**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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  QUARTER ENDED DECEMBER 31, 2006** |
| ** **                                   | ** ** | ** **                                                                                    |
| **o**                                        | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSIONFILE NUMBER: 000-51233**

**GLADSTONE INVESTMENT CORPORATION**

(Exact name ofregistrant as specified in its charter)

| **DELAWARE**                                                    |   | **83-0423116**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**1521 WESTBRANCH DRIVE, SUITE 200**

**MCLEAN, VIRGINIA 22102**

(Address ofprincipal executive office)

**(703) 287-5800**

(Registrant’stelephone number, including area code)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months and (2) has been subject tosuch filing requirements for the past 90 days. Yes x   No o.

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

Large acceleratedfiler o  Accelerated filer o  Non-accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12 b-2 of the Exchange Act).

Yes oNo x

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date. Thenumber of shares of the issuer’s Common Stock, $0.001 par value, outstanding asof February 1, 2007 was 16,560,100.

 

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**GLADSTONEINVESTMENT CORPORATION**

**TABLE OF CONTENTS**
| PART I.       |   | FINANCIAL INFORMATION                                                                                                                                                          |   |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|          |   |                                                                                                                                                                           |   |
| Item 1.       |   | Financial Statements (Unaudited)                                                                                                                                               |   |
|          |   |                                                                                                                                                                           |   |
|          |   | Consolidated  Statements of Assets and Liabilities as of December 31, 2006 and March 31,  2006                                                                                 |   |
|          |   | Consolidated  Schedule of Investments as of December 31, 2006                                                                                                                  |   |
|          |   | Consolidated  Schedule of Investments as of March 31, 2006                                                                                                                     |   |
|          |   | Consolidated  Statements of Operations for the three months ended December 31, 2006 and  2005                                                                                  |   |
|          |   | Consolidatd  Statements of Operations for the nine months ended December 31, 2006 and for  the period June 22, 2005 (Commencement of Operations) to December 31, 2005          |   |
|          |   | Consolidated  Statements of Changes in Net Assets for nine months ended December 31, 2006  and for the period June 22, 2005 (Commencement of Operations) to December 31,  2005 |   |
|          |   | Consolidated  Statements of Cash Flows for the nine months ended December 31, 2006 and for  the period June 22, 2005 (Commencement of Operations) to December 31, 2005         |   |
|          |   | Financial  Highlights for the three months ended December 31, 2006 and 2005                                                                                                    |   |
|          |   | Financial  Highlights for the nine months ended December 31, 2006 and for the period  June 22, 2005 (Commencement of Operations) to December 31, 2005                          |   |
|          |   | Notes to  Consolidated Financial Statements                                                                                                                                    |   |
|          |   |                                                                                                                                                                           |   |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                    |   |
|          |   | Overview                                                                                                                                                                       |   |
|          |   | Results  of Operations                                                                                                                                                         |   |
|          |   | Liquidity and  Capital Resources                                                                                                                                               |   |
|          |   |                                                                                                                                                                           |   |
| Item 3.       |   | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                    |   |
|          |   |                                                                                                                                                                           |   |
| Item 4.       |   | Controls and  Procedures                                                                                                                                                       |   |
|          |   |                                                                                                                                                                           |   |
| PART II. |   | OTHER INFORMATION                                                                                                                                                              |   |
|          |   |                                                                                                                                                                           |   |
| Item 1.       |   | Legal Proceedings                                                                                                                                                              |   |
|          |   |                                                                                                                                                                           |   |
| Item 1A. |   | Risk  Factors                                                                                                                                                                  |   |
|          |   |                                                                                                                                                                           |   |
| Item 2.       |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                   |   |
|          |   |                                                                                                                                                                           |   |
| Item 3.       |   | Defaults  Upon Senior Securities                                                                                                                                               |   |
|          |   |                                                                                                                                                                           |   |
| Item 4.       |   | Submission  of Matters to a Vote of Security Holders                                                                                                                           |   |
|          |   |                                                                                                                                                                           |   |
| Item 5.       |   | Other Information                                                                                                                                                              |   |
|          |   |                                                                                                                                                                           |   |
| Item 6.       |   | Exhibits                                                                                                                                                                       |   |
|          |   |                                                                                                                                                                           |   |
| SIGNATURES    |   |
|               |        |                                                                                                                                                                                |        |  |

 

2

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**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES(UNAUDITED)**
| ** **                                                                                                   | ** ** | **December 31, 2006** | ** **  | **March 31, 2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|---------------------------------|-------------|------------------------------|------------|
| ASSETS                                                                                                       |       |                            |        |                         |       |
| Non-Control/Non-Affiliate  investments (Cost 12/31/06: $141,804,619; 3/31/06: $97,423,004)                   |       | $                               | 140,777,989 |                         | $          | 97,585,972 |   |
| Control investments  (Cost 12/31/06: $80,601,004; 3/31/06: $55,846,318)                                      |       | 80,188,063                      |        | 55,796,318                   |       |
| Affiliate investments  (Cost 12/31/06: $19,550,000)                                                          |       | 19,550,000                      |        | —                       |       |
| Total investments at  fair value (Cost 12/31/06: $241,955,623; 3/31/06: $153,269,322)                        |       | 240,516,052                     |        | 153,382,290                  |       |
| Cash and cash  equivalents                                                                                   |       | 1,890,942                       |        | 75,672,605                   |       |
| Interest receivable                                                                                          |       | 1,444,705                       |        | 761,388                      |       |
| Due from custodian                                                                                           |       | 2,798,620                       |        | —                       |       |
| Deferred finance costs                                                                                       |       | 459,347                         |        | —                       |       |
| Prepaid directors fees                                                                                       |       | 37,900                          |        | —                       |       |
| Prepaid insurance                                                                                            |       | 145,382                         |        | 99,874                       |       |
| Due from Adviser                                                                                             |       | —                          |        | 234,551                      |       |
| Other assets                                                                                                 |       | 180,114                         |        | 173,099                      |       |
| TOTAL ASSETS                                                                                                 |       | $                               | 247,473,062 |                         | $          | 230,323,807 |   |
|                                                                                                         |       |                            |        |                         |       |
| LIABILITIES                                                                                                  |       |                            |        |                         |       |
| Administration fee  payable to Administrator                                                                 |       | $                               | 124,101     |                         | $          | 110,002 |   |
| Fees due to Adviser                                                                                          |       | 407,221                         |        | —                       |       |
| Borrowings under line  of credit                                                                             |       | 20,000,000                      |        | —                       |       |
| Accrued expenses                                                                                             |       | 812,864                         |        | 367,031                      |       |
| Other liabilities                                                                                            |       | 43,120                          |        | 5,077                        |       |
| Total Liabilities                                                                                            |       | 21,387,306                      |        | 482,110                      |       |
| NET ASSETS                                                                                                   |       | $                               | 226,085,756 |                         | $          | 229,841,697 |   |
|                                                                                                         |       |                            |        |                         |       |
| ANALYSIS OF NET ASSETS:                                                                                      |       |                            |        |                         |       |
|                                                                                                         |       |                            |        |                         |       |
| Common stock, $0.001  par value, 100,000,000 shares authorized and 16,560,100 shares issued and  outstanding |       | $                               | 16,560      |                         | $          | 16,560 |   |
| Capital in excess of  par value                                                                              |       | 230,096,572                     |        | 230,229,279                  |       |
| Net unrealized  (depreciation) appreciation of investment portfolio                                          |       | (1,439,571                      | )           | 112,968                      |       |
| Distributions in excess  of net investment income                                                            |       | (2,587,805                      | )           | (517,110                     | )          |
| TOTAL NET ASSETS                                                                                             |       | $                               | 226,085,756 |                         | $          | 229,841,697 |   |
| NET ASSETS PER SHARE                                                                                         |       | $                               | 13.65       |                         | $          | 13.88 |   |

 

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

3

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**GLADSTONE INVESTMENTCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSDecember 31, 2006**

**(UNAUDITED)**
| **Company (1)**                             | ** ** | **Industry**                                                    | ** ** | **Investment (2)**                           | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|----------------|------------|
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS**   |       |                                                            |       |                                         |       |       |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| ACS Media, LLC                              |       | Service -  directory advertising                                |       | Senior Term Debt (7.9%, Due 11/2013)(3)      |       | $          | 2,627,096  |           | $          | 2,626,550 |   |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Activant                                    |       | Service -  enterprise software and services                     |       | Senior Term Debt (7.4%, Due 5/2013)(3)       |       | 3,848,960  |       | 3,792,675      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| American Safety Razor Company Inc.          |       | Manufacturing -  razors and blades                              |       | Senior Term Debt (7.9%, Due 7/2013)(3)       |       | 1,494,998  |       | 1,499,963      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Aspect Software, Inc.                       |       | Service - call  center software                                 |       | Senior Term Debt (8.4%, Due 7/2011)(3)       |       | 2,996,361  |       | 2,992,500      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Bankruptcy Management Solutions, Inc.       |       | Service -  software and service to bankrupcy trustees           |       | Senior Term Debt (8.1%, Due 7/2012)(3)       |       | 1,000,942  |       | 1,004,981      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Brock Holdings II, Inc.                     |       | Service -  industrial specialty maintenance                     |       | Senior Term Debt (7.9%, Due 8/2013)(3)(5)    |       | 3,000,480  |       | 3,011,203      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Compsych Investments Corp.                  |       | Service -  independent employee assistance programs             |       | Senior Term Debt (8.1%, Due 2/2012)(3) (5)   |       | 3,926,043  |       | 3,919,775      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| CRC Health Group, Inc.                      |       | Service -  substance abuse treatment                            |       | Senior Term Debt (7.9%, Due 2/2012)(3)       |       | 10,041,596 |       | 10,005,278     |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| CST Industries Acquisition, Inc.            |       | Manufacturing -  metal storage units                            |       | Senior Term Debt (8.5%, Due 8/2013)(3)       |       | 999,523    |       | 1,002,488      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Dealer Computer Services, Inc.              |       | Manufacturing  & Service - systems for automotive retailers |       | Senior Term Debt (7.9%, Due 9/2013)(3)       |       | 1,045,380  |       | 1,051,914      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Dresser Holdings, Inc.                      |       | Manufacturing -  oilfield & energy products                 |       | Senior Term Debt (8.1%, Due 10/2013)(3)      |       | 2,015,898  |       | 2,033,537      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Generac Acquisition Corp.                   |       | Manufacturing -  standby power products                         |       | Senior Term Debt (7.8%, Due 11/2013)(3)      |       | 2,620,000  |       | 2,629,825      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Graham Packaging Holdings Co.               |       | Manufacturing -  custom blow molded plastic containers          |       | Senior Term Debt (7.6%, Due 10/2011)(3)      |       | 10,745,127 |       | 10,711,271     |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Hudson Products Holdings, Inc.              |       | Manufacturing -  heat transfer solutions                        |       | Senior Term Debt (8.1%, Due 12/2013)(3)      |       | 1,310,000  |       | 1,313,275      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| IPC Information Systems, LLC                |       | Manufacturing -  specialized telephony systems                  |       | Senior Term Debt (7.9%, Due 9/2013)(3)       |       | 262,000    |       | 263,310        |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| J. Crew Operating Corp.                     |       | Retail - apparel                                                |       | Senior Term Debt (7.1%, Due 5/2013)(3)       |       | 1,406,089  |       | 1,399,999      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Latham Manufacturing Corp.                  |       | Manufacturing -  swimming pool components accessories           |       | Senior Term Debt (8.9%, Due 6/2012)(3)       |       | 2,435,461  |       | 2,369,505      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Lexicon Marketing USA, Inc.                 |       | Service -  marketing to Hispanic community                      |       | Senior Term Debt (7.9%, Due 5/2012)(3) (5)   |       | 2,979,159  |       | 3,006,478      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| LVI Services, Inc.                          |       | Service -  asbestos and mold remediation                        |       | Senior Term Debt (10.4%, Due 11/2010)(3) (5) |       | 6,458,112  |       | 5,920,200      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Madison River Capital LLC                   |       | Service -  communications and information                       |       | Senior Term Debt (7.6%, Due 7/2012)(3)       |       | 5,729,255  |       | 5,702,357      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Maidenform, Inc.                            |       | Manufacturing -  intimate apparel                               |       | Senior Term Debt (7.2%, Due 5/2010)(3)       |       | 2,569,468  |       | 2,566,667      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| MedAssets, Inc.                             |       | Service -  pharmaceuticals and healthcare GPO                   |       | Senior Term Debt (7.9%, Due 10/2013)(3) (5)  |       | 3,502,680  |       | 3,500,000      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| MediMedia USA, LLC                          |       | Service -  healthcare and pharmeceutical marketing              |       | Senior Term Debt (7.8%, Due 10/2013)(3)      |       | 1,183,505  |       | 1,180,463      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| National Mentor Holdings, Inc.              |       | Service - home  health care                                     |       | Senior Term Debt (7.7%, Due 6/2013)(3)       |       | 1,991,799  |       | 2,000,503      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| NPC International Inc.                      |       | Service - Pizza  Hut franchisee                                 |       | Senior Term Debt (7.1%, Due 5/2013)(3)       |       | 3,018,085  |       | 2,995,367      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Nutro Products, Inc.                        |       | Manufacturing -  pet food                                       |       | Senior Term Debt (7.4%, Due 4/2012)(3)       |       | 2,503,442  |       | 2,484,352      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Ozburn-Hessey Holding Co. LLC               |       | Service - third  party logistics                                |       | Senior Term Debt (8.6%, Due 8/2012)(3)       |       | 7,791,254  |       | 7,714,823      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Patriot Media & Communications CNJ, LLC |       | Service -  telecommunications                                   |       | Senior Term Debt (7.4%, Due 3/2013)(3)       |       | 4,169,901  |       | 4,136,293      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Radio Systems Corporation                   |       | Service - design  electronic pet containment products           |       | Senior Term Debt (8.1%, Due 9/2013)(3)       |       | 1,048,000  |       | 1,051,930      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Rally Parts, Inc.                           |       | Manufacturing -  aftermarket motorcycle parts and accessories   |       | Senior Term Debt (7.9%, Due 11/2013)(3)      |       | 262,000    |       | 262,655        |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| RPG Holdings, Inc.                          |       | Manufacturing and  design - greeting cards                      |       | Senior Term Debt (8.9%, Due 12/2011)(3)      |       | 5,001,158  |       | 4,975,000      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| SGS International, Inc.                     |       | Service - digital  imaging and graphics                         |       | Senior Term Debt (7.9%, Due 12/2011)(3)      |       | 1,616,364  |       | 1,612,774      |       |
|                                        |       |                                                            |       |                                         |       |       |       |           |       |
| Stolle Machinery Company                    |       | Manufacturing -  can-making equipment and parts                 |       | Senior Term Debt (7.9%, Due 9/2012)(3)       |       | 262,000    |       | 263,310        |       |
|                                             |            |                                                                 |            |                                              |            |            |            |                |            |  |  |

 

4

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| **Company (1)**                                        | ** ** | **Industry**                                                                                                       | ** ** | **Investment (2)**                                   | ** **      | **Cost**   | ** **      | **Fair Value**  |
|--------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|-----------------|------------|-----------------|-----------------|
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS  (Continued)** |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| SunGard Data  Systems, Inc.                            |       | Service &  Manufacturing - integrated software and processing solutions and information  availability services |       | Senior Term Debt (7.9%,  Due 2/2013)(3)              |            | $          | 9,946,579       |            | $ | 9,960,813 |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Survey Sampling,  LLC                                  |       | Service -  telecommunications-based sampling                                                                       |       | Senior Term Debt (8.6%, Due 5/2011)(3)               |            | 3,373,571  |            | 3,331,493       |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Triad Laboratory  Alliance, LLC                        |       | Service -  regional medical laboratories                                                                           |       | Senior Term Debt (8.6%, Due 12/2011)(3) (5)          |            | 4,966,908  |            | 4,912,875       |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| US Investigative  Services, Inc.                       |       | Service -  background investigations                                                                               |       | Senior Term Debt (7.9%, Due 10/2012)(3)              |            | 10,943,766 |            | 10,927,767      |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Wastequip, Inc.                                        |       | Service - process  and transport waste materials                                                                   |       | Senior Term Debt (7.6%, Due 7/2011)(3)               |            | 5,471,659  |            | 5,390,720       |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| West Corporation                                       |       | Service -  business process outsourcing                                                                            |       | Senior Term Debt (8.1%, Due 10/2013)(3)              |            | 5,240,000  |            | 5,253,100       |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **Total Non-Control/Non-Affiliate Investments**        | ** ** | ** **                                                                                                         | ** ** | **$**                                                | **141,804,619** | ** ** | **$**           | **140,777,989** |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **CONTROL  INVESTMENTS**                               |       |                                                                                                               |       |                                                 |            |       |            |            |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Acme Cryogenics  Corporation                           |       | Manufacturing -  manifolds and pipes for industrial gasses                                                         |       | Senior Subordinated  Term Debt (11.5% Due 3/2013)(6) |            | $          | 14,500,000      |            | $ | 14,500,000 |   |
|                                                   |       |                                                                                                               |       | Redeemable Preferred Stock(4) (6)                    |            | 7,245,634  |            | 7,245,634       |   |
|                                                   |       |                                                                                                               |       | Common Stock(4) (6)                                  |            | 1,084,366  |            | 1,084,366       |   |
|                                                   |       |                                                                                                               |       | Common Stock Warrants(4) (6)                         |            | 24,686     |            | 24,686          |   |
|                                                   |       |                                                                                                               |       |                                                 |            | 22,854,686 |            | 22,854,686      |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Chase II Holdings  Corp.                               |       | Manufacturing -  traffic doors                                                                                     |       | Revolving Credit Facility(7)                         |            | —     |            | —          |   |
|                                                   |       |                                                                                                               |       | Senior Term Debt (9.9%, Due 3/2011)(5)               |            | 12,900,000 |            | 12,835,500      |   |
|                                                   |       |                                                                                                               |       | Senior Term Debt (12.0% Due 3/2011)(5)               |            | 8,000,000  |            | 7,910,000       |   |
|                                                   |       |                                                                                                               |       | Subordinated Term  Debt (13% Due 3/2013)(5)          |            | 6,167,810  |            | 6,036,744       |   |
|                                                   |       |                                                                                                               |       | Redeemable Preferred Stock(4) (6)                    |            | 6,960,806  |            | 6,960,806       |   |
|                                                   |       |                                                                                                               |       | Common Stock Warrants(4) (6)                         |            | 61,384     |            | 61,384          |   |
|                                                   |       |                                                                                                               |       |                                                 |            | 34,090,000 |            | 33,804,434      |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Hailey Transport  Corporation                          |       | Retail and  Service - school buses and parts                                                                       |       | Senior Subordinated Term Debt (12.0%, Due 1/2012)(5) |            | 4,000,000  |            | 3,900,000       |   |
|                                                   |       |                                                                                                               |       | Preferred Stock(4) (6)                               |            | 2,500,000  |            | 2,500,000       |   |
|                                                   |       |                                                                                                               |       |                                                 |            | 6,500,000  |            | 6,400,000       |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Quench Holdings  Corp.                                 |       | Service - sales,  installation and service of water coolers                                                        |       | Revolving Credit  Facility (9.4%, Due 3/2009)(5) (8) |            | 1,900,000  |            | 1,897,625       |   |
|                                                   |       |                                                                                                               |       | Senior Term Debt (9.4%, Due 3/2011)(5)               |            | 4,000,000  |            | 4,005,000       |   |
|                                                   |       |                                                                                                               |       | Subordinated Term  Debt (11.5%, Due 3/2011)(5)       |            | 8,000,000  |            | 7,970,000       |   |
|                                                   |       |                                                                                                               |       | Common Stock(4) (6)                                  |            | 3,256,318  |            | 3,256,318       |   |
|                                                   |       |                                                                                                               |       |                                                 |            | 17,156,318 |            | 17,128,943      |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **Total  Control Investments**                         |       |                                                                                                               |       |                                                 | ** **      | **$**      | **80,601,004**  | ** **      | **$** | **80,188,063** |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **AFFILIATE  INVESTMENTS**                             |       |                                                                                                               |       |                                                 |            |       |            |            |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| Noble Logistics,  Inc.                                 |       | Service -  aftermarket auto parts delivery                                                                         |       | Revolving Credit Facility(9)                         |            | $          | 1,800,000       |            | $ | 1,800,000 |   |
|                                                   |       |                                                                                                               |       | Senior Term Debt (9.8%, Due 3/2011)(6)               |            | 7,000,000  |            | 7,000,000       |   |
|                                                   |       |                                                                                                               |       | Senior Term Debt (12.0% Due 3/2011)(6)               |            | 7,000,000  |            | 7,000,000       |   |
|                                                   |       |                                                                                                               |       | Senior  Subordinated Term Debt (13% Due 3/2013)(6)   |            | 500,000    |            | 500,000         |   |
|                                                   |       |                                                                                                               |       | Preferred Stock(4) (6)                               |            | 1,750,000  |            | 1,750,000       |   |
|                                                   |       |                                                                                                               |       | Common Stock(4) (6)                                  |            | 1,500,000  |            | 1,500,000       |   |
|                                                   |       |                                                                                                               |       |                                                 |            | 19,550,000 |            | 19,550,000      |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **Total  Affiliate Investments**                       |       |                                                                                                               |       |                                                 | ** **      | **$**      | **19,550,000**  | ** **      | **$** | **19,550,000** |   |
|                                                   |       |                                                                                                               |       |                                                 |            |       |            |            |   |
| **Total  Investments**                                 |       |                                                                                                               |       |                                                 | ** **      | **$**      | **241,955,623** | ** **      | **$** | **240,516,052** |   |
|                                                        |            |                                                                                                                    |            |                                                      |                 |            |                 |                 |  |  |  |  |  |  |  |  |  |

 

----

(1)             Certain of the listed securities are issued byaffiliate(s) of the indicated portfolio company.

(2)             Percentage represents the weighted averageinterest rates in effect at December 31, 2006 and due date represents thecontractual maturity date.

(3)             Marketable securities are valued based on theindicative bid price, as of December 31, 2006, from the respective originatingsyndication agent’s trading desk.

(4)             Security is non-income producing.

(5)             Valued using Standard & Poor’s SecuritiesEvaluations, Inc. opinions of value at December 31, 2006.

(6)             Fair value is equal to cost due to recentacquisition.

(7)             Total available under the revolving creditfacility is $500,000 which was undrawn as of December 31, 2006.

(8)             Total available under the revolving creditfacility is $2,000,000, of which $100,000 remains undrawn at December 31, 2006.

(9)             Total available under the revolving creditfacility is $2,000,000, of which $200,000 remains undrawn at December 31, 2006.

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

5

----

**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSMarch 31, 2006(UNAUDITED)**
| **Company (1)**                                 | ** ** | **Industry**                                                      | ** ** | **Investment (2)**                          | ** ** | **Cost**       | ** ** | **Fair Value** |
|-------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------|------------|----------------|
|                                            |       |                                                              |       |                                        |       |           |       |           |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS**       |       |                                                              |       |                                        |       |           |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| CRC Health Group,  Inc.                         |       | Service -  substance abuse treatment                              |       | Senior Term Debt  (6.9%, Due 2/2016)(3)     |       | $              | 5,056,761  |           | $ | 5,056,250 |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Graham Packaging  Holdings Co.                  |       | Manufacturing -  custom blow molded                               |       | Senior Term Debt  (7.0%, Due 10/2011)(3)    |       | 10,071,296     |       | 10,061,087     |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Hertz Equipment  Rental Corporation             |       | Service - car  rentals                                            |       | Senior Term Debt  (6.7%, Due 12/2010)(3)    |       | 871,388        |       | 876,560        |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Latham  Manufacturing Corp.                     |       | Manufacturing -  swimming pool components accessories             |       | Senior Term Debt  (7.8%, Due 12/2010)(3)    |       | 4,454,333      |       | 4,461,188      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Le-Natures, Inc.                                |       | Marketing &  development - natural beverages                  |       | Senior Term Debt  (7.7%, Due 6/2010)(3)     |       | 5,042,467      |       | 5,074,713      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| LVI Services,  Inc.                             |       | Service -  asbestos and mold remediation                          |       | Senior Term Debt  (7.3%, Due 11/2010)(3)    |       | 6,511,390      |       | 6,540,483      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Madison River  Capital LLC                      |       | Service -  communications and information information             |       | Senior Term Debt  (6.8%, Due 7/2012)(3)     |       | 5,788,660      |       | 5,829,062      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Maidenform, Inc.                                |       | Manufacturing -  intimate apparel                                 |       | Senior Term Debt (6.5%, Due 5/2010)(3)      |       | 3,118,448      |       | 3,122,787      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| MedAssets, Inc.                                 |       | Service -  pharmaceuticals and healthcare GPO                     |       | Senior Term Debt  (7.7%, Due 7/2010)(3)(7)  |       | 2,340,111      |       | 2,348,526      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Ozburn-Hessey  Holding Co. LLC                  |       | Service - third  party logistics                                  |       | Senior Term Debt  (7.3%, Due 8/2012)(3)     |       | 6,382,673      |       | 6,376,646      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Patriot Media  & Communications CNJ, LLC    |       | Service -  telecommunications                                     |       | Senior Term Debt  (7.0%, Due 3/2013)(3)     |       | 4,360,777      |       | 4,359,125      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Revere  Industries, LLC                         |       | Manufacturing-plastic  and metal components                       |       | Senior Term Debt  (7.6%, Due 9/2010)(3)     |       | 3,508,831      |       | 3,504,546      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| RPG Holdings,  Inc.                             |       | Manufacturing and  design - greeting cards                        |       | Senior Term Debt  (8.2%, Due 12/2011)(3)    |       | 5,001,332      |       | 5,000,000      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| SGS  International, Inc.                        |       | Service - digital  imaging and graphics                           |       | Senior Term Debt  (7.2%, Due 12/2011)(3)    |       | 1,404,081      |       | 1,415,702      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| SunGard Data  Systems, Inc.                     |       | Service &  manufacturing - integrated software and processing |       | Senior Term Debt  (7.2%, Due 2/2013)(3)     |       | 10,033,531     |       | 10,049,063     |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Triad Laboratory  Alliance, LLC                 |       | Service -  regional medical laboratories                          |       | Senior Term Debt  (7.8%, Due 12/2011)(3)(7) |       | 5,006,982      |       | 5,012,438      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| TexStar  Operating, L.P.                        |       | Manufacturing -  midstream natural gas processing                 |       | Senior Term Debt  (8.3%, Due 12/2011)(3)(7) |       | 3,000,161      |       | 2,999,981      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| US Investigative  Services, Inc.                |       | Service -  background investigations                              |       | Senior Term Debt  (7.4%, Due 10/2012)(3)    |       | 9,948,345      |       | 9,984,478      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| Wastequip, Inc.                                 |       | Manufacturing -  waste removal equipment                          |       | Senior Term Debt  (7.0%, Due 7/2011)(3)     |       | 5,521,437      |       | 5,513,337      |
|                                            |       |                                                              |       |                                        |       |           |       |           |
| **Total Non-Control/Non-Affiliate Investments** |       |                                                              | ** ** | **97,423,004**                              | ** ** | **97,585,972** |
|                                                 |            |                                                                   |            |                                             |            |                |            |                |  |  |

 

6

----

 
| **Company (1)**                         | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                 | ** **      | **Cost**       | ** **      | **Fair Value** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------------------------|-----------------|----------------|-----------------|---------------------|------------|
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **CONTROL INVESTMENTS**                      | ** ** | ** **                                                  | ** ** | ** **                                              | ** **      | ** **     | ** **      |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| Chase II Holdings  Corporation               |       | Manufacturing  - Traffic doors                              |       | Revolving Credit  Facility (5)                          |            | —         |            | —              |       |
|                                         |       |                                                        |       | Senior Term Debt  (9.1%, Due 3/2011)                    |            | 12,900,000     |            | 12,900,000          |       |
|                                         |       |                                                        |       | Senior Term Debt  (12.0% Due 3/2011)                    |            | 8,000,000      |            | 8,000,000           |       |
|                                         |       |                                                        |       | Subordinated Term Debt  (13% Due 3/2013)                |            | 6,167,810      |            | 6,167,810           |       |
|                                         |       |                                                        |       | Redeemable Preferred  Stock (4) (8)                     |            | 6,960,806      |            | 6,960,806           |       |
|                                         |       |                                                        |       | Common Stock (4) (8)                                    |            | 61,384         |            | 61,384              |       |
|                                         |       |                                                        |       |                                                    |            | 34,090,000     |            | 34,090,000          |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| Hailey Transport  Corporation                |       | Retail and Service -  school  buses and parts               |       | Senior Subordinated  Term  Debt (12.0%, Due 1/2012) (7) |            | 4,000,000      |            | 3,950,000           |       |
|                                         |       |                                                        |       | Common Stock (4) (8)                                    |            | 2,500,000      |            | 2,500,00            |       |
|                                         |       |                                                        |       |                                                    |            | 6,500,000      |            | 6,450,000           |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| Quench Holdings  Corporation                 |       | Service - sales,  installation and service of water coolers |       | Revolving Credit  Facility (6)                          |            | —         |            | —              |       |
|                                         |       |                                                        |       | Senior Term Debt (9.1%,  Due 3/2011)                    |            | 4,000,000      |            | 4,000,000           |       |
|                                         |       |                                                        |       | Subordinated Term Debt (11.5%,  Due 3/2011)             |            | 8,000,000      |            | 8,000,000           |       |
|                                         |       |                                                        |       | Common Stock (4) (8)                                    |            | 3,256,318      |            | 3,256,318           |       |
|                                         |       |                                                        |       |                                                    |            | 15,256,318     |            | 15,256,318          |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **Total Control Investments**                | ** ** | ** **                                                  | ** ** | ** **                                              | ** **      | **55,846,318** | ** **      | **55,796,318**      | ** ** |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **Total Investments**                        | ** ** | ** **                                                  | ** ** | ** **                                              | ** **      | **$**          | **153,269,322** | ** **          | **$**      | **153,382,290** | ** ** |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **Cash equivalents**                         | ** ** | ** **                                                  | ** ** | ** **                                              | ** **      | ** **     | ** **      | ** **          | ** ** |
|                                         |       | Government                                                  |       | US  Treasury Bill  (4.2%, 4/20/2006)                    |            | 3,989,800      |            | 3,989,800           |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
|                                         |       | Government                                                  |       | US  Treasury Bill  (4.4%, 4/27/2006)                    |            | 15,241,694     |            | 15,241,694          |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
|                                         |       | Government                                                  |       | US  Treasury Bill  (4.4%, 5/4/2006)                     |            | 35,132,347     |            | 35,132,347          |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
|                                         |       | Government                                                  |       | US  Treasury Bill  (4.4%, 5/25/2006)                    |            | 15,243,245     |            | 15,243,245          |       |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **Total cash equivalents:**                  | ** ** | ** **                                                  | ** ** | ** **                                              | ** **      | **69,607,086** | ** **      | **69,607,086**      | ** ** |
|                                         |       |                                                        |       |                                                    |            |           |            |                |       |
| **Total  investments and cash equivalents:** | ** ** | ** **                                                  | ** ** | **$**                                                   | **222,876,408** | ** **     | **$**           | **222,989,376**     | ** ** |

 

----

(1)             Certain of the listed securities are issued byaffiliate(s) of the indicated portfolio company.

(2)             Percentage represents the weighted averageinterest rates in effect at March 31, 2006 and due date represents thecontractual maturity date.

(3)             Marketable securities are valued based on theindicative bid price, as of March 31, 2006, from the respective originatingsyndication agent’s trading desk.

(4)             Security is non-income producing.

(5)             Total available under the revolving creditfacility is $500,000 which was undrawn as of March 31, 2006.

(6)             Total available under the revolving creditfacility is $2,000,000 which was undrawn as of March 31, 2006.

(7)             Valued using Standard & Poor’s SecuritiesEvaluations, Inc. opinions of value at March 31, 2006.

(8)             Fair value is equal to cost due to recentacquisition.

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

7

----

**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                     | ** ** | **For the three**     | ** ** | **For the three**     | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                     | ** ** | **months ended**           | ** ** | **months ended**           | ** ** |
| ** **                                                                     | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|                                                                           |       |                            |       |                            |       |
| INVESTMENT  INCOME                                                             |       |                            |       |                            |       |
| Interest income                                                                |       |                            |       |                            |       |
| Non-Control/Non-Affiliate investments                                          |       | $                               | 2,586,171  |                            | $          | 790,879 |   |
| Control investments                                                            |       | 1,264,451                       |       | —                          |       |
| Affiliate investments                                                          |       | 114,668                         |       | —                          |       |
| Cash and cash equivalents                                                      |       | 332,586                         |       | 1,530,809                       |       |
| Total interest income                                                          |       | 4,297,876                       |       | 2,321,688                       |       |
| Other income                                                                   |       | 1,492                           |       | —                          |       |
| Total investment income                                                        |       | 4,299,368                       |       | 2,321,688                       |       |
|                                                                           |       |                            |       |                            |       |
| EXPENSES                                                                       |       |                            |       |                            |       |
| Base management fee                                                            |       | 551,235                         |       | 265,522                         |       |
| Loan servicing fee                                                             |       | 508,691                         |       | —                          |       |
| Administration fee                                                             |       | 124,101                         |       | 73,424                          |       |
| Directors fees                                                                 |       | 54,800                          |       | 51,000                          |       |
| Professional fees                                                              |       | 186,537                         |       | 69,570                          |       |
| Insurance expense                                                              |       | 60,696                          |       | 69,552                          |       |
| Stockholder related costs                                                      |       | 28,643                          |       | 24,363                          |       |
| Interest expense                                                               |       | 68,748                          |       | —                          |       |
| Amortization of deferred finance costs                                         |       | 91,392                          |       | —                          |       |
| Taxes and licenses                                                             |       | 41,550                          |       | —                          |       |
| Other expenses                                                                 |       | 60,132                          |       | 15,687                          |       |
| Expenses before credit from Adviser                                            |       | 1,776,525                       |       | 569,118                         |       |
| Credit to base management fee for fees collected by  Adviser (Refer to Note 3) |       | (375,225                        | )          | —                          |       |
| Total expenses net of credit to management fee                                 |       | 1,401,300                       |       | 569,118                         |       |
| NET INVESTMENT  INCOME                                                         |       | 2,898,068                       |       | 1,752,570                       |       |
|                                                                           |       |                            |       |                            |       |
| REALIZED AND  UNREALIZED LOSS ON INVESTMENTS                                   |       |                            |       |                            |       |
| Realized (loss) gain on sale of  Non-Control/Non-Affiliate investments         |       | (2,283                          | )          | 38,056                          |       |
| Net unrealized depreciation of investment portfolio                            |       | (211,242                        | )          | (175,879                        | )          |
| Net loss on investments                                                        |       | (213,525                        | )          | (137,823                        | )          |
|                                                                           |       |                            |       |                            |       |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS (Refer to Note 6)        |       | $                               | 2,684,543  |                            | $          | 1,614,747 |   |
|                                                                           |       |                            |       |                            |       |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:        |       |                            |       |                            |       |
| Basic and Diluted                                                              |       | $                               | 0.16       |                            | $          | 0.10 |   |
|                                                                           |       |                            |       |                            |       |
| SHARES OF COMMON  STOCK OUTSTANDING:                                           |       |                            |       |                            |       |
| Basic and  diluted weighted average shares                                     |       | 16,560,100                      |       | 16,560,100                      |       |

 

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

8

----

**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                | ** ** | ** **                      | ** ** | **For the period**    | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                | ** ** | ** **                      | ** ** | **June 22, 2005**     | ** ** |
| ** **                                                                | ** ** | **For the nine**      | ** ** | **(Commencement of**       | ** ** |
| ** **                                                                | ** ** | **months ended**           | ** ** | **Operations) to**         | ** ** |
| ** **                                                                | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|                                                                      |       |                            |       |                            |       |
| INVESTMENT INCOME                                                         |       |                            |       |                            |       |
| Interest income                                                           |       |                            |       |                            |       |
| Non-Control/Non-Affiliate  investments                                    |       | $                               | 6,938,026  |                            | $          | 984,457 |   |
| Control  investments                                                      |       | 3,711,056                       |       | —                          |       |
| Affiliate  investments                                                    |       | 114,668                         |       | —                          |       |
| Cash and cash  equivalents                                                |       | 1,610,506                       |       | 3,192,019                       |       |
| Total interest  income                                                    |       | 12,374,256                      |       | 4,176,476                       |       |
| Other income                                                              |       | 2,478                           |       | —                          |       |
| Total investment  income                                                  |       | 12,376,734                      |       | 4,176,476                       |       |
|                                                                      |       |                            |       |                            |       |
| EXPENSES                                                                  |       |                            |       |                            |       |
| Base management  fee                                                      |       | 2,214,437                       |       | 357,630                         |       |
| Loan servicing  fee                                                       |       | 508,691                         |       | —                          |       |
| Administration  fee                                                       |       | 364,351                         |       | 178,469                         |       |
| Directors fees                                                            |       | 154,300                         |       | 103,000                         |       |
| Professional  fees                                                        |       | 354,325                         |       | 135,872                         |       |
| Insurance  expense                                                        |       | 200,933                         |       | 112,030                         |       |
| Stockholder  related costs                                                |       | 187,509                         |       | 67,901                          |       |
| Interest expense                                                          |       | 68,748                          |       | 378                             |       |
| Amortization of  deferred finance costs                                   |       | 91,392                          |       | —                          |       |
| Taxes and  licenses                                                       |       | 139,994                         |       | —                          |       |
| Other expenses                                                            |       | 104,161                         |       | 35,920                          |       |
| Expenses before  credit from Gladstone Management                         |       | 4,388,841                       |       | 991,200                         |       |
| Credit to  management fee for fees collected by Adviser (Refer to Note 3) |       | (375,225                        | )          | —                          |       |
| Total expenses  net of credit to management fee                           |       | 4,013,616                       |       | 991,200                         |       |
| NET INVESTMENT INCOME                                                     |       | 8,363,118                       |       | 3,185,276                       |       |
|                                                                      |       |                            |       |                            |       |
| REALIZED AND UNREALIZED  LOSS ON INVESTMENTS                              |       |                            |       |                            |       |
| Realized (loss)  gain on sale of Non-Control/Non-Affiliate investments    |       | (944                            | )          | 38,056                          |       |
| Net unrealized  depreciation of investment portfolio                      |       | (1,552,539                      | )          | (112,053                        | )          |
| Net loss on  investments                                                  |       | (1,553,483                      | )          | (73,997                         | )          |
|                                                                      |       |                            |       |                            |       |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS (Refer to Note 6)   |       | $                               | 6,809,635  |                            | $          | 3,111,279 |   |
|                                                                      |       |                            |       |                            |       |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:   |       |                            |       |                            |       |
| Basic and  Diluted                                                        |       | $                               | 0.41       |                            | $          | 0.19 |   |
|                                                                      |       |                            |       |                            |       |
| SHARES OF COMMON STOCK  OUTSTANDING:                                      |       |                            |       |                            |       |
| Basic and diluted  weighted average shares                                |       | 16,560,100                      |       | 16,560,100                      |       |

 

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

9

----

**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**
| ** **                                           | ** ** | ** **                      | ** **  | **For the period**    | ** ** |
|------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                           | ** ** | ** **                      | ** **  | **June 22, 2005**     | ** ** |
| ** **                                           | ** ** | **For the nine**      | ** **  | **(Commencement of**       | ** ** |
| ** **                                           | ** ** | **months ended**           | ** **  | **Operations) to**         | ** ** |
| ** **                                           | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
| *Operations:*                                        | * *   | * *                        | * *    | * *                        | * *   |
| Net investment income                                |       | $                               | 8,363,118   |                            | $          | 3,185,276 |   |
| Realized (loss) gain on sale of investments          |       | (944                            | )           | 38,056                          |       |
| Unrealized depreciation of portfolio                 |       | (1,552,539                      | )           | (112,053                        | )          |
| Increase in net  assets from operations              |       | 6,809,635                       |        | 3,111,279                       |       |
|                                                 |       |                            |        |                            |       |
| *Capital  transactions:*                             | * *   | * *                        | * *    | * *                        | * *   |
| Issuance of common stock                             |       | —                          |        | 230,244,339                     |       |
| Shelf registration offering costs                    |       | (132,707                        | )           | —                          |       |
| Dividends from net investment income                 |       | (10,432,869                     | )           | (2,980,818                      | )          |
| Total change in net assets from capital transactions |       | (10,565,576                     | )           | 227,263,521                     |       |
|                                                 |       |                            |        |                            |       |
| Total change in  net assets                          |       | (3,755,941                      | )           | 230,374,800                     |       |
|                                                 |       |                            |        |                            |       |
| Net Assets                                           |       |                            |        |                            |       |
| Beginning of period                                  |       | 229,841,697                     |        | 1,500                           |       |
| End of period                                        |       | $                               | 226,085,756 |                            | $          | 230,376,300 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OFTHESE CONSOLIDATED FINANCIAL STATEMENTS.*

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**GLADSTONEINVESTMENT CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**
| ** **                                                           | ** ** | ** **                      | ** ** | **For the period**    | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                           | ** ** | ** **                      | ** ** | **June 22, 2005**     | ** ** |
| ** **                                                           | ** ** | **For the nine**      | ** ** | **(Commencement of**       | ** ** |
| ** **                                                           | ** ** | **months ended**           | ** ** | **Operations) to**         | ** ** |
| ** **                                                           | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|                                                                 |       |                            |       |                            |       |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                            | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Net increase in net assets resulting from operations                 |       | $                               | 6,809,635  |                            | $          | 3,111,279 |   |
| Adjustments to reconcile net increase in net assets                  |       |                            |       |                            |       |
| resulting from operations to net cash used in  operating activities: |       |                            |       |                            |       |
| Purchase of investments                                              |       | (118,850,626                    | )          | (64,221,339                     | )          |
| Principal repayments of investments                                  |       | 10,448,688                      |       | 1,376,483                       |       |
| Proceeds from the sale of investments                                |       | 19,589,945                      |       | 2,038,056                       |       |
| Net unrealized depreciation of investment portfolio                  |       | 1,552,539                       |       | 112,053                         |       |
| Net realized loss (gain) on sales of investments                     |       | 944                             |       | (38,056                         | )          |
| Net amortization of premiums and discounts                           |       | 124,748                         |       | 21,797                          |       |
| Increase in interest receivable                                      |       | (683,317                        | )          | (317,233                        | )          |
| Increase in due from custodian                                       |       | (2,798,620                      | )          | —                          |       |
| Increase in prepaid assets                                           |       | (67,993                         | )          | (214,485                        | )          |
| Increase in other assets                                             |       | (22,429                         | )          | (108,604                        | )          |
| Increase in other liabilities                                        |       | 38,042                          |       | —                          |       |
| Increase in administration fee payable to  Administrator             |       | 410,561                         |       | 73,424                          |       |
| Increase in base management fee payable to Adviser                   |       | 14,099                          |       | 192,787                         |       |
| Increase in loan servicing fee payable to Adviser                    |       | 231,211                         |       | —                          |       |
| Increase in accounts payable                                         |       | —                          |       | 2,207                           |       |
| Increase in accrued expenses                                         |       | 445,833                         |       | 53,933                          |       |
| Net cash used in operating activities                                |       | (82,756,740                     | )          | (57,917,698                     | )          |
|                                                                 |       |                            |       |                            |       |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                            | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Net proceeds from the issuance of common stock                       |       | —                          |       | 230,292,203                     |       |
| Borrowings from line of credit                                       |       | 23,500,000                      |       | —                          |       |
| Repayments of line of credit                                         |       | (3,500,000                      | )          | —                          |       |
| Deferred finance costs                                               |       | (459,347                        | )          | —                          |       |
| Shelf offering registration costs                                    |       | (132,707                        | )          | —                          |       |
| Distributions paid                                                   |       | (10,432,869                     | )          | (2,980,818                      | )          |
| Decrease in loan payable to affiliate                                |       | —                          |       | (50,000                         | )          |
| Net cash provided by financing activities                            |       | 8,975,077                       |       | 227,261,385                     |       |
|                                                                 |       |                            |       |                            |       |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1)**        |       | (73,781,663                     | )          | 169,343,687                     |       |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                  |       | 75,672,605                      |       | 3,636                           |       |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                        |       | $                               | 1,890,942  |                            | $          | 169,347,323 |   |
|                                                                 |       |                            |       |                            |       |
| **CASH PAID DURING PERIOD FOR  INTEREST TO AFFILIATE**               |       | $                               | —     |                            | $          | 378 |   |

 

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(1)             Cashand cash equivalents consist of demand deposits and highly liquid investmentswith original maturities of three months or less when purchased.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OFTHESE CONSOLIDATED  FINANCIAL STATEMENTS.*

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**GLADSTONEINVESTMENT CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                         | ** ** | **For the three**     | ** **  | **For the three**     | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                                         | ** ** | **months ended**           | ** **  | **months ended**           | ** ** |
| ** **                                                         | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
| Per Share Data  (1)                                                |       |                            |        |                            |       |
| Balance at beginning of period                                     |       | $                               | 13.71       |                            | $          | 13.93 |   |
|                                                               |       |                            |        |                            |       |
| *Income from investment operations:*                               | * *   | * *                        | * *    | * *                        | * *   |
| Net investment income (2)                                          |       | 0.18                            |        | 0.11                            |       |
| Realized gain on sale of investments (2)                           |       | —                          |        | —                          |       |
| Net unrealized depreciation of investments (2)                     |       | (0.02                           | )           | (0.01                           | )          |
| Total from investment operations                                   |       | 0.16                            |        | 0.10                            |       |
| Distributions                                                      |       | (0.21                           | )           | (0.12                           | )          |
| Net asset value at end of period                                   |       | $                               | 13.65       |                            | $          | 13.91 |   |
|                                                               |       |                            |        |                            |       |
| Per share market value at beginning of period                      |       | $                               | 14.46       |                            | $          | 15.05 |   |
| Per share market value at end of period                            |       | 15.31                           |        | 13.59                           |       |
| Total return (3)                                                   |       | 7.38                            | %           | (6.63                           | %)         |
| Shares outstanding at end of period                                |       | 16,560,100                      |        | 16,560,100                      |       |
|                                                               |       |                            |        |                            |       |
| Ratios/Supplemental Data                                           |       |                            |        |                            |       |
| Net assets at end of period                                        |       | $                               | 226,085,756 |                            | $          | 230,376,300 |   |
| Average net assets (4)                                             |       | $                               | 225,338,878 |                            | $          | 229,896,936 |   |
| Ratio of expenses to average net assets (annualized)               |       | 3.15                            | %           | 0.99                            | %          |
| Ratio of net expenses to average net assets  (annualized)          |       | 2.49                            | %           | 0.99                            | %          |
| Ratio of net  investment income to average net assets (annualized) |       | 5.14                            | %           | 3.05                            | %          |

 

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(1)             Basedon actual shares outstanding.

(2)             Basedon weighted average basic per share data.

(3)             Totalreturn equals the change in the market value of the Company’s common stock fromthe beginning of the period taking into account dividends reinvested inaccordance with the terms of our dividend reinvestment plan.

(4)             Calculatedusing the average of the ending monthly net assets for the respective periods.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OFTHESE CONSOLIDATED FINANCIAL STATEMENTS.*

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**GLADSTONEINVESTMENT CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                         | ** ** | ** **                      | ** **  | **For the period**    | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                                         | ** ** | ** **                      | ** **  | **June 22, 2005**     | ** ** |
| ** **                                                         | ** ** | **For the nine**      | ** **  | **(Commencement of**       | ** ** |
| ** **                                                         | ** ** | **months ended**           | ** **  | **Operations) to**         | ** ** |
| ** **                                                         | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
| Per Share Data  (1)                                                |       |                            |        |                            |       |
| Balance at beginning of period                                     |       | $                               | 13.88       |                            | $          | — |   |
| Net proceeds from initial public offering (2)                      |       | —                          |        | 13.95                           |       |
| Offering costs                                                     |       | —                          |        | (0.05                           | )          |
|                                                               |       |                            |        |                            |       |
| *Income from investment operations:*                               | * *   | * *                        | * *    | * *                        | * *   |
| Net investment income (3)                                          |       | 0.51                            |        | 0.20                            |       |
| Realized gain on sale of investments (3)                           |       | —                          |        | —                          |       |
| Net unrealized depreciation of investments (3)                     |       | (0.10                           | )           | (0.01                           | )          |
| Total from investment operations                                   |       | 0.41                            |        | 0.19                            |       |
| Distributions                                                      |       | (0.63                           | )           | (0.18                           | )          |
| Net asset value at end of period                                   |       | $                               | 13.65       |                            | $          | 13.91 |   |
|                                                               |       |                            |        |                            |       |
| Per share market value at beginning of period                      |       | $                               | 14.90       |                            | $          | 15.00 |   |
| Per share market value at end of period                            |       | 15.31                           |        | 13.59                           |       |
| Total return (4)                                                   |       | 7.28                            | %           | (8.25                           | %)         |
| Shares outstanding at end of period                                |       | 16,560,100                      |        | 16,560,100                      |       |
|                                                               |       |                            |        |                            |       |
| Ratios/Supplemental Data                                           |       |                            |        |                            |       |
| Net assets at end of period                                        |       | $                               | 226,085,756 |                            | $          | 230,376,300 |   |
| Average net assets (5)                                             |       | $                               | 226,399,367 |                            | $          | 225,793,817 |   |
| Ratio of expenses to average net assets (annualized)               |       | 2.59                            | %           | 0.75                            | %          |
| Ratio of net expenses to average net assets  (annualized)          |       | 2.36                            | %           | 0.75                            | %          |
| Ratio of net  investment income to average net assets (annualized) |       | 4.93                            | %           | 2.42                            | %          |

 

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(1)             Basedon actual shares outstanding.

(2)             Netof initial underwriting discount of $1.05 per share.

(3)             Basedon weighted average basic per share data.

(4)             Totalreturn equals the change in the market value of the Company’s common stock fromthe beginning of the period taking into account dividends reinvested inaccordance with the terms of our dividend reinvestment plan.

(5)             Calculatedusing the average of the ending monthly net assets for the respective periods.

*THE ACCOMPANYING NOTES ARE ANINTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

** **

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**GLADSTONEINVESTMENT CORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2006(UNAUDITED)**

NOTE 1. ORGANIZATION

Gladstone Investment Corporation (the “Company”) wasincorporated under the General Corporation Laws of the State of Delaware on February18, 2005 and completed an initial public offering on June 22, 2005.   The Company is a closed-end, non-diversifiedmanagement investment company that has elected to be treated as a businessdevelopment company under the Investment Company Act of 1940, as amended (the“1940 Act”). In addition, the Company has elected to be treated for taxpurposes as a regulated investment company, or RIC, under the Internal RevenueCode of 1986, as amended (the “Code”). The Company’s investment objectives areto achieve a high level of current income and capital gains by investing indebt and equity securities of established private businesses.

Gladstone Business Investment LLC, (“BusinessInvestment”) a wholly-owned subsidiary of the Company, was established on August11, 2006 for the sole purpose of owning the Company’s portfolio of investmentsin connection with the establishment of its line of credit facility withDeutsche Bank AG, which recently closed on October 19, 2006.  The financial statements of Business Investmentare consolidated with those of the Company.

The Company is externally managed by GladstoneManagement Corporation (“GMC” or the “Adviser”), an unconsolidated affiliate ofthe Company.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

*Unaudited Interim FinancialStatements*

Interim financial statements of the Company areprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) for interim financial information andpursuant to the requirements for reporting on Form 10-Q and Article 10 ofRegulation S-X. Accordingly, certain disclosures accompanying annual financialstatements prepared in accordance with GAAP are omitted. In the opinion ofmanagement, all adjustments, consisting solely of normal recurring accruals,necessary for the fair statement of financial statements for the interimperiods have been included. The current period’s results of operations are notnecessarily indicative of results that ultimately may be achieved for the year.  The interim financial statements and notesthereto should be read in conjunction with the financial statements and notesthereto included in the Company’s Form 10-K for the fiscal year ended March 31,2006, as filed with the Securities and Exchange Commission on June 14, 2006.

*Use of Estimates*

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

*Classification of Investments*

The 1940 Act requires classification of the Company’sinvestments by its respective level of control. As defined in the 1940 Act, “Control Investments” are investments inthose portfolio companies that the Company is deemed to “Control”.  “Affiliate Investments” are investments inthose portfolio companies that are “Affiliated Companies” of the Company, asdefined in the 1940 Act, other than Control Investments.  “Non-Control/Non-Affiliate Investments” arethose that are neither Control Investments nor Affiliate Investments.  In general, the 1940 Act prescribes that theCompany has control over a portfolio company if it owns greater than 25% of thevoting securities of the portfolio company. The Company is deemed to be an affiliate of a portfolio company if itowns between 5% and 25% of the voting securities of such portfolio company orhas one or more seats on the affiliated company’s board of directors.  However, if the Company holds 50% or more 

14

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representation on a portfolio company’s board ofdirectors, the Company will be deemed to have control over the portfoliocompany.

*Investment Valuation*

The Company carries itsinvestments at fair value, as determined by its Board of Directors.  Securities that are publicly traded arevalued at the closing price on the valuation date.  Securities for which a limited market exists,such as participations in syndicated loans, are valued at the indicative bidprice on the valuation date from the respective originating syndication agent’strading desk.  Debt and equity securitiesthat are not publicly traded are valued at fair value. The Company’s Board ofDirectors has established a valuation policy and consistently applied valuationprocedures used to determine the fair value of these securities quarterly.  These procedures for the determination ofvalue of 13 of the Company’s debt securities rely on the opinions of valuesubmitted to us by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”).SPSE will only evaluate the debt portion of the Company’s investments for whichthe Company specifically requests evaluation, and may decline to make requestedevaluations for any reason in its sole discretion.  SPSE opinions of value are submitted to theBoard of Directors along with the Adviser’s supplemental assessment andrecommendation regarding valuation of each of these investments. The Board ofDirectors then reviews whether the Adviser has followed its establishedprocedures for determinations of fair value, and votes to accept or not acceptthe recommended valuation of the Company’s investment portfolio. The Company’sfair valuation procedures provide for valuation of non-convertible debtsecurities at cost plus amortized original issue discount (“OID”) plus paid inkind (“PIK”) interest, if any, unless adverse factors lead to a determinationof a lesser valuation.  The fair value ofconvertible debt, equity, success or exit fees or other equity-like securitiesis determined based on the collateral, the enterprise value of the issuer, theissuer’s ability to make payments, the earnings of the issuer, sales to thirdparties of similar securities, the comparison to publicly traded securities,discounted cash flow and other pertinent factors.  Due to the uncertainty inherent in thevaluation process, such estimates of fair value may differ significantly fromthe values that would have resulted had a ready market for the securitiesexisted, and the differences could be material. Additionally, changes in themarket environment and other events that may occur over the life of theinvestments may cause the gains or losses ultimately realized on theseinvestments to be different than the valuation currently assigned.  Because there is a delay between when theCompany closes an investment and when the investment can be evaluated by SPSE,new investments are not valued immediately by SPSE; rather, the Adviser makesits own determination about the recommended value of these investments inaccordance with the Company’s valuation policy without the input of SPSE duringthe specific quarter in which the investment is made.  Because SPSE does not currently performindependent valuations of mortgage loans or equity securities for the Company,the Adviser also determines a recommendation for the fair value of theseinvestments without the input of SPSE. The Adviser considers a number of qualitative and quantitative factorsin current market conditions when performing valuations.  The Board of Directors then determineswhether or not to accept the Adviser’s recommendations for the aggregatevaluation of the Company’s portfolio of investments.  The Board of Directors is ultimatelyresponsible for setting the fair value and disclosure of investments in thefinancial statements.

*Interest and Dividend IncomeRecognition*

Interest income, adjusted for amortization of premiumsand acquisition costs and for the accretion of discounts, is recorded on theaccrual basis to the extent that such amounts are expected to be collected. TheCompany stops accruing interest on its investments when it is determined thatinterest is no longer collectible.  Therewere no uncollectible accounts at December 31, 2006.  Conditional interest or a success fee isrecorded upon full repayment of a loan investment. Dividend income on preferredequity securities is accrued to the extent that such amounts are expected to becollected and that the Company has the option to collect such amounts incash.  To date, the Company has notaccrued any dividend income.

*Services Provided to PortfolioCompanies*

The 1940 Act requires that a business developmentcompany make available managerial assistance to its portfolio companies byproviding significant guidance and counsel concerning the management,operations, or business objectives and policies of the respective portfoliocompany. The Company provides these and other services to portfolio companiesthrough its Adviser.   Currently, neitherthe Company nor the Adviser receives fees in connection with managerialassistance. 

The Adviser receives fees for other services itprovides to portfolio companies.  Theseother fees are typically non-recurring, are recognized as revenue when earnedand are generally paid directly to the Adviser by the borrower or potentialborrower upon closing of the investment. The services the Adviser provides to portfolio companies vary byinvestment, but generally include a broad array of services, such as investmentbanking services, arranging bank and equity financing, structuring 

15

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financing from multiple lenders and investors,reviewing existing credit facilities, restructuring existing investments,raising equity and debt capital, turnaround management, merger and acquisitionservices and recruiting new management personnel.  When the Adviser receives fees for theseservices, 50% of those fees are credited against the base management fee due tothe Adviser from the Company.  Anyservices of this nature subsequent to the closing would typically generate aseparate fee at the time of completion. 

The Adviser also receives fees for monitoring andreviewing portfolio company investments. These fees are recurring and are generally paid annually or quarterly inadvance to the Adviser throughout the life of the investment.  Fees of this nature are recorded as revenueby the Adviser when earned and are not credit against the base management fees.

The Company may receive fees for the origination andclosing services it provides to portfolio companies through its Adviser. Thesefees are paid directly to the Company and are recognized as revenue uponclosing of the originated investment and are reported as fee income in theconsolidated statements of operations.  

*Cash and Cash Equivalents*

The Company considers all short-term, highly liquidinvestments that are both readily convertible to cash and have a maturity ofthree months or less at the time of purchase to be cash equivalents. Itemsclassified as cash equivalents include temporary investments in U.S. Treasurybills and can also include commercial paper and money-market funds. All of theCompany’s cash at December 31, 2006 was deposited with two financial institutions,and the Company’s balances exceed federally insurable limits. The Company seeksto mitigate this risk by depositing funds with major financial institutions.

*Realized Gain or Loss and UnrealizedAppreciation or Depreciation of Portfolio Investments*

Realized gain or loss is recognized when an investmentis sold and is computed as the difference between the Company’s cost basis inthe investment at the date of sale and the net proceeds received from suchsale.  Unrealized appreciation ordepreciation reflects the difference between the fair market value of theinvestment and the cost basis of such investment.

*Federal Income Taxes*

The Company intends to continue to qualify fortreatment as a RIC under subchapter M of the Code. As a RIC, the Company willnot be subject to federal income tax on the portion of its taxable income andgains distributed to stockholders. To qualify as a RIC, the Company is requiredto distribute at least 90% of investment company taxable income, as defined bythe Code. The Company intends to distribute at least 90% of its ordinaryincome, and as a result, no income tax provisions have been recorded. TheCompany may, but does not intend to, pay out a return of capital.

*Recent Accounting Pronouncements*

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, *FairValue Measurments* (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fairvalue in GAAP and expands disclosures about fair value measurements.  SFAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007, and interim periods within those fiscal years. The Company is required to adopt the provisions of SFAS 157 beginning with thefiscal year ended March 31, 2009.  The Company is currently evaluating theimpact of this pronouncement on its consolidated financial statements.

In September 2006, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”).SAB 108 addresses how the effects of prior year uncorrected misstatementsshould be considered when quantifying misstatements in current year financialstatements and requires registrants to consider the effect of all carry overand reversing effects of prior year misstatements when quantifying errors incurrent year financial statements. SAB 108 does not change the SEC’s previousguidance in SAB No. 99, “*Materiality*,”on evaluating the materiality of misstatements. A registrant applying the newguidance for the first time that identifies material errors in existence at thebeginning of the first fiscal year ending after November 15, 2006, maycorrect those errors through a one-time cumulative effect adjustment tobeginning-of-year retained earnings. The cumulative effect alternative is availableonly if the application of the new guidance results in a conclusion that amaterial error exists as of the beginning of the first fiscal year ending afterNovember 15, 2006, and those misstatements were determined to beimmaterial based on a proper application of the registrant’s previous method 

16

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for quantifying misstatements. The Company iscurrently evaluating the impact of this pronouncement on its consolidatedfinancial statements

In June 2006, the FASB issued FASB InterpretationNo. 48, “*Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109,”*which clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS No. 109, “*Accounting for Income Taxes*.” SFAS No. 109is effective as of the beginning of an entity’s first fiscal year that beginsafter December 15, 2006. The Company will adopt this Interpretationeffective April 1, 2007. The Company is currently evaluating the impact ofthis pronouncement on its consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, *“Accounting for Certain Hybrid Financial Instruments,an amendment of FASB statements No. 133 and 140”* (SFAS No.155). SFAS No. 155 allows financial instruments that have embeddedderivatives to be accounted for as a whole (eliminating the need to bifurcatethe derivative from its host) as long as the entire instrument is valued on afair value basis. The statement also resolves and clarifies other specific SFASNo. 133 and SFAS No. 140 related issues. SFAS No. 155 iseffective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006. TheCompany will be required to adopt SFAS No. 155 on April 1, 2007. TheCompany is currently evaluating the impact of this pronouncement on itsconsolidated financial statements.

NOTE 3. RELATED PARTY TRANSACTIONS

**Investment Advisory and ManagementAgreement**

We have entered into an investment advisory and managementagreement with the Adviser (the “Advisory Agreement”), which is controlled byour chairman and chief executive officer. In accordance with the AdvisoryAgreement, we pay the Adviser a fee, as compensation for its services,consisting of a base management fee and an incentive fee.

The base management fee is assessed at an annual rateof 2.0% computed on the basis of the average value of the Company’s grossinvested assets at the end of the two most recently completed quarters, whichare total assets less the cash proceeds and cash and cash equivalents from theproceeds of the Company’s initial public offering that are not invested in debtand equity securities of portfolio companies. Through December 31, 2006, the base management fee was computed andpayable quarterly.  Beginning in periodssubsequent to December 31, 2006, the base management fee will be computed andpayable quarterly and will be assessed at an annual rate of 2.0% computed onthe basis of the value of the Company’s average gross assets at the end of thetwo most recently completed quarters, which are total assets, includinginvestments made with proceeds of borrowings, less any uninvested cash or cashequivalents resulting from borrowings. This new calculation was originally scheduled to begin in periods afterMarch 31, 2006; however, on April 11, 2006, July 11, 2006 and October 10, 2006,the Company’s Board of Directors accepted voluntary waivers from the Adviserthat allowed the current calculation of the base management fee to be effectivethrough June 30, 2006, September 30, 2006 and December 31, 2006,respectively.  

On January 9, 2007, the Company’s Board of Directorsaccepted a voluntary waiver from the Adviser to reduce the annual 2.0% basemanagement fee on senior syndicated loan participations to 0.5% to the extentthat proceeds resulting from borrowings were used to purchase such syndicatedloan participations.  

When the Adviser receives fees from portfoliocompanies, as discussed in Note 2 under “Services Provided to PortfolioCompanies,” 50% of certain of these fees will be credited against the basemanagement fee that the Company would otherwise be required to pay to theAdviser. 

For the three and nine months ended December 31, 2006,the Company incurred a base management fee to the Adviser of $551,235 and$2,214,437, respectively.  For the threemonths ended December 31, 2005 and for the period June 22, 2005 (commencementof operations) to December 31, 2005, the Company incurred a base management feeto the Adviser of $265,522 and $357,630, respectively.  As of December 31, 2006, $176,010 was unpaidand included in fees due to Adviser in the accompanying consolidated statementsof assets and liabilities.  For the threeand nine months ended December 31, 2006, the Company recognized aggregatecredits against the base management fee of $375,225 resulting from investmentbanking fees paid to the Adviser during the respective periods.

In addition, the Adviser services the loans held byBusiness Investment, in return for which the Adviser receives a 2.0% annual feebased on the monthly aggregate balance of loans held by BusinessInvestment.  Since the Company owns theseloans, all loan servicing fees paid to the Adviser are treated as reductionsagainst the 2.0% base management fee payable to 

17

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the Adviser. Overall, the management fee due to the Adviser cannot exceed 2.0% oftotal assets (as reduced by cash and cash equivalents pledged to creditors)during any given fiscal year.

For the three and nine months ended December 31, 2006,the Company recorded loan servicing fees to the Adviser of $508,691, of which$231,211 was unpaid at December 31, 2006 and included in fees due to Adviser inthe accompanying consolidated statements of assets and liabilities.

The incentive fee consists of two parts: anincome-based incentive fee and a capital gains incentive fee. The income-basedincentive fee is calculated and payable quarterly in arrears based on theCompany’s pre-incentive fee net investment income for the immediately precedingcalendar quarter. The capital gains incentive fee is determined and payableannually in arrears as of the end of each fiscal year (or upon termination ofthe Advisory Agreement, as of the termination date) and equals 20.0% of theCompany’s realized capital gains since inception through the end of the currentfiscal year, if any, computed net of all realized capital losses sinceinception, and unrealized capital depreciation at the end of each fiscal year.Refer to the Company’s Form 10-K for the fiscal year ended March 31, 2006 formore information regarding the calculation of the incentive fee.

Because pre-incentive fee net investment income wasbelow the hurdle rate of 1.75% of net assets, no income-based incentive fee wasrecorded for the three or nine months ended December 31, 2006, the three monthsended December 31, 2005 or the period June 22, 2005 (commencement ofoperations) to December 31, 2005.

**Administration Agreement**

The Company has entered into an administrationagreement (the “Administration Agreement”) with Gladstone Administration, LLC(“Gladstone Administration” or the “Administrator”), a wholly-owned subsidiaryof the Adviser. Under the Administration Agreement, the Company pays separatelyfor administrative services.  TheAdministration Agreement provides for payments equal to the Company’s allocableportion of the Administrator’s overhead expenses in performing its obligationsunder the Administration Agreement, including but not limited to, rent foremployees of the Administrator, and the allocable portion of salaries andbenefits expenses of the Company’s chief financial officer, controller, chiefcompliance officer, treasurer and their respective staffs.   The Company recorded fees to theAdministrator on the consolidated statements of operations of $124,101 and$73,424 for the three months ended December 31, 2006 and 2005, respectively.The Company recorded fees to the Administrator on the consolidated statementsof operations of $364,351 and $178,469 for the nine months ended December 31,2006 and the period June 22, 2005 (commencement of operations) to December 31,2005, respectively. As of December 31, 2006 and March 31, 2006, $124,101 and110,002, respectively, was unpaid and included in the administration feepayable to Administrator in the accompanying consolidated statements of assetsand liabilities.

**Loan Payable to Affiliate**

On June 30, 2005, theCompany repaid a $50,000 loan payable to its chairman and chief executiveofficer. The demand recourse promissory note accrued interest at the rate of3.0% per annum and was repaid with accrued interest of $378 using a portion ofthe net proceeds from the Company’s initial public offering.

NOTE 4. LINE OF CREDIT

Through the Company’swholly-owned subsidiary, Business Investment, the Company has obtained a $100million revolving credit facility (the “Credit Facility”).  On October 19, 2006, the Company executed aPurchase and Sale Agreement pursuant to which it agreed to sell certain loansto Business Investment in consideration of a membership interest therein.  Simultaneously, Business Investment executeda Credit Agreement (the “Credit Agreement”) with Deutsche Bank AG, New YorkBranch (“Deutsche Bank”), as administrative agent, pursuant to which BusinessInvestment pledged the loans purchased from the Company to secure futureadvances by certain institutional lenders. Availability under the CreditFacility will terminate on October 18, 2007, unless extended in the discretionof the lenders, at the request of Business Investment. Interest will be payablemonthly during the term of the Credit Facility and principal will be payableout of collections on loans purchased from the Company during the periodfollowing the date of which availability for advances has terminated throughmaturity.  The Credit Facility willmature two years following the date on which availability for advances hasterminated and on such date, all principal, interest and other amounts owingunder the Credit Facility will be due and payable.  Interest rates charged on the advances underthe facility are based on the rate paid by the lenders on commercial papernotes issued by such lenders to fund some or all of the advances, the LondonInterbank Offered Rate (“LIBOR”), the 

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Prime Rate or the FederalFunds Rate, depending on market conditions, and adjust periodically.  Available borrowings are subject to variousconstraints imposed under the Credit Agreement, based on the aggregate loanbalance pledged by Business Investment, which varies as loans are added andrepaid, regardless of whether such repayments are early prepayment or are madeas contractually required.

The Credit Facility contains covenants that requireBusiness Investment to maintain its status as a separate entity; prohibitcertain significant corporate transactions (such as mergers, consolidations,liquidations or dissolutions); and restrict material changes to the Company’scredit and collection policies.  Thefacility also restricts some of the terms and provisions (including interestrates, terms to maturity and payments schedules) and limits the borrower andindustry concentrations of loans that are eligible to secure advances.  As of December 31, 2006, Business Investmentwas in compliance with all of the facility covenants.  As of December 31, 2006 there was $20 millionof borrowings outstanding on the Credit Facility and the remaining borrowingcapacity under the Credit Facility was $80 million.

The administrative agent also requires that anyinterest or principal payments on pledged loans be remitted directly by theborrower into a lockbox account with the Bank of New York as custodian.  Deutsche Bank is also the trustee of theaccount and once a month remits the collected funds to the Company. At December31, 2006, the amount due from the custodian was $2,798,620.  

The Adviser services the loans pledged under theCredit Facility.  As a condition to this servicing arrangement, theCompany executed a performance guaranty pursuant to which it guaranteed thatthe Adviser would comply fully with all of its obligations under the CreditFacility. The performance guaranty requires the Company to maintain a minimumnet worth of $100 million and to maintain “asset coverage” with respect to“senior securities representing indebtedness” of at least 200%, in accordancewith Section 18 of the 1940 Act. As of December 31, 2006, the Company wasin compliance with the covenants under the performance guaranty.

NOTE 5. COMMON STOCK

As of December 31, 2006 and March 31, 2006,100,000,000 shares of $0.001 par value common stock were authorized and16,560,100 shares were outstanding.

NOTE 6. INCREASE IN NET ASSETS PER SHARE RESULTINGFROM OPERATIONS

The following table sets forth the computation ofbasic and diluted net increase in net assets per share resulting fromoperations:
| ** **                                                                                       | ** ** | **For the three  months ended  December 31, 2006** | ** ** | **For the three  months ended  December 31, 2005** | ** ** | **For the nine  months ended  December 31, 2006** | ** ** | **For the period  June 22, 2005  (Commencement of  Operations) to  December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                             |       |                                                                        |       |                                                                        |       |                                                                       |       |                                                                                                                           |       |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                                                      | 2,684,543  |                                                                        | $     | 1,614,747                                                                  |       | $                                                                                                                         | 6,809,635  |   | $  | 3,111,279 |   |
|                                                                                             |       |                                                                        |       |                                                                        |       |                                                                       |       |                                                                                                                           |       |
| Denominator for  basic and diluted shares                                                        |       | 16,560,100                                                                  |       | 16,560,100                                                                  |       | 16,560,100                                                                 |       | 16,560,100                                                                                                                     |       |
|                                                                                             |       |                                                                        |       |                                                                        |       |                                                                       |       |                                                                                                                           |       |
| Basic and diluted  net increase in net assets per share resulting from operations                |       | $                                                                           | 0.16       |                                                                        | $          | 0.10                                                                       |       | $                                                                                                                              | 0.41       |   | $ | 0.19 |   |

 

NOTE 7. DIVIDENDS 

The Company is requiredto pay out as a dividend, 90% of its ordinary income and realized netshort-term capital gains in excess of realized net short-term capital losses,if any, for each taxable year in order to maintain its status as a RIC under 

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Subtitle A, Chapter 1 of Subchapter M of the Code. It is the policy ofthe Company to pay out as a dividend up to 100% of those amounts. The amount tobe paid out monthly as a dividend is determined by the Board of Directors eachquarter and is based on the annual earnings estimated by the management of theCompany. Based on that estimate, three monthly dividends are declared eachquarter.  At year-end the Company may paya bonus dividend, in addition to the monthly dividends, to ensure that it haspaid out at least 90% of its ordinary income and realized net short-termcapital gains for the year. Long-term capital gains are composed of successfees, prepayment fees and gains from the sale of securities held from one yearor more. The Company intends to retain long-term capital gains from the sale ofsecurities, if any, and not pay them out as dividends, however, the Board ofDirectors may decide to declare and pay out capital gains during any fiscalyear.  If the Company decides to retainlong-term capital gains, the portion of the retained capital gains will besubject to 35% tax.  The Companycurrently pays a monthly dividend.  Thetax characteristics of all dividends will be reported to stockholders on Form1099 at the end of each calendar year. The Company’s Board of Directors declared the following monthlydividends for the nine months ended December 31, 2006 and the period June 22,2005 (commencement of operations) to December 31, 2005:

 

**Fiscal Year 2007**

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| October 10, 2006          |       | December  20, 2006   |       | December  29, 2006    |       | $                                | 0.07       |   |
| October 10, 2006          |       | November  21, 2006   |       | November  30, 2006    |       | $                                | 0.07       |   |
| October 10, 2006          |       | October  23, 2006    |       | October  31, 2006     |       | $                                | 0.07       |   |
| July 11, 2006             |       | September  21, 2006  |       | September  29, 2006   |       | $                                | 0.07       |   |
| July 11, 2006             |       | August  21, 2006     |       | August  31, 2006      |       | $                                | 0.07       |   |
| July 11, 2006             |       | July  19, 2006       |       | July  31, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | June  22, 2006       |       | June  30, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | May  22, 2006        |       | May  31, 2006         |       | $                                | 0.07       |   |
| April 11, 2006            |       | April 20, 2006       |       | April 28, 2006        |       | $                                | 0.07       |   |

 

**Fiscal Year 2006**
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| October 7, 2005           |       | December  21, 2005   |       | December  31, 2005    |       | $                                | 0.04       |   |
| October 7, 2005           |       | November  21, 2005   |       | November  31, 2005    |       | $                                | 0.04       |   |
| October 7, 2005           |       | October  21, 2005    |       | October  30, 2005     |       | $                                | 0.04       |   |
| July 7, 2005              |       | September  22, 2005  |       | September  30, 2005   |       | $                                | 0.02       |   |
| July 7, 2005              |       | August  23, 2005     |       | August  31, 2005      |       | $                                | 0.02       |   |
| July 7, 2005              |       | July 21, 2005        |       | July 29, 2005         |       | $                                | 0.02       |   |

 

 NOTE 8. CONTRACTUAL OBLIGATIONS****

As of December 31, 2006,the Company was a party to signed and non-binding term sheets for twoallocations of syndicated loan participations for $3.0 million.  The future scheduled contractual payments atDecember 31, 2006 are as follows:
| ** **                       | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Investments                      |       | 3,000,000  |       | 3,000,000                                |       | — |   | — |   | — |   |
| Total                            |       | $          | 3,000,000  |                                     | $          | 3,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

In January 2007, all ofthe investment purchase obligations summarized above were funded.

NOTE 9. SUBSEQUENT EVENTS****

*LoanParticipations*

In Janaury and February2007, the Company purchased additional loan participations of 4 new and 2existing portfolio companies of approximately $6.7 million.

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*Dividends*

On January 9, 2007, theCompany’s Board of Directors declared the following monthly dividends:
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| January 10, 2007          |       | January  23, 2007    |       | January  31, 2007     |       | $                                | 0.075      |   |
| January 10, 2007          |       | February  20, 2007   |       | February  28, 2007    |       | $                                | 0.075      |   |
| January 10, 2007          |       | March 22, 2007       |       | March 30, 2007        |       | $                                | 0.075      |   |

 

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** ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

**All statements contained herein, other than historicalfacts, may constitute “forward-looking statements” within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These statements may relate to,among other things, future events or our future performance or financialcondition. In some cases, you can identify forward-looking statements byterminology such as “may,” “might,” “believe,” “will,” “provided,”“anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,”“should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or thenegative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by suchforward-looking statements. Such factors include, among others: (1) our futureoperating results as we are a company with a limited operating history; (2) theloss of one or more of our executive officers, in particular, David Gladstone,George Stelljes III, or Terry Lee Brubaker; (3) the impact of the investmentsthat we make and the ability of these investments to achieve their objectives;(4) our contractual relationships with third parties; (5) the adequacy of ourcash resources and working capital; (6) our ability to obtain future financing,if at all; and (7) those factors listed under the caption “Risk Factors” of theCompany’s Annual Report on Form 10-K dated March 31, 2006, as filed with theSecurities and Exchange Commission on June 14, 2006, and in the Company’sPre-effective Amendment No. 1 to Registration Statement on Form N-2 as filedwith the Securities and Exchange Commission on December 22, 2006. We cautionreaders not to place undue reliance on any such forward-looking statements,which are made pursuant to the Private Securities Litigation Reform Act of 1995and, as such, speak only as of the date made. We undertake no obligation topublicly update or revise any forward-looking statements, whether as a resultof new information, future events or otherwise, after the date of this Form10-Q.**

*The following analysis of ourfinancial condition and results of operations should be read in conjunctionwith our consolidated financial statements and the notes thereto containedelsewhere in this report and our annual report on Form 10-K for the fiscal yearended March 31, 2006.*

**OVERVIEW**

We were incorporatedunder the General Corporation Laws of the State of Delaware on February 18,2005. We were primarily established for the purpose of investing insubordinated loans, mezzanine debt, preferred stock and warrants to purchasecommon stock of small and medium-sized companies in connection with buyouts andrecapitalizations. We also may invest in common stock and from time to time, wealso may invest in senior and subordinated syndicated loans. Our investmentobjective is to generate both current income and capital gains through thesedebt and equity instruments. We operate as a closed-end, non-diversifiedmanagement investment company, and have elected to be treated as a businessdevelopment company under the Investment Company Act of 1940, as amended (the“1940 Act”).

**Our Investment Strategy**

We seek to achievereturns from current income and capital gains from senior, subordinated andmezzanine debt, as well as preferred stock and warrants to purchase commonstock representing controlling investments that we make in connection withbuyouts and recapitalizations of small and mid-sized companies with establishedmanagement teams.  We expect that ourinvestments will generally range between $10 million and $30 million each,although this investment size may vary proportionately as the size of ourcapital base changes. We may invest either by ourselves or jointly with otherbuyout funds, depending on the opportunity. If we are participating in aninvestment with one or more co-investors, then our investment is likely to besmaller than if we were to be investing alone.

We expect that our targetportfolio over time will include mostly subordinated loans, mezzanine debt,preferred stock, and warrants to buy common stock. Structurally, subordinatedloans and mezzanine loans usually rank lower in priority of payment to seniordebt, such as senior bank debt, and may be unsecured. However, subordinateddebt and mezzanine loans rank senior to common and preferred equity in aborrower’s capital structure. Typically, subordinated debt and mezzanine loanshave elements of both debt and equity instruments, offering the returns in theform of interest payments associated with senior debt, while providing lendersan opportunity to participate in the capital appreciation of a borrower, ifany, through an equity interest. This equity interest typically takes the formof warrants. Due to its higher risk profile and often less restrictive 

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covenants as compared tosenior debt, mezzanine debt generally earns a higher return than senior secureddebt. The warrants associated with mezzanine loans are typically detachable,which allows lenders to receive repayment of their principal on an agreedamortization schedule while retaining their equity interest in the borrower.Mezzanine debt also may include a “put” feature, which permits the holder tosell its equity interest back to the borrower at a price determined through anagreed formula.

*Non-Control/Non-AffiliateInvestments*

Following the completionof our initial public offering in June 2005, we began investing the proceeds ofour initial public offering in senior secured syndicated loans because theseinvestments typically may be originated more quickly than investments in smallbusinesses that are undergoing a buyout or recapitalization. We have employedthis strategy in order to more quickly invest our initial capital to generatecurrent income. Senior secured syndicated loans typically involve a number ofbanks or other financial institutions and are generally more marketable thanloans that are not syndicated. In order to invest in certain senior securedsyndicated loans, we may purchase these investments at a premium or discount.Weamortize premiums and discounts over the contractual life of the investment. Inthe event that an investment is sold prior to its contractual maturity date, werecognize a loss on any unamortized premium or a gain on any unamortizeddiscount.

While we expect that,over time, our investment portfolio will consist primarily of subordinateddebt, mezzanine debt and preferred stock that we receive when makinginvestments in connection with buyouts and recapitalizations, our Board ofDirectors has recommended that we continue our current strategy of investing insenior syndicated loans, primarily in order to build a portfolio that may besecuritized in the future to obtain financing to pay down borrowings and investin additional buyout and recapitalization investments. To date, we haveacquired interests in 39 such syndicated loans in the aggregate principalamount, net of any repayments, of approximately $142.0 million.  We expect to continue purchasing syndicatedloans using borrowings from our credit facility.

*Control and Affiliate Investments*

At December 31, 2006, wehad investments of approximately $75.8 million in revolving credit facilities,senior debt and subordinated debt of five portfolio companies.  In addition, at December 31, 2006 we hadinvested approximately $24.4 million in preferred and common equity of thosecompanies. These investments are the result of buyout and recapitalizationtransactions and represent our primary investment focus. A summary of theinvestments made during the nine months ended December 31, 2006 is as follows: 

·                  $22.9 million inAcme Cryogenics Inc., including senior subordinated debt of $14.5 million, $7.3million in preferred equity and $1.1 million in common equity; and 

·                  $19.6  million in Noble Logistics Services, Inc., including senior debt of $14.0million, senior subordinated debt of $0.5 million, a revolving credit facilityof $2.0 million (of which $0.2 million remains undrawn at December 31, 2006),$1.8 million in preferred equity and $1.5 million in common equity.

Certain loan investmentsmay have a form of interest that is not paid currently but is accrued and addedto the loan balance and paid at the end of the term. This interest is called“paid in kind” interest or “PIK.” We will generally seek investments that donot generate PIK interest as we have to pay out this accrued interest asdividends to our stockholders and we may have to borrow money or raiseadditional capital in order to meet the tax test for a regulated investmentcompany (“RIC”) by having to pay out at least 90% of our ordinary income.  As of December 31, 2006, none of ourinvestments bore PIK interest. 

We may also encounter“original issue discount” income, or “OID” income, which arises when an investorsimultaneously purchases a warrant and a note from a company. This transactionrequires an allocation of a portion of the purchase price to the warrant andreduces the note by the same amount. This would cause us to have to record thenote as if we paid less than the face amount of the note and, therefore, wewould have to amortize the OID over the life of the loan. This would createincome that would be required to be paid out as dividends to our stockholdersin accordance with the tax test for RICs to pay out at least 90% of our income.We will seek to purchase warrants from the issuer at fair market value in orderto avoid OID income.

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As a business developmentcompany under the 1940 Act, we are required to make available significantmanagerial assistance to our portfolio companies. We provide these servicesthrough Gladstone Management Corporation (the “Adviser” or “GMC”),who providesthese services on our behalf through its officers who are also ourofficers.  If a portfolio company ischarged for managerial assistance then our Adviser will credit all suchmanagerial assistance fees against the base management fee.  In addition, our Adviser provides otherservices to our portfolio companies, for which it receives fees, in connectionwith our investments.  These fees aregenerally non-recurring, however in some instances they may have a recurringcomponent that is also paid to our Adviser. One half of certain of these fees received by our Adviser are creditedagainst the base management advisory fee payable to our Adviser pursuant to theterms of our advisory agreement, which has the effect of reducing our expensesto the extent of any such credit.  Thespecific services our Adviser provides to portfolio companies vary byinvestment, but generally include a broad array of services such as investmentbanking, arranging bank and equity financing, structuring financing frommultiple lenders and investors, reviewing existing credit facilities,restructuring existing loans, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel.

In the event that weexpend significant effort in considering and negotiating a potential investmentthat ultimately is not consummated, we generally will seek reimbursement fromthe proposed borrower for our reasonable expenses incurred in connection withthe transaction, including legal fees. Any amounts collected for expenses incurred by our Adviser in connectionwith unconsummated investments will be reimbursed to our Adviser. Amountscollected for these expenses incurred by us will be reimbursed to us and willbe recognized in the period in which such reimbursement is received, however,there can be no guarantee that we will be successful in collecting any suchreimbursements.

**Our Investment Adviser andAdministrator**

Our Adviser is led by amanagement team which has extensive experience in our lines of business. OurAdviser is controlled by David Gladstone, our chairman and chief executiveofficer. Mr. Gladstone is also the chairman and chief executive officer ofour Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer,secretary and director, is a member of the board of directors of our Adviserand its vice chairman and chief operating officer. George Stelljes III,our president, chief investment officer and director, is a member of the boardof directors of our Adviser and its president and chief investment officer.Harry Brill, our chief financial officer, is also the chief financial officerof our Adviser. Our Adviser also has a wholly-owned subsidiary, GladstoneAdministration, LLC (the “Administrator”), which employs our chief financialofficer, chief compliance officer, controller, treasurer and their respectivestaffs.

Our Adviser and Administratoralso provide investment advisory and administrative services to our affiliatesGladstone Commercial Corporation, a publicly traded real estate investmenttrust; Gladstone Capital Corporation, a publicly traded business developmentcompany; and Gladstone Land Corporation, an agricultural real estate companyowned by Mr. Gladstone. All of our directors and executive officers serveas either directors or executive officers, or both, of Gladstone CommercialCorporation and Gladstone Capital Corporation. In the future, our Adviser mayprovide investment advisory and administrative services to other funds, bothpublic and private, of which it is the sponsor.

We have been externallymanaged by our Adviser pursuant to an investment advisory and managementagreement since our inception. Our Adviser was organized as a corporation underthe laws of the State of Delaware on July 2, 2002, and is a registeredinvestment adviser under the Investment Advisers Act of 1940, as amended. OurAdviser is headquartered in McLean, Virginia, a suburb of Washington D.C., andhas offices in New York, New Jersey, Pennsylvania, Illinois, Texas andKentucky.

**Investment Advisory andManagement Agreement**

Pursuant to the advisoryagreement with our Adviser we pay our Adviser a fee, as compensation for itsservices, consisting of a base management fee and an incentive fee.

The base management feeis assessed at an annual rate of 2.0% computed on the basis of the averagevalue of our gross invested assets at the end of the two most recentlycompleted quarters, which are total assets less the cash proceeds and cash andcash equivalent investments from the proceeds of our initial public offeringthat are not invested in debt and equity securities of portfolio companies.  Through December 31, 2006, the basemanagement fee was computed and payable quarterly.  Beginning in periods subsequent to December31, 2006, the base management fee will be computed and payable

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quarterly and will beassessed at an annual rate of 2.0% computed on the basis of the value of ouraverage gross assets at the end of the two most recently completed quarters,which are total assets, including investments made with proceeds of borrowings,less any uninvested cash or cash equivalents resulting from borrowings.  This new calculation was originally scheduledto begin in periods after March 31, 2006; however, on April 11, 2006, July 11,2006 and October 10, 2006, our Board of Directors accepted voluntary waiversfrom our Adviser that allowed the current calculation of the base managementfee to be effective through June 30, 2006, September 30, 2006 and December 31,2006, respectively. 

On January 9, 2007, ourBoard of Directors accepted a voluntary waiver from the Adviser to reduce theannual 2.0% base management fee on senior syndicated loan participations to0.5% to the extent that proceeds resulting from borrowings were used topurchase such syndicated loan participations. 

When our Adviser receivesfees from our portfolio companies, such as investment banking fees, structuringfees or executive recruiting services fees, 50% of certain of these fees will be credited against the base managementfee that we would otherwise be required to pay to our Adviser. 

In addition, our Adviserservices the loans held by Business Investment, in return for which the Adviserreceives a 2.0% annual fee based on the monthly aggregate balance of loans heldby Business Investment.  Since we ownthese loans, all loan servicing fees paid to our Adviser are treated asreductions against the 2.0% base management fee.  Overall, the base management fee due to ourAdviser cannot exceed 2.0% of total assets (as reduced by cash and cashequivalents pledged to creditors) during any given fiscal year.

The incentive feeconsists of two parts: an income-based incentive fee and a capital gainsincentive fee. The income-based incentive fee will reward our Adviser if ourquarterly net investment income (before giving effect to the incentive fee)exceeds 1.75% of our net assets.  OurAdviser will receive a capital gains incentive fee that is determined andpayable annually in arrears as of the end of each fiscal year (or upontermination of the Advisory Agreement, as of the termination date) and equals20.0% of the Company’s realized capital gains since inception through the endof the current fiscal year, if any, computed net of all realized capital lossessince inception, and unrealized capital depreciation at the end of each fiscalyear.

**Administration Agreement**

Under the AdministrationAgreement, we pay separately for administrative services. The AdministrationAgreement provides for payments equal to our allocable portion of theAdministrator’s overhead expenses in performing its obligations under theAdministration Agreement including, but not limited to, rent for employees ofthe Administrator, and our allocable portion of the salaries and benefitsexpenses of our chief financial officer, controller, chief compliance officer, treasurerand their respective staffs.  Ourallocable portion of expenses is derived by multiplying our Administrator’stotal expenses by the percentage of our average total assets (the total assetsat the beginning and end of each quarter) in comparison to the average totalassets of all companies managed by our Adviser. 

**Critical Accounting Policies**

The preparation of financial statements and relateddisclosures in conformity with accounting principles generally accepted in theUnited States (“GAAP”) requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, and disclosure ofcontingent assets and liabilities at the date of the financial statements, andrevenues and expenses during the period reported. Actual results could differmaterially from those estimates. Our accounting policies are more fullydescribed in the “*Notes to Consolidated Financial Statements*”contained elsewhere in this report. We have identified our investment valuationprocess as our most critical accounting policy.

***InvestmentValuation***

Themost significant estimate inherent in the preparation of our consolidatedfinancial statements is the valuation of investments and the related amounts ofunrealized appreciation and depreciation of investments recorded. 

*General Valuation Policy:* Usingprocedures established by our Board of Directors, we value our investmentportfolio each quarter. We carry our investments at fair value, as determinedin good faith by or under the direction of our Board of Directors. Securitiesthat are publicly traded, if any, are valued at the closing price of theexchange or securities market on

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whichthey are listed on the valuation date. Securities that are not traded on apublic exchange or securities market, but for which a limited market exists andthat have been rated by a nationally recognized statistical ratingorganizations (“NRSRO”), (such as certain participations in syndicated loans)are valued at the indicative bid price offered by the syndication agent on thevaluation date.

Debt and equitysecurities that are not publicly traded, for which a limited market does notexist, or for which a limited market exists but that have not been rated by aNRSRO (or for which we have various degrees of trading restrictions) are valuedat fair value as determined in good faith by or under the direction of ourBoard of Directors.  In making the goodfaith determination of the value of these securities, we start with the costbasis of the security, which includes the amortized OID and PIK interest, ifany.  We then apply the methods set outbelow in “*Valuation Methods*.”  Members of our Adviser’s portfolio managementteam prepare the valuations of our investments in portfolio companies using themost recent portfolio company financial statements and forecasts.  These individuals also consult with portfoliocompany senior management and ownership to obtain further updates on theportfolio company’s performance, including information such as industry trends,new product development, and other operational issues.  Due to the uncertainty inherent in thevaluation process, such estimates of fair value may differ significantly fromthe values that would have been obtained had a ready market for the securitiesexisted, and the differences could be material. Additionally, changes in the market environment and other events thatmay occur over the life of the investments may cause the gains or lossesultimately realized on these investments to be different than the valuationscurrently assigned.  There is no singlestandard for determining fair value in good faith, as fair value depends uponcircumstances of each individual case. In general, fair value is the amount that we might reasonably expect toreceive upon the current sale of the security.

At December 31, 2006, weengaged Standard and Poor’s Securities Evaluations, Inc. (“SPSE”) to submitopinions of value for 13 of our loan securities.  We request that SPSE also evaluate and assignvalues to success fees (conditional interest included in some loan securities)when we determine that the probability of receiving a success fee on a givenloan is above 6-8%, a threshold of significance.  Upon completing our collection of data withrespect to the investments (including the information described under “*Credit Information*,” the risk ratings of the loans describedunder “*Loan Grading and Risk Rating*” and thefactors described under “*Valuation Methods*”),this valuation data is forwarded to SPSE for review and analysis.  SPSE makes its independent assessment of thedata that we have assembled and assesses its independent data to form anopinion as to what they consider to be the market values for thesecurities.  With regard to its work,SPSE has issued the following paragraph:

SPSE provides evaluated price opinions which are reflective of whatSPSE believes the bid side of the market would be for each loan after carefulreview and analysis of descriptive, market and credit information. Each pricereflects SPSE’s best judgment based upon careful examination of a variety ofmarket factors. Because of fluctuation in the market and in other factorsbeyond its control, SPSE cannot guarantee these evaluations. The evaluationsreflect the market prices, or estimates thereof, on the date specified. Theprices are based on comparable market prices for similar securities. Marketinformation has been obtained from reputable secondary market sources. Althoughthese sources are considered reliable, SPSE cannot guarantee their accuracy.

SPSE opinions of valueare submitted to our Board of Directors along with our Adviser’s supplementalassessment and recommendation regarding valuation of each of these investments.our Adviser generally accepts the opinion of value given by SPSE, however incertain limited circumstances, such as when our Adviser  may learn new information regarding aninvestment between the time of submission to SPSE and the date of the boardassessment, our Adviser’s conclusions as to value may differ from the opinionof value delivered by SPSE.  Our Board ofDirectors then reviews whether our Adviser has followed its establishedprocedures for determinations of fair value, and votes to accept or not acceptthe recommended valuation of our investment portfolio.  Our Adviser and our management recommended,and the Board of Directors elected to accept, the opinions of value deliveredby SPSE on the 13 loans in our portfolio as denoted on the Schedule ofInvestments as of December 31, 2006 included in our consolidated financialstatements.

Because there is a delaybetween when we close an investment and when the investment can be evaluated bySPSE, new loans are not valued immediately by SPSE; rather, management  makes its own determination about the valueof these investments in accordance with our valuation policy.  Because SPSE does not provide values forequity securities, our Adviser determines the fair value of these investmentsusing valuation policies approved by our Board of Directors.

*Credit Information:*** **OurAdviser monitors a wide variety of key credit statistics that provideinformation regarding our portfolio companies to help us assess credit qualityand portfolio performance.  We and ourAdviser participate in the 

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periodic board meetingsof our portfolio companies in which we hold control and affiliate investmentsand also require them to provide annual audited and monthly unaudited financialstatements.  Using these statements andboard discussions, our Adviser calculates and evaluates the creditstatistics.  

*Loan Grading and Risk Rating:*** **Aspart of our valuation procedures we risk rate all of our investments in debtsecurities. For syndicated loans that have been rated by a NRSRO (as defined inRule 2a-7 under the 1940 Act), we use the NRSRO’s risk rating for such security. For all other debt securities, weuse a proprietary risk rating system. Our risk rating system uses a scale of 0to 10, with 10 being the lowest probability of default. This system is used toestimate the probability of default on debt securities and the probability ofloss if there is a default. These types of systems are referred to as riskrating systems and are used by banks and rating agencies. The risk ratingsystem covers both qualitative and quantitative aspects of the business and thesecurities we hold.

For the debt securities for which we do not use athird-party NRSRO risk rating, we seek to have our risk rating system mirrorthe risk rating systems of major risk rating organizations, such as thoseprovided by a NRSRO. While we seek to mirror the NRSRO systems, we cannotprovide any assurance that our risk rating system will provide the same riskrating as a NRSRO for these securities. The following chart is an estimate ofthe relationship of our risk rating system to the designations used by two NRSROsas they risk rate debt securities of major companies. Because our system ratesdebt securities of companies that are unrated by any NRSRO, there can be noassurance that the correlation to the NRSRO set out below is accurate. Webelieve our risk rating would be significantly higher than a typical NRSRO riskrating because the risk rating of the typical NRSRO is designed for largerbusinesses. However, our risk rating has been designed to risk rate thesecurities of smaller businesses that are not rated by a typical NRSRO.Therefore, when we use our risk rating on larger business securities, the riskrating is higher than a typical NRSRO rating. The primary difference betweenour risk rating and the rating of a typical NRSRO is that our risk rating uses morequantitative determinants and includes qualitative determinants that we believeare not used in the NRSRO rating. It is our understanding that most debtsecurities of medium-sized companies do not exceed the grade of BBB on a NRSROscale, so there would be no debt securities in the middle market that wouldmeet the definition of AAA, AA or A. Therefore, our scale begins with thedesignation 10 as the best risk rating which may be equivalent to a BBB from aNRSRO, however, no assurance can be given that a 10 on our scale is equal to aBBB on a NRSRO scale.
| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Investment’s Description(a)**                                                |
|----------------------------|------------|------------------|------------|-------------------|------------|---------------------------------------------------------------------------------------------------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of  Default (PD) during the next ten years is 4% and the Expected Loss   (EL) is 1% or less |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5 and the  EL is 1 to 2%                                                                          |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10 and the  EL is 2 to 3%                                                                         |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16 and the  EL is 3 to 4%                                                                         |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8 and  the EL is 4 to 5%                                                                       |
| **6**                      |       | B1               |       | B+                |       | PD is 22.0 and  the EL is 5 to 6.5%                                                                     |
| **5**                      |       | B2               |       | B                 |       | PD is 25 and the  EL is 6.5 to 8%                                                                       |
| **4**                      |       | B3               |       | B-                |       | PD is 27 and the  EL is 8 to 10%                                                                        |
| **3**                      |       | Caa1             |       | CCC+              |       | PD is 30 and the  EL is 10.0 to 13.3%                                                                   |
| **2**                      |       | Caa2             |       | CCC               |       | PD is 35 and the  EL is 13.3 to 16.7%                                                                   |
| **1**                      |       | Caa3             |       | CC                |       | PD is 65 and the  EL is 16.7 to 20%                                                                     |
| **0**                      |       | N/a              |       | D                 |       | PD is 85 or  there is a Payment Default and the EL is greater than 20%                                  |

 

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*(a)**          thedefault rates set forth are for a ten year term debt security.  If the company’s debt security is less thanten years then the probability of default is adjusted to a lower percentage forthe shorter period which may move the security higher on the company’s riskrating scale.*

The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default.  Our policy is to stopaccruing interest on an investment if we determine that interest is no longercollectible.  At December 31, 2006, nopayments were past due on any of our debt securities.  Additionally, we do not risk rate our equitysecurities.  

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The followingtable lists the risk ratings for all non-syndicated loans in our portfolio atDecember 31, 2006 and March 31, 2006, representing approximately 35% and 31%,respectively, of all loans in our portfolio:

| Rating           | ** ** | **December 31, 2006** | ** ** | **March 31, 2006** |
|------------------|------------|----------------------------|------------|------------------------------|
| Highest          |       | 7.0                        |       | 6.0                          |
| Average          |       | 6.0                        |       | 5.3                          |
| Weighted Average |       | 5.8                        |       | 5.3                          |
| Lowest           |       | 5.0                        |       | 5.0                          |

 

The followingtable lists the risk ratings for syndicated loans in our portfolio that are notcurrently rated by an NRSRO at December 31, 2006 and March 31, 2006,representing approximately 14% and 12%, respectively, of all loans in ourportfolio:

| Rating           | ** ** | **December 31, 2006** | ** ** | **March 31, 2006** |
|------------------|------------|----------------------------|------------|------------------------------|
| Highest          |       | 9.0                        |       | 9.0                          |
| Average          |       | 7.8                        |       | 7.8                          |
| Weighted Average |       | 7.8                        |       | 7.7                          |
| Lowest           |       | 7.0                        |       | 7.0                          |

 

For syndicatedloans that are currently rated by an NRSRO, we risk rate such loans inaccordance with the risk rating systems of major risk rating organizations suchas those provided by a NRSRO. The following table lists the risk ratingsfor  all syndicated loans in our portfoliothat are currently rated by an NRSRO at December 31, 2006 and March 31, 2006,representing approximately 51% and 57%, respectively, of all loans in ourportfolio:

| Rating           | ** ** | **December 31, 2006** | ** ** | **March 31, 2006** |
|------------------|------------|----------------------------|------------|------------------------------|
| Highest          |       | BB-/Ba2                    |       | BB/Ba2                       |
| Average          |       | B+/B1                      |       | B+/B1                        |
| Weighted Average |       | B+/B1                      |       | B/B2                         |
| Lowest           |       | B/B1                       |       | B/B2                         |

 

*Valuation Methods:*  We determine the value of publicly-tradeddebt securities based on the closing price for the security on the exchange orsecurities market on which it is listed on the valuation date.  We value debt securities that are notpublicly traded, but for which a limited market for the security exists, suchas participations in syndicated loans, at the indicative bid price offered bythe syndication agent on the valuation date. At December 31, 2006, none of the debt securities in our portfolio werepublicly traded and there was a limited market for 28 debt securities in ourportfolio.

For debt securities thatare not publicly traded, for which there is no market, or for which there is amarket but the securities have not been rated by a NRSRO, we begin with therisk rating designation of the security as described above.  Using this risk rating designation, we seekto determine the value of the security as if we intended currently to sell thesecurity and consider some or all of the following factors:

·                  the cost basis and the type of thesecurity;

·                  the nature and realizable value ofthe collateral;

·                  the portfolio company’s ability tomake payments and discounted cash flow;

·                  reports from portfolio company seniormanagement and board meetings; 

·                  reported values of similar securitiesof the portfolio company or comparable companies; and

·                  changesin the economy affecting the portfolio company.

We value convertibledebt, equity, success fees or other equity-like securities for which there is amarket based on the market prices for such securities, even if that market isnot robust.  At March 31, 2006 andDecember 31, 2006 there was no market for any of the equity securities weowned.  To value convertible debt,equity, success fees or other equity-like securities for which no marketexists, we use the same information we would use for a debt security valuationdescribed above, except risk-rating, as well as standard valuation techniquesused by major valuation firms to value the equity securities of privatecompanies.  These valuation techniquesconsist of discounted cash flow of the expected sale price in the future,valuation of 

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the securities based onrecent sales in comparable transactions, and a review of similar companies thatare publicly traded and the market multiple of their equity securities.  At December 31, 2006 we had $24.4  million invested, at cost, in equity securitiescompared to our debt portfolio with a cost basis of $217.6 million.  At March 31, 2006 we had $12.8 millioninvested, at cost, in equity securities compared to our debt portfolio with acost basis of $140.5 million.  

At December 31, 2006 wehad total unrealized depreciation of approximately $1.4 million, which wasprimarily composed of net unrealized depreciation of our syndicated loaninvestments.  At March 31, 2006 we hadtotal unrealized appreciation of approximately $113,000, which was mainlycomposed of net unrealized appreciation of our syndicated loan investments.

***Tax Status***

*Federal Income Taxes*

We currently qualify and intend to continue to qualifyfor treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M of theInternal Revenue Code of 1986, as amended (the “Code”). As a RIC, we are notsubject to federal income tax on the portion of our taxable income and gainsdistributed to stockholders. To qualify as a RIC, we are required to distributeto stockholders at least 90% of investment company taxable income, as definedby the Code. It is our policy to pay out as a dividend up to 100% of thoseamounts.  

In an effort to avoid certain excise taxes imposed onRICs, we currently intend to distribute during each calendar year, an amount atleast equal the sum of (1) 98% of our ordinary income for the calendar year,(2) 98% of our capital gains in excess of capital losses for the one-yearperiod ending on October 31 of the calendar year, and (3) any ordinary incomeand net capital gains for preceding years that were not distributed during suchyears.

***Revenue Recognition***

*Interest and Dividend  Income Recognition*

Interest income isrecorded on the accrual basis to the extent that such amounts are expected tobe collected. We will stop accruing interest on investments when it isdetermined that interest is no longer collectible. There were no uncollectibleaccounts at December 31, 2006. Conditional interest, or a success fee, isrecorded when earned upon full repayment of a loan investment. Dividend incomeon preferred equity securities is accrued to the extent that such amounts areexpected to be collected and that we have the option to collect such amounts incash.  To date, we have not accrued anydividend income.

*Services Provided to Portfolio Companies*

The1940 Act requires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objectives andpolicies of the respective portfolio company. We provide these and otherservices to portfolio companies through our Adviser. Currently, neither we norour Adviser receive fees in connection with managerial assistance. 

OurAdviser receives fees for the other services it provides to portfoliocopmanies.  These other fees aretypically non-recurring, are recognized as revenue when earned and aregenerally paid directly to our Adviser by the borrower or potential borrowerupon the closing of the investment. The services our Adviser provides vary byinvestment, but generally include a broad array of services such as investmentbanking services, arranging bank and equity financing, structuring financingfrom multiple lenders and investors, reviewing existing credit facilities,restructuring existing investments, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel.  When our Adviser receivesfees for these services, 50% of those fees are credited agains the basemanagement fee due to the Adviser from us. Any services of this naturesubsequent to the closing would typically generate a separate fee at the timeof completion. 

OurAdviser also receives fees for monitoring and reviewing portfolio companyinvestments.  These fees are recurringand are generally paid annually or quarterly in advance to our Adviserthroughout the life of the investment. Fees of this nature are recorded as revenue when earned by our Adviserwhich are not credited against the base management fee. 

Wemay receive fees for the origination and closing services we provide toportfolio companies through our Adviser. These fees are paid directly to us and are recognized as revenue uponclosing of the originated investment.

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**RESULTS OF OPERATIONS**

*Three months ended December 31, 2006compared to the three months ended December 31, 2005*

**Investment Income**

Investment income for the three months ended December31, 2006 increased $1,977,680 to $4,299,368 from $2,321,688 for the threemonths ended December 31, 2005. 

Interest income from Non-Control/Non-Affiliate investmentsincreased $1,795,292 to $2,586,171 for the three months ended December 31, 2006compared to $790,879 for the three months ended December 31, 2005.  This increase was mainly the result ofapproximately $81 million of additional Non-Control/Non-Affiliate investmentsat December 31, 2006 compared to the prior year period.  

Interest income from Control investments was$1,264,451 for the three months ended December 31, 2006 representing intereston our loan investments to our Control affiliates. At December 31, 2005, we hadnot yet invested in any Control investments.

Interest income from Affiliate investments was$114,668 for the three months ended December 31, 2006 representing interest onour loan investments to our Non-Control affiliates. At December 31, 2005, wehad not yet invested in any Affiliate investments.

Interest income from cash and equivalents decreased$1,198,223 to $332,586 for the three months ended December 31, 2006 from$1,530,809 for the three months ended December 31, 2005.  This decrease is the result of the completeinvestment of the proceeds of our initial public offering in Control, Affiliateand Non-Control/Non-Affiliate investments. At December 31, 2005 we had approximately $153 million of cashequivalents invested in treasury securities and at December 31, 2006 we had noinvestments in treasury securities as all of the proceeds from our initialpublic offering had been invested.  

The weighted average yield on our portfolio ofinvestments, excluding cash and cash equivalents, was 9.41% for the threemonths ended December 31, 2006 and 6.42% for the three months ended December31, 2005.  This increase is largely theresult of rising interest rates and the increase in our investments in non-syndicatedloans that typically bear higher interest ratest than those of syndicatedloans.

**Operating Expenses**

Operating expenses for the three months ended December31, 2006 were $1,776,525 compared to $569,118 for the three months endedDecember 31, 2005, representing an overall increase of $1,207,407.

Forthe three months ended December 31, 2006, we incurred a gross base managementfee of $551,235 less credits for fees received by our Adviser of $375,225, fora net management fee of $176,010 as compared to the three months ended December31, 2005, in which we incurred a gross base management fee of $265,522. Thebase management fee is currently computed quarterly as described under “InvestmentAdvisory and Management Agreement.” The fees increased in the current perioddue to the growth of the investment portfolio as compared to the same period ofthe prior year, however, the increase was partially offset by credits againstthe management fee in the current fiscal quarter of which there were none inthe prior year quarter.

Loan servicingfees of $508,691 were incurred for the three months ended December 31,2006.  These fees were incurred inconnection with a loan servicing agreement between Business Investment and ourAdviser, which is based on the size of the aggregate outstanding loanportfolio.  These fees reduced the amountof the management fee due to our Adviser.

The administration fee payable to our Administratorwas $124,101 for the three months ended December 31, 2006 compared to $73,424for the three months ended December31, 2005. This fee consists of our allocable portion of ourAdministrator’s rent and other overhead expenses, and our allocable portion ofthe salaries and benefits of our chief financial officer, chief complianceofficer, treasurer, controller and their respective staffs. Our allocableportion of expenses is derived by multiplying the percentage of our averageassets (the assets at the beginning and ending of each quarter) in comparisonto the average assets of all companies managed by our Adviser.  The increase was mainly attributable to thepersonnel growth of 

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our Administrator. 

Directors’ fees for the three months ended December31, 2006 and 2005 were $54,800 and $51,000, respectively.  Directors’fees consist of the amortization of the directors’ annual stipend andindividual meeting fees.  

Insurance expense for the three months ended December31, 2006 was $60,696 compared to $69,552 for the three months ended December31, 2005.  Insurance expense consists ofthe amortization of the directors and officers insurance policy andprofessional liability policy premiums. 

Professional fees for the three months ended December31, 2006 were $186,537, an increase of $116,967 over the professional fees forthe three months ended December 31, 2005 of $69,570.  Professional fees primarily consist of legalfees and audit and accounting fees.  Theincrease is mainly due to an increase in audit fees related to our compliance withSarbanes-Oxley regulations and direct consulting and legal fees incurred onpotential investments that were not executed. 

Stockholder related costs increased $4,280 for thethree months ended December 31, 2006 to $28,643 from $24,363 in the threemonths ended December 31, 2005. Stockholder related costs consist of the amortization of annual Nasdaqlisting fees, transfer agent fees, annual report printing fees, Securities andExchange Commission (“SEC”) filing fees and press release costs.  

Interest expense for thethree months ended was $68,748 and resulted from borrowings on our creditfacility in December 2006, which were used to finance our investment purchasesduring December 2006.

Deferred finance costamortization for the three months ended December 31, 2006 was $91,392 and isdirectly attributable to the amortization of the capitalized finance costsassociated with our credit facility.

Taxes and licensesexpense for the three months ended December 31, 2006 was $41,550 and wasprimarily comprised of franchise taxes due to the state of Delaware and otherfees surrounding state and regulatory licensing, registration and othercorporate filing fees.

Other expenses for the three months ended December 31,2006 were $60,132 compared to $15,687 for the three months ended December 31,2005.  Other expenses consist primarilyof direct expenses such as travel related specifically to our portfoliocompanies, loan evaluation services for our portfolio companies and backupservicer expenses.  The overall increaseof $44,445 is mainly due to the increase in direct expenses as the overall sizeof our investment portfolio grew from the prior year period.

**Realized and Unrealized Loss onInvestments**

For the three months ended December 31, 2006, werecognized a net loss on the sale of three loan participations aggregating$2,283 and we recorded net unrealized depreciation of investments in theaggregate amount of $211,242.  The netunrealized depreciation of our investments for the three months ended December31, 2006 was primarily related to the decline in market value of our Controlinvestments over the three month period. 

**Net Increase in Net Assets fromOperations**

Overall, we realized a net increase in net assetsresulting from operations of $2,684,543 for the three months ended December 31,2006 as a result of the factors discussed above. Our net increase in net assetsfrom operations per basic and diluted weighted average common share for thethree months ended December 31, 2006 was $0.16 compared to $0.10 for the threemonths ended December 31, 2005.   

*Nine months ended December 31, 2006 comparedto the period June 22, 2005 (commencement of operations) to December 31, 2005*

**Investment Income**

Investment income for the nine months ended December31, 2006 increased $8,200,258 to $12,376,734 from $4,176,476 for the periodJune 22, 2005 (commencement of operations) to December 31, 2005. 

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Interest income from Non-Control/Non-Affiliateinvestments increased $5,953,569 to $6,938,026 for the nine months endedDecember 31, 2006 compared to $984,457 for the the period June 22, 2005(commencement of operations) to December 31, 2005. This increase was mainly theresult of approximately $81 million of new Non-Control/Non-Affiliateinvestments compared to the prior year period.

Interest income from Control investments was$3,711,056 for the nine months ended December 31, 2006 representing interest onour loan investments in Control affiliates. At December 31, 2005, we had notyet invested in any Control investments. 

Interest income from Affiliate investments was$114,668 for the nine months ended December 31, 2006 representing interest onour loan investments in Non-Control affiliates. At December 31, 2005, we hadnot yet invested in any Affiliate investments. 

Interest income from cash and equivalents decreased$1,581,513 to $1,610,506 for the nine months ended December 31, 2006 from$3,192,019 for the period June 22, 2005 (commencement of operations) toDecember 31, 2005.  This decrease ismainly the result of the complete investment of the proceeds of our initial publicoffering in Control, Affiliate and Non-Control/Non-Affiliate investments. 

The weighted average yield on our portfolio ofinvestments, excluding cash and cash equivalents, was 10.03% for the ninemonths ended December 31, 2006 and 6.42% for the period June 22, 2005(commencement of operations) to December 31, 2005. This increase is largely theresult of rising interest rates and the increase in our non-syndicated loansthat typically bear higher interest ratest than those of syndicated loans.

**Operating Expenses**

Operating expenses for the nine months ended December31, 2006 were $4,388,841 compared to $991,200 for the period June 22, 2005(commencement of operations) to December 31, 2005, representing an overallincrease of $3,397,641.

Forthe nine months ended December 31, 2006, we incurred gross base management feesof $2,214,437, less credits for fees received by our Adviser of $375,225, for anet management fee of $1,839,212 as compared to the period June 22, 2005(commencement of operations) to December 31, 2005, in which we incurred grossbase management fees of $357,630. The base management fee is currently computedquarterly as described under “Investment Advisory and Management Agreement.”The fees increased in the current period due to the growth of the investmentportfolio as compared to the same period of the prior year, however, theincrease was partially offset by credits against the management fee in thecurrent fiscal year of which there were none in the prior fiscal year.

Loan servicingfees of $508,691 were incurred for the nine months ended December 31,2006.  These fees were incurred inconnection with a loan servicing agreement between Business Investment and ourAdviser, which is based on the size of the aggregate outstanding loan portfolio.  These fees reduced the amount of themanagement fee due to our Adviser.

The administration fee payable to our Administratorwas $364,351 for the nine months ended December 31, 2006 compared to $178,469for the period June 22, 2005(commencement of operations) to December 31, 2005. This fee consists ofour allocable portion of our Administrator’s rent and other overhead expenses,and our allocable portion of the salaries and benefits of our chief financialofficer, chief compliance officer, treasurer, controller and their respectivestaffs. Our allocable portion of expenses is derived by multiplying thepercentage of our average assets (the assets at the beginning and ending ofeach quarter) in comparison to the average assets of all companies managed byour Adviser.  The increase was mainlyattributable to the personnel growth of our Administrator and fewer periodsincluded in the prior year period.  

Directors’ fees for the nine months ended December 31,2006 and 2005 were $154,300 and $103,000, respectively.  Directors’ fees consist of the amortizationof the directors’ annual stipend and individual meeting fees.  The directors’ fees for the prior year periodwere not declared until July 2005 and, therefore, only six months of expensewas recognized.

Insurance expense for the nine months ended December31, 2006 was $200,933 compared to $112,030 for the period June 22, 2005(commencement of operations) to December 31, 2005.  Insurance expense consists of theamortization of the directors and officers insurance policy and professionalliability policy. The increase of $88,903 is mainly due to our policies 

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not beginning until August 2005 thereby resulting inthe amortization of only five months of insurance premiums in the prior yearperiod. 

Professional fees for the nine months ended December31, 2006 were $354,325, an increase of $218,453 over the professional fees forthe period June 22, 2005 (commencement of operations) to December 31, 2005 of$135,872.  Professional fees primarilyconsist of legal fees and audit and accounting fees.  The increase is mainly due to the shortenedprior year period, an increase in audit fees related to our compliance withSarbanes-Oxley regulations and direct consulting and legal fees incurred onpotential investments that were not executed . 

Stockholder related costs increased $119,608 for thenine months ended December 31, 2006 to $187,509 from $67,901 in the period June22, 2005 (commencement of operations) to December 31, 2005.  Stockholder related costs consist of theamortization of annual Nasdaq listing fees, transfer agent fees, annual reportprinting fees, SEC filing fees and press release costs.  The increase in stockholder related costs ismainly due to the shortened prior year period and fees incurred in connectionwith our inaugural annual meeting of stockholders on August 10, 2006.

Interest expense for the nine months ended December31, 2006 was $68,748 and resulted from borrowings on our credit facility inDecember 2006, which were used to finance our investment purchases duringDecember 2006. Interest expense for the period June 22, 2005 (commencement ofoperations) to December 31, 2005 was $378 and consisted of interest due on aloan payable to an affiliate, which was repaid in June 2005.

Deferred finance cost amortization for the nine monthsended December 31, 2006 was $91,392 and is directly attributable to theamortization of the capitalized finance costs associated with our creditfacility. 

Taxes and licensesexpense for the nine months ended December 31, 2006 was $139,994 and wasprimarily comprised of franchise taxes due to the state of Delaware and otherfees surrounding state and regulatory licensing, registration and othercorporate filing fees.  

Other expenses for the nine months ended December 31,2006 were $104,161 compared to $35,920 for the period June 22, 2005(commencement of operations) to December 31, 2005.  Other expenses consist primarily of directexpenses such as travel related specifically to our portfolio companies, loanevaluation services for our portfolio companies and backup servicerexpenses.  The overall increase of$68,241 is mainly due to the increase in direct expenses as the overall size ofour investment portfolio grew from the prior year period and the shorter prioryear period.

**Realized and Unrealized Loss onInvestments**

For the nine months ended December 31, 2006, werecognized a net loss on the sale of eleven loan participations in theaggregate amount of $944 and we recorded net unrealized depreciation ofinvestments in the aggregate amount of $1,552,539.

At March 31, 2006, the fair value of our investmentportfolio exceeded the cost basis of our portfolio by approximately$113,000.  At December 31, 2006, the fairvalue of our investment portfolio was less than the cost basis of our portfolioby approximately $1.4 million, representing an unrealized loss of approximately$1.6 million.  This decrease is primarilythe result of the decline in market value of our syndicated loan investments aswell as that of our Control investments.  

**Net Increase in Net Assets fromOperations**

Overall, we realized a net increase in net assetsresulting from operations of $6,809,635 for the nine months ended December 31,2006 as a result of the factors discussed above. Our net increase in net assetsfrom operations per basic and diluted weighted average common share for thenine months ended December 31, 2006 was $0.41 and our net increase in netassets from operations per basic and diluted weighted average common share forthe period June 22, 2005 (commencement of operations) to December 31, 2005 was$0.19.  

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**LIQUIDITY AND CAPITAL RESOURCES**

**Operating Activities**

Net cash used in operating activities for the ninemonths ended December 31, 2006 was approximately $82.8 million and consistedprimarily of the purchase of investments, an increase in our investmentinterest receivable and amounts due from custodian,  offset by sales of existing portfolioinvestments, increases in base management fee and administrative fees payable,increases in accrued expenses from prior year end and unrealized depreciationof our portfolio investments.

A summary of our investment activity for the ninemonths ended December 31, 2006 and the period June 22, 2005 (Commencement ofoperations) to December 31, 2005 is as follows:

| Quarter Ended | ** ** | **New Investments** | ** **  | **Principal Repayments** | ** ** | **Investments Sold** | ** ** | **Gain on Disposal** | ** ** |
|--------------------|------------|--------------------------|-------------|-------------------------------|------------|---------------------------|------------|--------------------------------|------------|
|               |       |                     |        |                          |       |                      |       |                           |       |
| June 30, 2006      |       | $                        | 33,665,549  |                          | $          | 874,222                   |       | $                              | 15,548,453 |   | $ | 3,273 |   |
| September 30, 2006 |       | 15,812,230               |        | 5,964,245                     |       | 999,436                   |       | (1,934                         | )          |
| December 31, 2006  |       | 69,372,847               |        | 3,610,221                     |       | 3,043,000                 |       | (2,283                         | )          |
| **Total**          |       | $                        | 118,850,626 |                          | $          | 10,448,688                |       | $                              | 19,590,889 |   | $ | (944 | ) |

 

| Quarter Ended | ** ** | **New Investments** | ** ** | **Principal Repayments** | ** ** | **Investments Sold** | ** ** | **Gain on Disposal** | ** ** |
|--------------------|------------|--------------------------|------------|-------------------------------|------------|---------------------------|------------|--------------------------------|------------|
|               |       |                     |       |                          |       |                      |       |                           |       |
| June 30, 2005      |       | $                        | —     |                          | $          | —                    |       | $                              | —     |   | $ | — |   |
| September 30, 2005 |       | 40,844,381               |       | 333,363                       |       | —                    |       | —                         |       |
| December 31, 2005  |       | 23,376,958               |       | 1,043,120                     |       | 2,000,000                 |       | 38,056                         |       |
| **Total**          |       | $                        | 64,221,339 |                          | $          | 1,376,483                 |       | $                              | 2,000,000  |   | $ | 38,056 |   |

 

During the ninemonths ended December 31, 2006, we purchased new investments using the balanceof the proceeds from our initial public offering and borrowings under ourcredit facility.  

The following tablesummarizes the contractual principal amortization and maturity of ourinvestment portfolio by fiscal year:
| Fiscal Year Ended March 31, | ** ** | **Amount**  | ** **  |
|-------------------------------------------------|------------|-------------|-------------|
| 2007                                            |       | $           | 399,752     |   |
| 2008                                            |       | 5,218,326   |        |
| 2009                                            |       | 7,407,132   |        |
| 2010                                            |       | 9,012,292   |        |
| 2011                                            |       | 49,339,432  |        |
| Thereafter                                      |       | 145,352,182 |        |
|                                            |       |        |        |
| **Total contractual repayments**                |       | 216,729,116 |        |
|                                            |       |        |        |
| Investments in equity securities                |       | 24,383,194  |        |
| Unamortized premiums on debt securities:        |       | 843,313     |        |
| **Total**                                       |       | $           | 241,955,623 |   |

 

**Financing Activities**

During the nine monthsended December 31, 2006, we recorded net borrowings under our credit facilityof $20.0 million which were used to purchase new investments.  As a result of our credit facility, weincurred approximately $459,000 of legal, accounting and other costs associatedwith the credit facility that will be amortized over the life of the facility.

We anticipate issuingadditional equity securities to obtain additional capital in the future. Theterms of the future equity issuances cannot be determined and there can be noassurances that the equity markets will be available to us on terms we deemfavorable.  On October 13, 2006 we fileda registration statement with the SEC (as amended on December 22, 2006) that,if and when declared effective, would permit us to issue, through one or moretransactions, up to an aggregate of $100 

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million in securities,consisting of common stock, preferred stock and/or debt securities.  To date we have incurred approximately$132,000 of costs in connection with this registration statement.  

For the nine months ended December 31, 2006, ourdividends paid of $10,432,869 exceeded our net investment income (includingrealized losses) by $2,070,695.  Wedeclared these dividends based on our estimates of net investment income forthe fiscal year.  Our investment pacecontinues to be slower than expected in our second year of operations and,consequently, our net investment income was lower than our original estimates.

For the period June 22, 2005 (commencement ofoperations) to December 31, 2005, we recorded net cash proceeds resulting fromour initial public offering of $230,292,203, of which approximately $61 millionwas invested in portfolio companies and the remainder was invested in cash andshort-term investments at December 31, 2005.

In order to qualify as a RIC and to avoid corporatelevel tax on the income we distribute to our stockholders, we are required,under Subchapter M of the Code, to distribute at least 90% of our ordinaryincome and realized net short-term capital gains to our stockholders on anannual basis. In accordance with these requirements, we have declared thefollowing dividends since our inception:
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| January 10, 2007          |       | March  22, 2007      |       | March  30, 2007       |       | $                                | 0.075      |   |
| January 10, 2007          |       | February  20, 2007   |       | February  28, 2007    |       | $                                | 0.075      |   |
| January 10, 2007          |       | January  23, 2007    |       | January  31, 2007     |       | $                                | 0.075      |   |
| October 10, 2006          |       | December  20, 2006   |       | December  29, 2006    |       | $                                | 0.07       |   |
| October 10, 2006          |       | November  21, 2006   |       | November  30, 2006    |       | $                                | 0.07       |   |
| October 10, 2006          |       | October  23, 2006    |       | October  31, 2006     |       | $                                | 0.07       |   |
| July 11, 2006             |       | September  21, 2006  |       | September  29, 2006   |       | $                                | 0.07       |   |
| July 11, 2006             |       | August  21, 2006     |       | August  31, 2006      |       | $                                | 0.07       |   |
| July 11, 2006             |       | July  19, 2006       |       | July  31, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | June  22, 2006       |       | June  30, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | May  22, 2006        |       | May  31, 2006         |       | $                                | 0.07       |   |
| April 11, 2006            |       | April  20, 2006      |       | April  28, 2006       |       | $                                | 0.07       |   |
| January 10, 2006          |       | March  17, 2006      |       | March  31, 2006       |       | $                                | 0.07       |   |
| January 10, 2006          |       | February  16, 2006   |       | February  28, 2006    |       | $                                | 0.07       |   |
| January 10, 2006          |       | January  23, 2006    |       | January  31, 2006     |       | $                                | 0.07       |   |
| October 7, 2005           |       | December  21, 2005   |       | December  31, 2005    |       | $                                | 0.04       |   |
| October 7, 2005           |       | November  21, 2005   |       | November  30, 2005    |       | $                                | 0.04       |   |
| October 7, 2005           |       | October  21, 2005    |       | October  30, 2005     |       | $                                | 0.04       |   |
| July 7, 2005              |       | September  22, 2005  |       | September  30, 2005   |       | $                                | 0.02       |   |
| July 7, 2005              |       | August  23, 2005     |       | August  31, 2005      |       | $                                | 0.02       |   |
| July 7, 2005              |       | July 21, 2005        |       | July 29, 2005         |       | $                                | 0.02       |   |

 

**Revolving Credit Facility**

OnOctober 19, 2006, through our wholly-owned subsidiary, Business Investment, weobtained a $100 million revolving credit facility (the “Credit Facility”). On October 19, 2006, we executed a Purchase and Sale Agreement pursuant towhich we agreed to sell certain loans to Business Investment in considerationof a membership interest therein.  Simultaneously, Business Investmentexecuted a Credit Agreement (the “Credit Agreement”) with Deutsche Bank AG, NewYork Branch (“Deutsche Bank”), as administrative agent, and others, pursuant towhich Business Investment pledged the loans purchased from us to secure futureadvances by certain institutional lenders. Availability under the CreditFacility will terminate on October 18, 2007, unless extended in the discretionof the lenders, at the request of Business Investment. Interest is payablemonthly during the term of the Credit Facility and principal is payable out ofcollections on loans purchased from us during the period following the date ofwhich availability for advances has terminated through maturity.  The Credit Facility will mature two yearsfollowing the date on which availability for advances has terminated and onsuch date, all principal, interest and other amounts owing under the CreditFacility will be due and payable. Interest rates charged on the advances under the facility are based onthe rate paid by the lenders on commercial paper notes issued by such lendersto fund some or all of the advances, the London Interbank Offered Rate (“LIBOR”),the Prime Rate or the Federal Funds Rate, depending on market conditions, andadjusts periodically.  As of December 31, 2006, there was an outstandingprincipal balance of $20.0 million

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underthe Credit Facility. Available borrowings are subject to various constraintsimposed under the Credit Agreement, based on the aggregate loan balance pledgedby Business Investment, which varies as loans or added and repaid, regardlessof whether such repayments are early prepayment or are made as contractuallyrequired.  At December  31, 2006,the remaining borrowing capacity available under the Credit Facility was $80.0million.  If we request a renewal of the Credit Facility, any such renewalwill be granted in the discretion of the lenders and there can be no guaranteethat we will be able to renew the Credit Facility on terms that are favorableto us, if at all.  In the event that we are not able to renew or refinancethe Credit Facility this could have a material adverse impact on our liquidityand ability to fund new investments.

TheCredit Facility contains covenants that require Business Investment to maintainits status as a separate entity; prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions);and restrict material changes to our credit and collection policies.  Thefacility also restricts some of the terms and provisions (including interestrates, terms to maturity and payments schedules) and limits the borrower andindustry concentrations of loans that are eligible to secure advances.  Asof December 31, 2006, Business Investment was in compliance with all of thefacility covenants.  We currently intend to securitize some or all of theloans held by Business Investment and if we are able to do so, we will use theproceeds from the securitization to pay down any amounts then outstanding underthe revolving credit facility.

Theadministrative agent also requires that any interest or principal payments onpledged loans be remitted directly by the borrower into lockbox accountscontrolled by Deutsche Bank. Once a month, Deutsche Bank remits the collectedfunds to the Company after payment of any interest and expenses provided forunder the Credit Agreement.

OurAdviser services the loans pledged under the Credit Facility.  As acondition to this servicing arrangement, we executed a performance guarantypursuant to which we guaranteed that our Adviser would comply fully with all ofits obligations under the Credit Facility. The performance guaranty requires usto maintain a minimum net worth of $100 million and to maintain “asset coverage”with respect to “senior securities representing indebtedness” of at least 200%,in accordance with Section 18 of the 1940 Act. As of December 31, 2006, wewere in compliance with our covenants under the performance guaranty.

**Contractual Obligations andOff-Balance Sheet Arrangements**

As of December 31,2006, we were a party to signed and non-binding term sheets for two allocationsof syndicate loan participations for approximately $3.0 million.  The future scheduled contractual payments atDecember 31, 2006 were as follows:
| ** **                       | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Investments                      |       | 3,000,000  |       | 3,000,000                                |       | — |   | — |   | — |   |
| Total                            |       | $          | 3,000,000  |                                     | $          | 3,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

In Janury 2007, all of the investment purchaseobligations summarized above have been funded. See Note 9 “Subsequent Events” inour consolidated financial statements for further information.

We do not have any significant off-balance sheetarrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K as ofDecember 31, 2006.

**ITEM3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

We are subject to financial market risks, includingchanges in interest rates. General interest rate fluctuations may have asubstantial negative impact on our investments and investment opportunitiesand, accordingly have a material adverse effect on our investment objectivesand our rate of return on invested capital. Currenty, approximately 83% of ourinvestment portfolio is at variable rates. In addition, an increase in interestrates would make it more expensive to use debt for our financing needs, if any.

We expect to continue toborrow funds to finance future lending activities as we have fully invested theproceeds of our initial public offering. These future borrowings may be atfixed or variable rates. For example, interest rates charged on the advancesunder our credit facility are based on the rate paid by the lenders oncommercial paper notes issued by such lenders to fund some or all of theadvances, LIBOR, the Prime Rate or the Federal Funds Rate, depending on marketconditions, and

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adjust periodically.  As of December 31, 2006, there was anoutstanding principal balance of $20.0 million under the credit facility.

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant. Under this analysis, a hypothetical increase in the one monthLIBOR by 1.0% would increase our net increase in net assets resulting fromoperations by approximately $1.8 million or 18.0%, over the next twelve months,compared to the net increase in net assets resulting from operations for theperiod January 1, 2006 to December 31, 2006. A hypothetical decrease in the onemonth LIBOR by 1.0% would decrease our net increase in net assets resultingfrom operations by approximately $1.8 million or 18.0%, over the next twelvemonths, compared to the net increase in net assets from operations for theperiod January 1, 2006 to December 31, 2006. Although management believes thatthis analysis is indicative of our existing interest rate sensitivity, it doesnot adjust for potential changes in credit quality, size and composition of ourinvestment portfolio and other business developments that could affect netincrease in net assets resulting from operations. Accordingly, no assurancescan be given that actual results would not differ materially from the resultsunder this hypothetical analysis.

In the event that we securitizea portion of our loan portfolio, we believe that we will likely be required toenter into further hedging arrangements in the future with respect tosecuritized loans.  While hedgingactivities may mitigate our exposure to adverse fluctuations in interest rates,certain hedging transactions that we may enter into in the future, such asinterest rate swap agreements, may also limit our ability to participate in thebenefits of lower interest rates with respect to our portfolio of investments.

We may also experience risk associated with investingin securities of companies with foreign operations. We currently do notanticipate investing in debt or equity of foreign companies, however, somepotential portfolio companies may have operations located outside the UnitedStates. These risks include, but are not limited to, fluctuations in foreigncurrency exchange rates, imposition of foreign taxes, changes in exportationregulations and political and social instability.

**ITEM4.   CONTROLS AND PROCEDURES.**

As of December 31, 2006, we, including our ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of our disclosure controls and procedures. Based onthat evaluation, our management, including the Chief Executive Officer andChief Financial Officer, concluded that our disclosure controls and procedureswere effective in timely alerting management, including the Chief ExecutiveOfficer and Chief Financial Officer, of material information about us requiredto be included in periodic Securities and Exchange Commission filings. However,in evaluating the disclosure controls and procedures, management recognizedthat any controls and procedures, no matter how well designed and operated canprovide only reasonable assurance of achieving the desired control objectives,and management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

There have been no changes in our internal controlover financial reporting that occurred during the quarter ended December 31,2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

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**PARTII—OTHER INFORMATION**

**ITEM1. LEGAL PROCEEDINGS.**

Neither we, nor any of our subsidiaries are currentlysubject to any material legal proceeding, nor, to our knowledge, is anymaterial legal proceeding threatened against us or any of our subsidiaries.

**ITEM1A. RISK FACTORS.**

Our business is subjectto certain risks and events that, if they occur, could adversely affect ourfinancial condition and results of operations and the trading price of ourcommon stock. For a discussion of these risks, please refer to the “RiskFactors” sections of our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2006, filed by us with the Securities and Exchange Commission on June14, 2006, our Quarterly Report on Form 10-Q for the quarter ended September 30,2006 filed on November 1, 2006, and Pre-Effective Amendment No. 1 to ourRegistration Statement on Form N-2, filed on December 22, 2006.

**ITEM2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

Not applicable.

**ITEM3. DEFAULTS UPON SENIOR SECURITIES.**

Not applicable.

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

Not applicable.

**ITEM5. OTHER INFORMATION.**

Not applicable

**ITEM 6. EXHIBITS**

See the exhibit index.

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**SIGNATURE**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|            | ** ** | **GLADSTONE INVESTMENT CORPORATION** |
|------------|------------|--------------------------------------|
| ** ** | ** ** | ** **                           | ** ** | ** ** |
| ** ** | ** ** | ** **                           | ** ** | ** ** |
|       |       | By:                                  |   |  /s/ HARRY BRILL |   |
|       |       |                                 |   | Harry Brill |
|       |       |                                 |   | Chief Financial Officer |

 

**Date: February 5, 2007**

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**EXHIBIT INDEX**
| Exhibit | ** ** | **Description**                                                                                                                                                                                                                                                                                  |
|---------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1     |       | Amended and Restated Certificate of Incorporation,  incorporated by reference to Exhibit a.2 to Pre-Effective Amendment No. 1 to  the Registration Statement on Form N-2 (File No. 333-123699), filed May 13,  2005.                                                                             |
|    |       |                                                                                                                                                                                                                                                                                             |
| 3.2     |       | Amended and Restated Bylaws, incorporated by  reference to Exhibit b.2 to Pre-Effective Amendment No. 3 to the Registration  Statement on Form N-2 (File No. 333-123699), filed June 21, 2005.                                                                                                   |
|    |       |                                                                                                                                                                                                                                                                                             |
| 4.1     |       | Specimen Stock Certificate, incorporated by reference  to Exhibit 99.d to Pre-Effective Amendment No. 3 to the Registration  Statementon Form N-2 (File No. 333-123699), filed June 21, 2005.                                                                                                    |
|    |       |                                                                                                                                                                                                                                                                                             |
| 10.1    |       | Credit Agreement by and among Gladstone Business  Investment LLC, Deutsche Bank AG, and certain other parties, dated as of  October 19, 2006, incorporated by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K (File No. 814-00704), filed on October 23,  2006. |
|    |       |                                                                                                                                                                                                                                                                                             |
| 11      |       | Computation of Per Share Earnings (included in the  notes to the unaudited financial statements contained in this report).                                                                                                                                                                       |
|    |       |                                                                                                                                                                                                                                                                                             |
| 31.1    |       | Certification of Chief Executive Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             |
|    |       |                                                                                                                                                                                                                                                                                             |
| 31.2    |       | Certification of Chief Financial Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             |
|    |       |                                                                                                                                                                                                                                                                                             |
| 32.1    |       | Certification of Chief Executive Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             |
|    |       |                                                                                                                                                                                                                                                                                             |
| 32.2    |       | Certification of Chief Financial Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             |

 

All other exhibits for which provision is made in theapplicable regulations of the Securities and Exchange Commission are notrequired under the related instruction or are inapplicable and therefore havebeen omitted.

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