Starfire Systems, Inc. (5)(6)(11) -- Producing ceramic-forming polymers
Common Stock
(M)
     375,000       0  
Series A-1 Convertible Preferred Stock
(M)
     600,000       0  
                0  
                   
                   
TetraVitae Bioscience, Inc. (5)(6)(7)(12) -- Developing methods of
producing alternative chemicals and fuels through biomass fermentation
                  
Series B Convertible Preferred Stock
(M)
     118,804       125,000  
                   
                   
Total Unaffiliated Private Placement Portfolio (cost: $26,648,390)
             $ 16,892,041  
                   
                   
                   
Publicly Traded Portfolio (Liquid) – 0.2% of net assets at value
                  
                   
Orthovita, Inc. (6)(13) -- Developing materials and devices
for orthopedic medical implant applications
Common Stock
(M)
     39,500       173,405  
                   
                   
                   
Total Unaffiliated Publicly Traded Portfolio (cost: $199,432)
             $ 173,405  
                   
Total Investments in Unaffiliated Companies (cost: $26,847,822)
             $ 17,065,446  

 
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, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Non-Controlled Affiliated Companies (2)(14) – 43.9% of net assets at value
              
               
Private Placement Portfolio (Illiquid) – 43.9% of net assets at value
              
               
               
Adesto Technologies Corporation (5)(6)(7) -- Developing low-power,
high-performance memory devices
              
Series A Convertible Preferred Stock
(M)
     6,547,619     $ 2,420,000  
Series B Convertible Preferred Stock
(M)
     5,952,381       2,200,000  
                4,620,000  
                   
Ancora Pharmaceuticals Inc. (5)(6)(7) -- Developing synthetic
carbohydrates for pharmaceutical applications
                  
Series B Convertible Preferred Stock
(M)
     1,663,808       34,940  
Secured Convertible Bridge Note (including interest)
(M)
   $ 325,000       327,307  
                362,247  
                   
BridgeLux, Inc. (5)(6) -- Manufacturing high-power light emitting
diodes (LEDs) and arrays
                  
Series B Convertible Preferred Stock
(M)
     1,861,504       1,804,914  
Series C Convertible Preferred Stock
(M)
     2,130,699       2,065,926  
Series D Convertible Preferred Stock
(M)
     833,333       807,999  
Warrants at $0.7136 expiring 12/31/14
( I )
     163,900       102,602  
Warrants at $1.50 expiring 8/26/14
( I )
     124,999       59,250  
                4,840,691  
                   
Cambrios Technologies Corporation (5)(6)(7) – Developing nanowire-
enabled electronic materials for the display industry
                  
Series B Convertible Preferred Stock
(M)
     1,294,025       970,519  
Series C Convertible Preferred Stock
(M)
     1,300,000       975,000  
Series D Convertible Preferred Stock
(M)
     515,756       386,817  
                2,332,336  
                   
CFX Battery, Inc. (5)(6)(7)(15) -- Developing batteries using
nanostructured materials
                  
Series A Convertible Preferred Stock
(M)
     2,565,798       2,822,378  


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, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
               
Investments in Non-Controlled Affiliated Companies (2)(14) – 43.9% of net assets at value (cont.)
              
               
Private Placement Portfolio (Illiquid) – 43.9% of net assets at value (cont.)
              
               
               
               
Crystal IS, Inc. (5)(6) -- Developing single-crystal
aluminum nitride substrates for light-emitting diodes
              
Series A Convertible Preferred Stock
(M)
     391,571     $ 0  
Series A-1 Convertible Preferred Stock
(M)
     1,300,376       0  
Unsecured Convertible Bridge Note (including interest)
(M)
   $ 408,573       0  
Warrants at $0.78 expiring 05/05/13
( I )
     15,231       0  
Warrants at $0.78 expiring 05/12/13
( I )
     2,350       0  
Warrants at $0.78 expiring 08/08/13
( I )
     4,396       0  
                0  
                   
CSwitch Corporation (5)(6)(7)(16) -- Developed system-
on-a-chip solutions for communications-based platforms
                  
Series A-1 Convertible Preferred Stock
(M)
     6,863,118       0  
Unsecured Convertible Bridge Note (including interest)
(M)
   $ 1,766,673       0  
                0  
                   
Ensemble Discovery Corporation (5)(6)(7)(17) -- Developing DNA-
Programmed ChemistryTM for the discovery of new classes of
therapeutics and bioassays
                  
Series B Convertible Preferred Stock
(M)
     1,449,275       1,000,000  
Unsecured Convertible Bridge Note (including interest)
(M)
   $ 250,286       271,351  
                1,271,351  
                   
Innovalight, Inc. (5)(6)(7) -- Developing solar power products
enabled by silicon-based nanomaterials
                  
Series B Convertible Preferred Stock
(M)
     16,666,666       2,969,667  
Series C Convertible Preferred Stock
(M)
     5,810,577       1,252,984  
                4,222,651  


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, 2009
(Unaudited)
 
 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Non-Controlled Affiliated Companies (2)(14) – 43.9% of net assets at value (cont.)
              
               
Private Placement Portfolio (Illiquid) – 43.9% of net assets at value (cont.)
              
               
               
Kovio, Inc. (5)(6)(7) -- Developing semiconductor products
using printed electronics and thin-film technologies
Series C Convertible Preferred Stock
(M)
     2,500,000     $ 1,920,938  
Series D Convertible Preferred Stock
(M)
     800,000       614,700  
Series E Convertible Preferred Stock
(M)
     1,200,000       922,050  
Warrants at $1.25 expiring 12/31/12
( I )
     355,880       160,858  
                3,618,546  
                   
                   
Mersana Therapeutics, Inc. (5)(6)(7) -- Developing treatments for
cancer based on novel drug delivery polymers
                  
Series A Convertible Preferred Stock
(M)
     68,451       68,451  
Series B Convertible Preferred Stock
(M)
     866,500       866,500  
Unsecured Convertible Bridge Note (including interest)
(M)
   $ 650,000       691,780  
Warrants at $2.00 expiring 10/21/10
( I )
     91,625       21,257  
                1,647,988  
                   
Metabolon, Inc. (5)(6) -- Developing service and diagnostic products
through the use of a metabolomics, or biochemical, profiling platform
                  
Series B Convertible Preferred Stock
(M)
     371,739       1,034,061  
Series B-1 Convertible Preferred Stock
(M)
     148,696       413,625  
Series C Convertible Preferred Stock
(M)
     1,000,000       1,000,000  
Warrants at $1.15 expiring 3/25/15
( I )
     74,348       115,815  
                2,563,501  
                   
NanoGram Corporation (5)(6) -- Developing solar power products
enabled by silicon-based nanomaterials
                  
Series I Convertible Preferred Stock
(M)
     63,210       0  
Series II Convertible Preferred Stock
(M)
     1,250,904       0  
Series III Convertible Preferred Stock
(M)
     1,242,144       0  
Series IV Convertible Preferred Stock
(M)
     432,179       0  
                0  

 
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, 2009
(Unaudited)
 
 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Non-Controlled Affiliated Companies (2)(14) – 43.9% of net assets at value (cont.)
              
               
Private Placement Portfolio (Illiquid) – 43.9% of net assets at value (cont.)
              
               
               
               
Nextreme Thermal Solutions, Inc. (5)(6) -- Developing thin-film
thermoelectric devices for cooling and energy conversion
              
Series A Convertible Preferred Stock
(M)
     17,500     $ 1,750,000  
Series B Convertible Preferred Stock
(M)
     4,870,244       2,655,257  
                4,405,257  
                   
                   
Questech Corporation (5)(6) -- Manufacturing and marketing
proprietary metal and stone decorative tiles
                  
Common Stock
(M)
     655,454       340,836  
Warrants at $1.50 expiring 11/19/09
( I )
     5,000       0  
                340,836  
                   
                   
Solazyme, Inc. (5)(6)(7) -- Developing algal biodiesel, industrial
chemicals and special ingredients based on synthetic biology
                  
Series A Convertible Preferred Stock
(M)
     988,204       4,978,157  
Series B Convertible Preferred Stock
(M)
     495,246       2,494,841  
Series C Convertible Preferred Stock
(M)
     651,309       3,281,021  
                10,754,019  
                   
                   
Xradia, Inc. (5)(6) -- Designing, manufacturing and selling ultra-high
resolution 3D x-ray microscopes and fluorescence imaging systems
                  
Series D Convertible Preferred Stock
(M)
     3,121,099       5,118,602  
                   
                   
                   
Total Non-Controlled Private Placement Portfolio (cost: $60,109,424)
             $ 48,920,403  
                   
Total Investments in Non-Controlled Affiliated Companies (cost: $60,109,424)
             $ 48,920,403  

 
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, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
Investments in Controlled Affiliated Companies (2)(18) – 3.6% of net assets at value
              
               
Private Placement Portfolio (Illiquid) – 3.6% of net assets at value
              
               
               
Laser Light Engines, Inc. (5)(6)(7) -- Manufacturing solid-state light
sources for digital cinema and large-venue projection displays
              
Series A Convertible Preferred Stock
(M)
     7,499,062     $ 1,000,000  
Secured Convertible Bridge Note (including interest)
(M)
   $ 890,000       911,458  
                1,911,458  
                   
                   
SiOnyx, Inc. (5)(6)(7) -- Developing silicon-based optoelectronic
products enabled by its proprietary "Black Silicon"
                  
Series A Convertible Preferred Stock
(M)
     233,499       67,843  
Series A-1 Convertible Preferred Stock
(M)
     2,966,667       861,965  
Series A-2 Convertible Preferred Stock
(M)
     4,207,537       1,222,500  
                2,152,308  
                   
                   
Total Controlled Private Placement Portfolio (cost: $6,996,458)
             $ 4,063,766  
                   
                   
Total Investments in Controlled Affiliated Companies (cost: $6,996,458)
             $ 4,063,766  
                   
                   
Total Private Placement and Publicly Traded Portfolio (cost: $93,953,704)
             $ 70,049,615  

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

 
13
 


HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2009
(Unaudited)

 
Method of
  
Shares/
        
 
Valuation (1)
  
Principal
    
Value
  
               
U.S. Government Securities (19) – 60.1% of net assets at value
              
               
U.S. Treasury Bill       -- due date 10/01/09
(M)
   $ 25,725,000     $ 25,725,000  
U.S. Treasury Bill       -- due date 12/17/09
(M)
     11,700,000       11,697,894  
U.S. Treasury Bill       -- due date 12/24/09
(M)
     25,725,000       25,720,198  
U.S. Treasury Notes    -- due date 02/28/10, coupon 2.000%
(M)
     3,800,000       3,828,348  
                   
                   
                   
                   
Total Investments in U.S. Government Securities (cost: $66,960,793)
             $ 66,971,440  
                   
                   
                   
                   
Total Investments (cost: $160,914,497)
             $ 137,021,055  
                      




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

 
14
 


HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2009
(Unaudited)


Notes to Consolidated Schedule of Investments

(1)
See Footnote to Consolidated Schedule of Investments on page 17 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 or less than five percent of the common shares of the publicly traded 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 private companies is $26,648,390.  The gross unrealized appreciation based on the tax cost for these securities is $1,124,915.  The gross unrealized depreciation based on the tax cost for these securities is $10,881,264.

(4)
The aggregate cost for federal income tax purposes of investments in unaffiliated publicly traded companies is $199,432.  The gross unrealized appreciation based on the tax cost for these securities is $0.  The gross unrealized depreciation based on the tax cost for these securities is $26,027.

(5)
Legal restrictions on sale of investment.

(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)
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.

(8)
With our purchase of Series E Convertible Preferred Stock of BioVex, we received a warrant to purchase a number of shares of common stock of BioVex as determined by dividing 624,999.99 by the price per share at which the common stock is offered and sold to the public in connection with the initial public offering.  The ability to exercise this warrant is therefore contingent on BioVex completing successfully an initial public offering before the expiration date of the warrant on September 27, 2012.  The exercise price of this warrant shall be 110 percent of the initial public offering price.


The accompanying notes are an integral part of this consolidated schedule.

 
15
 


HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 30, 2009
(Unaudited)

(9)
Cobalt Technologies, Inc., does business as Cobalt Biofuels.

(10)
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."

(11)
Starfire Systems, Inc., filed for Chapter 11 bankruptcy on August 13, 2009.

(12)
With our purchase of the Series B Convertible Preferred Stock of TetraVitae Bioscience, Inc., we received the right to purchase, at a price of $2.63038528 per share, a number of shares in the Series C financing equal to the number of shares of Series B Preferred Stock purchased.  The ability to exercise this right is contingent on TetraVitae Bioscience completing successfully a subsequent round of financing.

(13)
Initial investment was made during 2009.

(14)
The aggregate cost for federal income tax purposes of investments in non-controlled affiliated companies is $60,109,424.  The gross unrealized appreciation based on the tax cost for these securities is $10,051,394.  The gross unrealized depreciation based on the tax cost for these securities is $21,240,415.

(15)
On February 28, 2008, Lifco, Inc., merged with CFX Battery, Inc.  The surviving entity is CFX Battery, Inc. 

(16)
CSwitch Corporation ceased operations in June 2009.

(17)
With our investment in a convertible bridge note issued by Ensemble Discovery, we received a warrant to purchase a number of shares of the class of stock sold in the next financing of Ensemble Discovery equal to $125,105.40 divided by the price per share of the class of stock sold in the next financing of Ensemble Discovery.  The ability to exercise this warrant is, therefore, contingent on Ensemble Discovery completing successfully a subsequent round of financing.  This warrant shall expire and no longer be exercisable on September 10, 2015.  The cost basis of this warrant is $75.20.

(18)
The aggregate cost for federal income tax purposes of investments in controlled affiliated companies is $6,996,458.  The gross unrealized appreciation based on the tax cost for these securities is $0.  The gross unrealized depreciation based on the tax cost for these securities is $2,932,692.

(19)
The aggregate cost for federal income tax purposes of our U.S. government securities is $66,960,793. The gross unrealized appreciation on the tax cost for these securities is $10,647. The gross unrealized depreciation on the tax cost of these securities is $0.


The accompanying notes are an integral part of this consolidated schedule.

 
16
 


HARRIS & HARRIS GROUP, INC.
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS

 VALUATION PROCEDURES

I.
Determination of Net Asset Value

The 1940 Act requires periodic valuation of each investment in the portfolio of the Company to determine its 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.

The Board of Directors is responsible for (1) determining overall valuation guidelines and (2) ensuring that the investments of the Company are valued within the prescribed guidelines.

The Valuation Committee, comprised of all of the independent Board members, is responsible for determining the valuation of the Company’s assets within the guidelines established by the Board of Directors.  The Valuation Committee receives information and recommendations from management.

The values assigned to these investments are based on available information and do not necessarily represent amounts that might ultimately be realized, as such amounts depend on future circumstances and cannot reasonably be determined until the individual investments are actually liquidated or become readily marketable.


II.
Approaches to Determining Fair Value

Under accounting principles generally accepted in the United States of America (“GAAP”), fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).

The main approaches to measuring fair value utilized are the market approach and the income approach.

 
·
Market Approach (M): The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. For example, the market approach often uses market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range each appropriate multiple falls requires judgment considering factors specific to the measurement (qualitative and quantitative).  

 
17
 


 
·
Income Approach (I): The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. Those valuation techniques include present value techniques; option-pricing models, such as the Black-Scholes-Merton formula (a closed-form model) and a binomial model (a lattice model), which incorporate present value techniques; and the multi-period excess earnings method, which is used to measure the fair value of certain assets.

Inputs used to measure fair value by these approaches are classified into the following hierarchy:

 
·
Level 1:  Unadjusted quoted prices in active markets for identical assets or liabilities.
 
 
 
·
Level 2:  Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
 
 
 
·
Level 3:  Unobservable inputs for the asset or liability.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement and are not necessarily an indication of risks associated with the investment.


III.
Investment Categories

The Company’s investments can be classified into five broad categories for valuation purposes:

 
·
Equity-related securities;
 
·
Long-term fixed-income securities;
 
·
Short-term fixed-income securities;
 
·
Investments in intellectual property, patents, research and development in technology or  product development; and
 
·
All other securities.

 
The Company applies the methods for determining fair value discussed above to the valuation of investments in each of these five broad categories as follows:

 
A.
EQUITY-RELATED SECURITIES

Equity-related securities, including warrants, are fair valued using the market or income approaches.  The following factors may be considered when the market approach is used to fair value these types of securities:

 
18
 


 
§
Readily available public market quotations;

 
§
The cost of the Company’s investment;

 
§
Transactions in a company's securities or unconditional firm offers by responsible parties as a factor in determining valuation;

 
§
The financial condition and operating results of the company;

 
§
The company's progress towards milestones;

 
§
The long-term potential of the business and technology of the company;

 
§
The values of similar securities issued by companies in similar businesses;

 
§
Multiples to revenue, net income or EBITDA that similar securities issued by companies in similar businesses receive;

 
§
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; and

 
§
The rights and preferences of the class of securities we own as compared to other classes of securities the portfolio company has issued.

When the income approach is used to value warrants, the Company uses the Black-Scholes-Merton formula.


 
B.
LONG-TERM FIXED-INCOME SECURITIES

1.   Readily Marketable:  Long-term fixed-income securities for which market quotations are readily available are valued using the most recent bid quotations when available.

2.   Not Readily Marketable:  Long-term fixed-income securities for which market quotations are not readily available are fair valued using the market approach.  The factors that may be considered when valuing these types of securities by the market approach include:

 
·
Credit quality;
 
·
Interest rate analysis;
 
·
Quotations from broker-dealers;
 
·
Prices from independent pricing services that the Board believes are reasonably reliable; and
 
·
Reasonable price discovery procedures and data from other sources.

 
19
 


 
C.
SHORT-TERM FIXED-INCOME SECURITIES

Short-term fixed-income securities are valued using the market approach in the same manner as long-term fixed-income securities until the remaining maturity is 60 days or less, after which time such securities may be valued at amortized cost if there is no concern over payment at maturity.


 
D.
INVESTMENTS IN INTELLECTUAL PROPERTY, PATENTS, RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT

Such investments are fair valued using the market approach. The Company may consider factors specific to these types of investments when using the market approach including:

 
·
The cost of the Company’s investment;
 
·
Investments in the same or substantially similar intellectual property or patents or research and development in technology or product development or offers by responsible third parties;
 
·
The results of research and development;
 
·
Product development and milestone progress;
 
·
Commercial prospects;
 
·
Term of patent;
 
·
Projected markets; and
 
·
Other subjective factors.


 
E.
ALL OTHER SECURITIES

All other securities are reported at fair value as determined in good faith by the Valuation Committee using the approaches for determining valuation as described above.

For all other securities, the reported values shall reflect the Valuation Committee's judgment of fair values as of the valuation date using the outlined basic approaches of valuation discussed in this Section III.  They do not necessarily represent an amount of money that would be realized if we had to sell such assets and that difference could be material.  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.


 
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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, from time to time, may be used to hold certain interests in portfolio companies.  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.   For the period ended September 30, 2009, there was no 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 accounting principles generally accepted in the United States of America (“GAAP”) 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 GAAP.  In the opinion of management, these financial statements reflect all adjustments, consisting of valuation adjustments and 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, 2008.

 
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 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 GAAP and include the accounts of the Company and its wholly owned subsidiary.  All significant inter-company accounts and transactions have been eliminated in consolidation.

Use of Estimates.  The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities and the reported amounts of revenues and expenses.  Actual results could differ from these estimates, and the differences could be material.  The most significant estimates relate to the fair valuations of our investments.

Cash and Cash Equivalents.  Cash and cash equivalents includes demand deposits.  Cash and cash equivalents are carried at cost which approximates value.

Portfolio Investment Valuations.  Investments are stated at "value" as defined in the 1940 Act and in the applicable regulations of the SEC and in accordance with GAAP.  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, 2009, our financial statements include private venture capital investments and one publicly traded venture capital investment valued at $69,876,210 and $173,405, respectively.  The fair values of our private venture capital investments 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.

On January 1, 2008, the Company adopted guidance issued by the Financial Accounting Standards Board (“FASB”) which requires the Company to assume that the portfolio investment is to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market.

On October 10, 2008, the FASB issued guidance for determining the fair value of a financial asset when the market for that asset is not active, which reiterated that an entity should utilize its own assumptions, information and techniques to estimate fair value when relevant observable inputs are not available, including the use of risk-adjusted discount factors for non-performance risk or liquidity risk.

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, 2009, included in the net decrease in unrealized depreciation on investments was a $399,892 gain resulting from foreign currency translation.

 
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Securities Transactions.  Securities transactions are accounted for on the date the transaction for the purchase or sale of the securities is entered into by the Company (i.e., trade date).

Interest Income Recognition.  Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis.  When securities are determined to be non-income producing, the Company ceases accruing interest and writes off any previously accrued interest.  During the three months and nine months ended September 30, 2009, the Company earned $39,625 and $113,213, respectively, in interest on U.S. government securities and interest-bearing accounts.  During the three months and nine months ended September 30, 2009, the Company recorded, net of write-offs, $60,052 and $25,649, respectively, of bridge note interest.

Realized Gain or Loss and Unrealized Appreciation or Depreciation of Portfolio Investments. Realized gain or loss is recognized when an investment is disposed of and is computed as the difference between the Company's cost basis in the investment at the disposition date and the net proceeds received from such disposition.  Realized gains and losses on investment transactions are determined by specific identification.  Unrealized appreciation or depreciation is computed as the difference between the fair value of the investment and the cost basis of such investment.

Stock-Based Compensation.  The Company has a stock-based employee compensation plan.  The Company accounts for the Harris & Harris Group, Inc. 2006 Equity Incentive Plan (the "Stock Plan") by determining 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, 2009, and December 31, 2008, 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.  The amount of non-cash, 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 options vested and pre-vesting forfeitures.  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 and is accounted for in the current period and prospectively.  See "Note 6. Stock-Based Compensation" 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.  The Company recognizes interest and penalties in income tax expense.