Table of Contents

 

 

 

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|------------|------------|---------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                    |
| ** ** | ** ** | **FOR THE QUARTER ENDED DECEMBER 31, 2008**                                                                   |
| ** ** | ** ** | ** **                                                                                                    |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

** **

**COMMISSION FILE NUMBER: 000-51233**

** **

**GLADSTONE INVESTMENT CORPORATION**

(Exact name of registrant as specified in itscharter)

 

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

 

**1521 WESTBRANCH DRIVE, SUITE 200MCLEAN, VIRGINIA 22102**

(Address of principal executive office)

 

**(703) 287-5800**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No o.

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o  Accelerated filer x  Non-accelerated filer o Smaller reporting company o.

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date. The number ofshares of the issuer’s Common Stock, $0.001 par value, outstanding as of January 30,2009 were 22,080,133.

 

 

 

----

Table of Contents

 

**GLADSTONE INVESTMENT CORPORATION**

 

**TABLE OF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                                  |   |
|---------------|------------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                   |   |   |
| Item 1.       | Financial Statements (Unaudited)                                                                                       |   |
|          |                                                                                                                   |   |   |
|          | Condensed Consolidated Statements of Assets  and Liabilities as of December 31, 2008 and March 31, 2008      | 3      |
|          | Condensed Consolidated Schedules of  Investments as of December 31, 2008 and March 31, 2008                  | 4      |
|          | Condensed  Consolidated Statements of Operations for the three and nine months ended  December 31, 2008 and 2007  | 12     |
|          | Condensed  Consolidated Statements of Changes in Net Assets for the nine months ended  December 31, 2008 and 2007 | 13     |
|          | Condensed  Consolidated Statements of Cash Flows for the nine months ended  December 31, 2008 and 2007            | 14     |
|          | Financial Highlights for the three and nine  months ended December 31, 2008 and 2007                              | 15     |
|          | Notes to  Condensed Consolidated Financial Statements                                                                  | 16     |
|          |                                                                                                                   |   |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 30     |
|          | Overview                                                                                                               | 30     |
|          | Results of  Operations                                                                                                 | 31     |
|          | Liquidity and Capital Resources                                                                                        | 38     |
|          |                                                                                                                   |   |   |
| Item 3.       | Quantitative and Qualitative Disclosures  About Market Risk                                                            | 47     |
|          |                                                                                                                   |   |   |
| Item 4.       | Controls and Procedures                                                                                                | 48     |
|          |                                                                                                                   |   |   |
| PART II. | OTHER INFORMATION                                                                                                      |   |
|          |                                                                                                                   |   |   |
| Item 1.       | Legal Proceedings                                                                                                      | 48     |
|          |                                                                                                                   |   |   |
| Item 1A.      | Risk Factors                                                                                                           | 48     |
|          |                                                                                                                   |   |   |
| Item 2.       | Unregistered Sales of Equity Securities and  Use of Proceeds                                                           | 53     |
|          |                                                                                                                   |   |   |
| Item 3.       | Defaults Upon Senior Securities                                                                                        | 53     |
|          |                                                                                                                   |   |   |
| Item 4.       | Submission of Matters to a Vote of Security  Holders                                                                   | 53     |
|          |                                                                                                                   |   |   |
| Item 5.       | Other Information                                                                                                      | 53     |
|          |                                                                                                                   |   |   |
| Item 6.       | Exhibits                                                                                                               | 54     |
|          |                                                                                                                   |   |   |
| SIGNATURES    | 54                                                                                                                     |

 

2

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

**(DOLLAR AMOUNTS IN THOUSANDS,EXCEPT PER SHARE AMOUNTS)**

**(UNAUDITED)**

 
| ** **                                                                                                                                                                               | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2008**              | ** ** | **2008**           | ** ** |
| **ASSETS**                                                                                                                                                                               |       |                  |       |               |       |
| Non-Control/Non-Affiliate investments (Cost  12/31/08: $138,599; Cost 3/31/08:$166,416)                                                                                                  |       | $                     | 107,208    |               | $          | 142,739 |   |
| Control investments (Cost 12/31/08:  $152,395; Cost 3/31/08: $138,354)                                                                                                                   |       | 167,175               |       | 145,407            |       |
| Affiliate investments (Cost 12/31/08:  $63,175; Cost 3/31/08: $46,035)                                                                                                                   |       | 50,912                |       | 47,458             |       |
| Total investments at fair value (Cost  12/31/08: $354,169; Cost 3/31/08: $350,805)                                                                                                       |       | 325,295               |       | 335,604            |       |
| Cash and cash equivalents                                                                                                                                                                |       | 13,123                |       | 9,360              |       |
| Interest receivable                                                                                                                                                                      |       | 1,616                 |       | 1,662              |       |
| Prepaid insurance                                                                                                                                                                        |       | 153                   |       | 90                 |       |
| Deferred finance costs                                                                                                                                                                   |       | —                |       | 324                |       |
| Due from Custodian                                                                                                                                                                       |       | 2,430                 |       | 4,399              |       |
| Due from Adviser (Refer to Note 4)                                                                                                                                                       |       | —                |       | 89                 |       |
| Other assets                                                                                                                                                                             |       | 470                   |       | 765                |       |
| **TOTAL ASSETS**                                                                                                                                                                         |       | $                     | 343,087    |               | $          | 352,293 |   |
|                                                                                                                                                                                     |       |                  |       |               |       |
| **LIABILITIES**                                                                                                                                                                          |       |                  |       |               |       |
| Fee due to Administrator (Refer to Note 4)                                                                                                                                               |       | $                     | 195        |               | $          | 208 |   |
| Fee due to Adviser (Refer to Note 4)                                                                                                                                                     |       | 55                    |       | —             |       |
| Borrowings under line of credit                                                                                                                                                          |       | 117,864               |       | 144,835            |       |
| Accrued expenses                                                                                                                                                                         |       | 717                   |       | 716                |       |
| Other liabilities                                                                                                                                                                        |       | 139                   |       | 89                 |       |
| **TOTAL LIABILITIES**                                                                                                                                                                    |       | 118,970               |       | 145,848            |       |
| **NET ASSETS**                                                                                                                                                                           |       | $                     | 224,117    |               | $          | 206,445 |   |
|                                                                                                                                                                                     |       |                  |       |               |       |
| **ANALYSIS OF NET ASSETS:**                                                                                                                                                              |       |                  |       |               |       |
| Common stock, $0.001 par value, 100,000,000  shares authorized, 22,080,133 and 16,560,100 shares issued and outstanding at  December 31, 2008 and March 31, 2008, respectively |       | $                     | 22         |               | $          | 16 |   |
| Capital in excess of par value                                                                                                                                                           |       | 264,762               |       | 224,173            |       |
| Net unrealized depreciation of investment  portfolio                                                                                                                                     |       | (28,874               | )          | (15,201            | )          |
| Net unrealized depreciation of derivative                                                                                                                                                |       | (53                   | )          | (53                | )          |
| Accumulated net investment loss                                                                                                                                                          |       | (11,740               | )          | (2,490             | )          |
| **TOTAL NET ASSETS**                                                                                                                                                                     |       | $                     | 224,117    |               | $          | 206,445 |   |
|                                                                                                                                                                                     |       |                  |       |               |       |
| **NET ASSETS PER SHARE**                                                                                                                                                                 |       | $                     | 10.15      |               | $          | 12.47 |   |

 

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

 

3

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULES OF INVESTMENTS**

**AS OF DECEMBER 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                           | ** **   | **Industry**                                                      | ** **   | **Investment  (2)**                       | ** **   | **Cost**     | ** **   | **Fair  Value** | ** **   |
|-------------------------------------------|--------------|-------------------------------------------------------------------|--------------|-------------------------------------------|--------------|--------------|--------------|-----------------|--------------|
|                                      |         |                                                              |         |                                      |         |         |         |            |         |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS** | ** **   | ** **                                                        | ** **   | ** **                                | ** **   | ** **   | ** **   |
| ***Senior Syndicated Loans:***            | *** *** | *** ***                                                      | *** *** | *** ***                              | *** *** | *** *** | *** *** | *** ***    | *** *** |
| Activant  Solutions, Inc.            |         | Service - enterprise software and services                        |         | Senior  Term Debt (6.1%, Due 5/2013) (3)  |         | $            | 1,659        |            | $            | 1,224 |   |
| Advanced  Homecare Holdings, Inc.    |         | Service - home health nursing services                            |         | Senior  Term Debt (4.2%, Due 8/2014) (3)  |         | 2,955        |         | 2,261           |         |
| Aeroflex, Inc.                       |         | Service - provider of highly specialized  electronic equipment    |         | Senior  Term Debt (5.4%, Due 8/2014) (3)  |         | 1,888        |         | 1,492           |         |
| Compsych  Investments Corp.               |         | Service - employee assistance programs                            |         | Senior  Term Debt (4.0%, Due 2/2012) (3)  |         | 3,167        |         | 2,750           |         |
| CRC  Health Group, Inc.              |         | Service - substance abuse treatment                               |         | Senior  Term Debt (3.7%, Due 2/2012) (3)  |         | 7,795        |         | 6,285           |         |
| Critical  Homecare Solutions, Inc.   |         | Service - home therapy and respiratory treatment                  |         | Senior  Term Debt (3.7%, Due 1/2012) (3)  |         | 4,418        |         | 3,801           |         |
| Generac  Acquisition Corp.                |         | Manufacturing - standby power products                            |         | Senior  Term Debt (6.7%, Due 11/2013) (3) |         | 6,869        |         | 5,162           |         |
| Graham  Packaging Holdings Company        |         | Manufacturing - plastic containers                                |         | Senior  Term Debt (5.5%, Due 10/2011) (3) |         | 3,399        |         | 2,768           |         |
| Hargray  Communications Group, Inc.  |         | Service - triple-play (cable, phone, internet)  provider          |         | Senior  Term Debt (3.4%, Due 6/2014) (3)  |         | 894          |         | 626             |         |
| HMTBP  Acquisition II Corp.               |         | Service - aboveground storage tanks                               |         | Senior  Term Debt (5.4%, Due 5/2014) (3)  |         | 3,848        |         | 2,873           |         |
| Huish  Detergents, Inc.              |         | Manufacturing - household cleaning products                       |         | Senior  Term Debt (2.2%, Due 4/2014) (3)  |         | 1,971        |         | 1,421           |         |
| Hyland  Software, Inc.               |         | Service - provider of enterprise content  management software     |         | Senior  Term Debt (5.6%, Due 7/2013) (3)  |         | 3,920        |         | 3,188           |         |
| Interstate  Fibernet, Inc.           |         | Service - provider of voice and data  telecommunications services |         | Senior  Term Debt (5.5%, Due 7/2013) (3)  |         | 9,863        |         | 7,252           |         |
| KIK  Custom Products, Inc.           |         | Manufacturing - consumer products                                 |         | Senior  Term Debt (5.8%, Due 5/2014) (3)  |         | 3,951        |         | 2,590           |         |
| Kronos, Inc.                         |         | Service - workforce management solutions                          |         | Senior  Term Debt (3.7%, Due 6/2014) (3)  |         | 1,904        |         | 1,331           |         |
| Local  TV Finance, LLC                    |         | Service - television station operator                             |         | Senior  Term Debt (2.5%, Due 5/2013) (3)  |         | 987          |         | 725             |         |
| LVI  Services, Inc.                  |         | Service - asbestos and mold remediation                           |         | Senior  Term Debt (6.5%, Due 11/2010) (3) |         | 5,933        |         | 5,162           |         |
| MedAssets, Inc.                      |         | Service - pharmaceuticals and healthcare GPO                      |         | Senior  Term Debt (5.3%, Due 10/2013) (3) |         | 3,973        |         | 3,121           |         |
| Network  Solutions, LLC                   |         | Service - internet domain solutions                               |         | Senior  Term Debt (3.3%, Due 3/2014) (3)  |         | 8,673        |         | 6,120           |         |
| Open  Solutions, Inc.                |         | Service - software outsourcing for financial  institutions        |         | Senior  Term Debt (6.0%, Due 1/2014) (3)  |         | 2,656        |         | 1,936           |         |
| Ozburn-Hessey  Holding Co. LLC            |         | Service - third party logistics                                   |         | Senior  Term Debt (5.6%, Due 8/2012) (3)  |         | 7,549        |         | 6,079           |         |
| Pinnacle  Foods Finance, LLC              |         | Manufacturing - branded food products                             |         | Senior  Term Debt (6.1%, Due 4/2014) (3)  |         | 1,955        |         | 1,367           |         |
| PTS  Acquisition Corp.                    |         | Manufacturing - drug delivery and packaging technologies          |         | Senior  Term Debt (3.7%, Due 4/2014) (3)  |         | 6,895        |         | 5,026           |         |
| QTC  Acquisition, Inc.               |         | Service - outsourced disability evaluations                       |         | Senior  Term Debt (4.1%, Due 11/2012) (3) |         | 1,914        |         | 1,462           |         |
| Radio  Systems Corporation                |         | Service - design electronic pet containment  products             |         | Senior  Term Debt (3.6%, Due 9/2013) (3)  |         | 1,876        |         | 1,391           |         |
| Rally  Parts, Inc.                   |         | Manufacturing - aftermarket motorcycle parts and  accessories     |         | Senior  Term Debt (3.6%, Due 11/2013) (3) |         | 2,471        |         | 1,769           |         |
| RPG  Holdings, Inc.                  |         | Manufacturing and design - greeting cards                         |         | Senior  Term Debt (non-accrual) (8)       |         | 4,553        |         | 2,048           |         |
| SafeNet, Inc.                        |         | Service - chip encryption products                                |         | Senior  Term Debt (7.8%, Due 4/2014) (3)  |         | 2,957        |         | 2,107           |         |
| SGS  International, Inc.             |         | Service - digital imaging and graphics                            |         | Senior  Term Debt (4.1%, Due 12/2011) (3) |         | 1,475        |         | 1,226           |         |
| Survey  Sampling, LLC                     |         | Service - telecommunications-based sampling                       |         | Senior  Term Debt (9.5%, Due 5/2011) (3)  |         | 2,598        |         | 2,386           |         |
|                                           |              |                                                                   |              |                                           |              |              |              |                 |              |  |  |

 

4

----

Table of Contents

 
| Triad  Laboratory Alliance, LLC                 |       | Service - regional medical laboratories         |        | Senior  Term Debt (4.7%, Due 12/2011) (3)                       |     | 4,131       |       | 3,527    |     |
|-------------------------------------------------|------------|-------------------------------------------------|-------------|-----------------------------------------------------------------|----------|-------------|------------|----------|----------|
| Wastequip, Inc.                            |       | Service - process and transport waste materials |        | Senior  Term Debt (2.7%, Due 2/2013) (3)                        |     | 2,900       |       | 2,139    |     |
| WaveDivision  Holdings, LLC                     |       | Service - cable                                 |        | Senior  Term Debt (4.4%, Due 6/2014)****(3)                     |     | 1,910       |       | 1,466    |     |
| West  Corporation                               |       | Service - business process outsourcing          |        | Senior  Term Debt (3.5%, Due 10/2013)****(3)                    |     | 3,331       |       | 2,446    |     |
| ***Subtotal - Senior Syndicated Loans***        |       |                                            |        |                                                            |     | $           | 127,238    |     | $        | 96,527 |   |
| *** ***                                    | * *   | * *                                        | * *    | * *                                                        | * * | * *    | * *   | * * | * * |
| ***Non-Syndicated Loans***                      | * *   | * *                                        | * *    | * *                                                        | * * | * *    | * *   | * * | * * |
| B-Dry,  LLC                                     |       | Service - basement waterproofer                 |        | Revolving Credit Facility, $300 available (10.5%,  Due 10/2009) |     | $           | 450        |     | $        | 442 |   |
|                                            |       |                                            |        | Senior Term Debt (10.0%, Due 5/2014) (5)                        |     | 6,681       |       | 6,447    |     |
|                                            |       |                                            |        | Senior Term Debt (10.0%, Due 5/2014) (5)                        |     | 3,930       |       | 3,792    |     |
|                                            |       |                                            |        | Common Stock Warrants (4)                                       |     | 300         |       | —   |     |
|                                            |       |                                            |        |                                                            |     | 11,361      |       | 10,681   |     |
|                                            |       |                                            |        |                                                            |     |        |       |     |     |
| **Total Non-Control/Non-Affiliate Investments** | ** ** | **$**                                           | **138,599** | ** **                                                      | **$**    | **107,208** | ** ** |

 

5

----

Table of Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULES OFINVESTMENTS**

**AS OF DECEMBER 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                | ** ** | **Industry**                                               | ** ** | **Investment  (2)**                                              | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|--------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| **CONTROL INVESTMENTS**        | ** ** | ** **                                                 | ** ** | ** **                                                       | ** ** | ** ** | ** **  | ** **      | ** ** |
| ** **                     | ** ** | ** **                                                 | ** ** | ** **                                                       | ** ** | ** ** | ** **  | ** **      | ** ** |
| A.  Stucki Holding Corp.       |       | Manufacturing - railroad freight car products              |       | Senior Term Debt (6.4%, Due 3/2012)                              |       | $          | 11,782      |            | $          | 11,782 |   |
|                           |       |                                                       |       | Senior Term Debt (8.7%, Due 3/2012) (6)                          |       | 10,587     |        | 10,587          |       |
|                           |       |                                                       |       | Senior Subordinated Term Debt (13%, Due 3/2014)                  |       | 8,586      |        | 8,586           |       |
|                           |       |                                                       |       | Preferred Stock (4)                                              |       | 4,387      |        | 5,034           |       |
|                           |       |                                                       |       | Common Stock (4)                                                 |       | 130        |        | 12,635          |       |
|                           |       |                                                       |       |                                                             |       | 35,472     |        | 48,624          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Acme  Cryogenics, Inc.    |       | Manufacturing - manifolds and pipes for industrial  gasses |       | Senior Subordinated Term Debt (11.5%, Due 3/2013)                |       | 14,500     |        | 14,500          |       |
|                           |       |                                                       |       | Redeemable Preferred Stock (4)                                   |       | 6,984      |        | 7,557           |       |
|                           |       |                                                       |       | Common Stock (4)                                                 |       | 1,045      |        | —          |       |
|                           |       |                                                       |       | Common Stock Warrants (4)                                        |       | 25         |        | —          |       |
|                           |       |                                                       |       |                                                             |       | 22,554     |        | 22,057          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| ASH  Holdings Corp.            |       | Retail and Service - school buses and parts                |       | Revolver, $400 available (non-accrual, Due 3/2010)               |       | 1,600      |        | —          |       |
|                           |       |                                                       |       | Senior Subordinated Term Debt (non-accrual, Due  1/2012)         |       | 5,250      |        | —          |       |
|                           |       |                                                       |       | Preferred Stock (4)                                              |       | 2,500      |        | —          |       |
|                           |       |                                                       |       | Common Stock Warrants (4)                                        |       | 4          |        | —          |       |
|                           |       |                                                       |       |                                                             |       | 9,354      |        | —          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Cavert  II Holding Corp.       |       | Manufacturing - bailing wire                               |       | Revolving Credit Facility, $1,200 available (8.0%,  Due 10/2010) |       | 1,800      |        | 1,800           |       |
|                           |       |                                                       |       | Senior Term Debt (8.3%, Due 10/2012)                             |       | 5,850      |        | 5,850           |       |
|                           |       |                                                       |       | Senior Term Debt (10.0%, Due 10/2012) (6)                        |       | 3,000      |        | 3,000           |       |
|                           |       |                                                       |       | Senior Subordinated Term Debt (13%, Due 10/2014)                 |       | 4,671      |        | 4,671           |       |
|                           |       |                                                       |       | Preferred Stock (4)                                              |       | 4,110      |        | 4,503           |       |
|                           |       |                                                       |       | Common Stock (4)                                                 |       | 69         |        | 906             |       |
|                           |       |                                                       |       |                                                             |       | 19,500     |        | 20,730          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Chase  II Holdings Corp.       |       | Manufacturing - traffic doors                              |       | Revolving Credit Facility, $1,105 available (5.9%,  Due 3/2009)  |       | 3,395      |        | 3,395           |       |
|                           |       |                                                       |       | Senior Term Debt (8.8%, Due 3/2011)                              |       | 9,075      |        | 9,075           |       |
|                           |       |                                                       |       | Senior Term Debt (12.0%, Due 3/2011) (6)                         |       | 7,720      |        | 7,720           |       |
|                           |       |                                                       |       | Senior Subordinated Term Debt (13.0%, Due 3/2013)                |       | 6,168      |        | 6,168           |       |
|                           |       |                                                       |       | Redeemable Preferred Stock (4)                                   |       | 6,961      |        | 9,089           |       |
|                           |       |                                                       |       | Common Stock (4)                                                 |       | 61         |        | 7,620           |       |
|                           |       |                                                       |       |                                                             |       | 33,380     |        | 43,067          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Country  Club Enterprises, LLC |       | Service – golf cart distribution                      |       | Subordinated Term Debt (14.0% Due 11/2014) (7)                   |       | 7,000      |        | 7,000           |       |
|                           |       |                                                       |       | Preferred Stock (4), (7)                                         |       | 3,725      |        | 3,725           |       |
|                           |       |                                                       |       |                                                             |       | 10,725     |        | 10,725          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Galaxy  Tool Holding Corp.     |       | Manufacturing - aerospace and plastics                     |       | Senior Subordinated Term Debt (13.5%, Due 8/2013)                |       | 17,250     |        | 17,250          |       |
|                           |       |                                                       |       | Preferred Stock (4)                                              |       | 4,112      |        | 4,333           |       |
|                           |       |                                                       |       | Common Stock (4)                                                 |       | 48         |        | 389             |       |
|                           |       |                                                       |       |                                                             |       | 21,410     |        | 21,972          |       |
|                           |       |                                                       |       |                                                             |       |       |        |            |       |
| Total Control Investments      | ** ** | ** **                                                 | ** ** | ** **                                                       | ** ** | **$**      | **152,395** | ** **      | **$**      | **167,175** | ** ** |

 

6

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULES OFINVESTMENTS**

**AS OF DECEMBER 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                 | ** ** | **Industry**                                                | ** ** | **Investment  (2)**                                              | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
|                            |       |                                                        |       |                                                             |       |       |        |            |       |
| **AFFILIATE INVESTMENTS**       | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** | ** ** | ** **  |
| ** **                      | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** | ** ** | ** **  | ** **      | ** ** |
| Danco  Acquisition Corp.        |       | Manufacturing - machining and sheet metal work              |       | Revolving Credit Facility, $2,600 available (9.3%,  Due 10/2010) |       | $          | 400         |            | $          | 376 |   |
|                            |       |                                                        |       | Senior Term Debt (9.3%, Due 10/2012) (5)                         |       | 5,100      |        | 4,807           |       |
|                            |       |                                                        |       | Senior Term Debt (11.5%, Due 4/2013) (5)                         |       | 9,135      |        | 8,496           |       |
|                            |       |                                                        |       | Redeemable  Preferred Stock (4)                                  |       | 2,500      |        | 2,664           |       |
|                            |       |                                                        |       | Common  Stock Warrants (4)                                       |       | 3          |        | —          |       |
|                            |       |                                                        |       |                                                             |       | 17,138     |        | 16,343          |       |
|                            |       |                                                        |       |                                                             |       |       |        |            |       |
| Mathey  Investments, Inc.  |       | Manufacturing - pipe-cutting and pipe-fitting equipment     |       | Revolving Credit Facility, $2,000 available (9.0%,  Due 3/2011)  |       | —     |        | —          |       |
|                            |       |                                                        |       | Senior Term Debt (9.0%, Due 3/2013) (5)                          |       | 2,406      |        | 2,346           |       |
|                            |       |                                                        |       | Senior Term Debt (12.0%, Due 3/2014) (5), (6)                    |       | 7,245      |        | 7,037           |       |
|                            |       |                                                        |       | Common  Stock (4)                                                |       | 500        |        | 586             |       |
|                            |       |                                                        |       | Common  Stock Warrants (4)                                       |       | 277        |        | 342             |       |
|                            |       |                                                        |       |                                                             |       | 10,428     |        | 10,311          |       |
|                            |       |                                                        |       |                                                             |       |       |        |            |       |
| Noble  Logistics, Inc.     |       | Service - aftermarket auto parts delivery                   |       | Revolving Credit Facility, $-0- available (7.4%,  Due 12/2009)   |       | 2,000      |        | 1,598           |       |
|                            |       |                                                        |       | Senior Term Debt (10.5%, Due 12/2011) (5)                        |       | 5,727      |        | 4,574           |       |
|                            |       |                                                        |       | Senior Term Debt (12.5%, Due 3/2011) (5), (6)                    |       | 7,300      |        | 5,831           |       |
|                            |       |                                                        |       | Preferred  Stock (4)                                             |       | 1,750      |        | —          |       |
|                            |       |                                                        |       | Common  Stock (4)                                                |       | 1,682      |        | —          |       |
|                            |       |                                                        |       |                                                             |       | 18,459     |        | 12,003          |       |
|                            |       |                                                        |       |                                                             |       |       |        |            |       |
| Quench  Holdings Corp.          |       | Service - sales, installation and service of water  coolers |       | Senior Subordinated Term Debt (10.0%, Due 8/2013) (5)            |       | 8,000      |        | 5,200           |       |
|                            |       |                                                        |       | Preferred  Stock (4)                                             |       | 2,950      |        | 1,433           |       |
|                            |       |                                                        |       | Common  Stock Warrants (4)                                       |       | 447        |        | —          |       |
|                            |       |                                                        |       |                                                             |       | 11,397     |        | 6,633           |       |
|                            |       |                                                        |       |                                                             |       |       |        |            |       |
| Tread  Corp.                    |       | Service - regional medical laboratories                     |       | Senior Term Debt (12.5%, Due 5/2013) (5)                         |       | 5,000      |        | 4,875           |       |
|                            |       |                                                        |       | Preferred  Stock (4)                                             |       | 750        |        | 747             |       |
|                            |       |                                                        |       | Common  Stock Warrants (4)                                       |       | 3          |        | —          |       |
|                            |       |                                                        |       |                                                             |       | 5,753      |        | 5,622           |       |
| ** **                      | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** |       |        |            |       |
| **Total Affiliate Investments** | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** | **$**      | **63,175**  | ** **      | **$**      | **50,912** |   |
| ** **                      | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** |       |        |            |       |
| **Total Investments**           | ** ** | ** **                                                  | ** ** | ** **                                                       | ** ** | **$**      | **354,169** | ** **      | **$**      | **325,295** |   |

 

----

| (1) |   | Certain  of the listed securities are issued by affiliate(s) of the indicated  portfolio company.                                                                      |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Percentage  represents the weighted average interest rates in effect at December 31,  2008, and due date represents the contractual maturity date.                     |
| (3) |   | Security  valued using internally-developed, risk-adjusted discounted cash flow  methodologies as of December 31, 2008.                                                |
| (4) |   | Security  is non-income producing.                                                                                                                                          |
| (5) |   | Fair  value based on opinions of value submitted by Standard & Poor’s  Securities Evaluations, Inc. at December 31, 2008.                           |
| (6) |   | Last  Out Tranche of senior debt, meaning if the portfolio company is liquidated  then the holder of the Last Out Tranche is paid after the senior debt.                    |
| (7) |   | Valued  at cost due to recent acquisition.                                                                                                                                  |
| (8) |   | Security  valued based on the indicative bid price on or near December 31, 2008,  offered by the respective syndication agent’s trading desk, or secondary  desk. |

 

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

 

7

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULES OF INVESTMENTS**

**AS OF MARCH 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                           | ** **   | **Industry**                                                         | ** **   | **Investment  (2)**                           | ** **   | **Cost**     | ** **   | **Fair  Value** | ** **   |
|-------------------------------------------|--------------|----------------------------------------------------------------------|--------------|-----------------------------------------------|--------------|--------------|--------------|-----------------|--------------|
|                                      |         |                                                                 |         |                                          |         |         |         |            |         |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS** |         |                                                                 |         |                                          |         |         |         |
| ***Senior Syndicated Loans:***            | *** *** | *** ***                                                         | *** *** | *** ***                                  | *** *** | *** *** | *** *** | *** ***    | *** *** |
| Activant  Solutions, Inc.            |         | Service - enterprise software and services                           |         | Senior Term Debt (6.7%, Due 5/2013) (3)       |         | $            | 1,734        |            | $            | 1,478 |   |
| Advanced  Homecare Holdings, Inc.    |         | Service - home health nursing services                               |         | Senior Term Debt (6.4%, Due 8/2014) (3)       |         | 2,977        |         | 2,829           |         |
| Aeroflex, Inc.                       |         | Service - provider of highly specialized electronic  equipment       |         | Senior Term Debt (6.4%, Due 8/2014) (3)       |         | 1,898        |         | 1,851           |         |
| Compsych  Investments Corp.               |         | Service - employee assistance programs                               |         | Senior Term Debt (5.5%, Due 2/2012) (3), (5)  |         | 3,421        |         | 2,965           |         |
| CRC  Health Group, Inc.              |         | Service – substance abuse treatment                             |         | Senior Term Debt (4.9%, Due 2/2012) (3)       |         | 9,878        |         | 8,536           |         |
| Critical  Homecare Solutions, Inc.   |         | Service - home therapy and respiratory treatment                     |         | Senior Term Debt (6.1%, Due 1/2012) (3), (5)  |         | 4,505        |         | 4,480           |         |
| Dealer  Computer Services, Inc.      |         | Manufacturing & Service - systems for  automotive retailers |         | Senior Term Debt (6.8%, Due 9/2013) (3)       |         | 1,799        |         | 1,595           |         |
| Generac  Acquisition Corp.                |         | Manufacturing - standby power products                               |         | Senior Term Debt (7.2%, Due 11/2013) (3), (5) |         | 6,874        |         | 5,435           |         |
| Graham  Packaging Holdings Company        |         | Manufacturing - plastic containers                                   |         | Senior Term Debt (5.9%, Due 10/2011) (3)      |         | 5,420        |         | 4,938           |         |
| Hargray  Communications Group, Inc.  |         | Service - triple-play (cable, phone, internet)  provider             |         | Senior Term Debt (4.9%, Due 6/2014) (3)       |         | 963          |         | 860             |         |
| HMTBP  Acquisition II Corp.               |         | Service - aboveground storage tanks                                  |         | Senior Term Debt (4.9%, Due 5/2014) (3), (5)  |         | 3,878        |         | 3,529           |         |
| Hudson  Products Holdings, Inc.      |         | Manufacturing - heat transfer solutions                              |         | Senior Term Debt (7.0%, Due 12/2013) (3)      |         | 6,020        |         | 5,283           |         |
| Huish  Detergents, Inc.              |         | Manufacturing - household cleaning products                          |         | Senior Term Debt (4.7%, Due 4/2014) (3)       |         | 1,986        |         | 1,652           |         |
| Hyland  Software, Inc.               |         | Service - provider of enterprise content management  software        |         | Senior Term Debt (5.9%, Due 7/2013) (3)       |         | 3,955        |         | 3,671           |         |
| Interstate  Fibernet, Inc.           |         | Service - provider of voice and data  telecommunications services    |         | Senior Term Debt (6.7%, Due 7/2013) (3)       |         | 9,932        |         | 9,676           |         |
| KIK  Custom Products, Inc.           |         | Manufacturing - consumer products                                    |         | Senior Term Debt (4.9%, Due 5/2014) (3)       |         | 3,981        |         | 2,746           |         |
| Kronos, Inc.                         |         | Service - workforce management solutions                             |         | Senior Term Debt (5.0%, Due 6/2014) (3)       |         | 1,971        |         | 1,577           |         |
| Lexicon  Marketing USA, Inc.         |         | Service - marketing to Hispanic community                            |         | Senior Term Debt (non-accrual) (3), (5)       |         | 2,947        |         | 412             |         |
| Local  TV Finance, LLC                    |         | Service - television station operator                                |         | Senior Term Debt (5.2%, Due 5/2013) (3)       |         | 995          |         | 824             |         |
| LVI  Services, Inc.                  |         | Service - asbestos and mold remediation                              |         | Senior Term Debt (7.5%, Due 11/2010) (3), (5) |         | 6,369        |         | 5,083           |         |
| MedAssets, Inc.                      |         | Service - pharmaceuticals and healthcare GPO                         |         | Senior Term Debt (5.2%, Due 10/2013) (3), (5) |         | 4,004        |         | 3,702           |         |
| National  Mentor Holdings, Inc.      |         | Service - home health care                                           |         | Senior Term Debt (4.8%, Due 6/2013) (3)       |         | 1,968        |         | 1,672           |         |
| Network  Solutions, LLC                   |         | Service - internet domain solutions                                  |         | Senior Term Debt (5.2%, Due 3/2014) (3)       |         | 9,196        |         | 7,355           |         |
| NPC  International Inc.                   |         | Service - Pizza Hut franchisee                                       |         | Senior Term Debt (4.7%, Due 5/2013) (3)       |         | 2,895        |         | 2,537           |         |
| Open  Solutions, Inc.                |         | Service - software outsourcing for financial  institutions           |         | Senior Term Debt (5.8%, Due 1/2014) (3)       |         | 2,678        |         | 2,196           |         |
| Ozburn-Hessey  Holding Co. LLC            |         | Service - third party logistics                                      |         | Senior Term Debt (6.3%, Due 8/2012) (3)       |         | 7,628        |         | 5,979           |         |
| Pinnacle  Foods Finance, LLC              |         | Manufacturing - branded food products                                |         | Senior Term Debt (7.4%, Due 4/2014) (3)       |         | 3,971        |         | 3,454           |         |
| PTS  Acquisition Corp.                    |         | Manufacturing - drug delivery and packaging  technologies            |         | Senior Term Debt (7.1%, Due 4/2014) (3)       |         | 6,948        |         | 5,697           |         |
| QTC  Acquisition, Inc.               |         | Service - outsourced disability evaluations                          |         | Senior Term Debt (5.4%, Due 11/2012) (3)      |         | 1,930        |         | 1,638           |         |
| Radio  Systems Corporation                |         | Service - design electronic pet containment  products                |         | Senior Term Debt (5.5%, Due 9/2013) (3)       |         | 1,966        |         | 1,807           |         |
|                                           |              |                                                                      |              |                                               |              |              |              |                 |              |  |  |

 

8

----

Table of Contents

 
| Rally  Parts, Inc.                            |       | Manufacturing - aftermarket motorcycle parts and  accessories |     | Senior Term Debt (5.2%, Due 11/2013) (3)                       |       | 2,486    |        | 2,074      |     |
|----------------------------------------------------|------------|---------------------------------------------------------------|----------|----------------------------------------------------------------|------------|----------|-------------|------------|----------|
| RPG  Holdings, Inc.                           |       | Manufacturing and design - greeting cards                     |     | Senior Term Debt (8.8%, Due 12/2011) (3)                       |       | 4,553    |        | 3,869      |     |
| SafeNet, Inc.                                 |       | Service - chip encryption products                            |     | Senior Term Debt (7.1%, Due 4/2014) (3)                        |       | 2,980    |        | 2,382      |     |
| SGS  International, Inc.                      |       | Service - digital imaging and graphics                        |     | Senior Term Debt (6.9%, Due 12/2011) (3)                       |       | 1,594    |        | 1,430      |     |
| Stolle  Machinery Company                          |       | Manufacturing - can-making equipment and parts                |     | Senior Term Debt (7.8%, Due 9/2012) (3)                        |       | 494      |        | 458        |     |
| Survey  Sampling, LLC                              |       | Service - telecommunications-based sampling                   |     | Senior Term Debt (5.2%, Due 5/2011) (3), (5)                   |       | 2,931    |        | 2,527      |     |
| Synagro  Technologies, Inc.                   |       | Service - waste treatment and recycling                       |     | Senior Term Debt (5.1%, Due 3/2014) (3)                        |       | 498      |        | 422        |     |
| Triad  Laboratory Alliance, LLC                    |       | Service - regional medical laboratories                       |     | Senior Term Debt (5.9%, Due 12/2011) (3), (5)                  |       | 4,900    |        | 4,154      |     |
| United  Surgical Partners International, Inc. |       | Service - outpatient surgical provider                        |     | Senior Term Debt (5.4%, Due 4/2014) (3)                        |       | 1,320    |        | 1,152      |     |
| Wastequip, Inc.                               |       | Service - process and transport waste materials               |     | Senior Term Debt (4.9%, Due 2/2013) (3)                        |       | 2,922    |        | 2,337      |     |
| WaveDivision  Holdings, LLC                        |       | Service - cable                                               |     | Senior Term Debt (6.7%, Due 6/2014) (3), (5)                   |       | 1,925    |        | 1,814      |     |
| West  Corporation                                  |       | Service - business process outsourcing                        |     | Senior Term Debt (5.3%, Due 10/2013) (3)                       |       | 3,357    |        | 2,929      |     |
| *Subtotal – Senior Syndicated Loans*          |       |                                                          |     |                                                           |       | $        | 154,647     |       | $        | 131,005 |   |
| * *                                           | * *   | * *                                                      | * * | * *                                                       | * *   | * * | * *    | * *   | * * |
| ***Non-Syndicated Loans***                         | * *   | * *                                                      | * * | * *                                                       | * *   | * * | * *    | * *   | * * |
| B-Dry,  LLC                                        |       | Service - basement waterproofer                               |     | Revolving Credit Facility, $-0- available (7.3%,  Due 10/2008) |       | 750      |        | 750        |     |
|                                               |       |                                                          |     | Senior Term Debt (10.0%, Due 5/2014)                           |       | 6,749    |        | 6,749      |     |
|                                               |       |                                                          |     | Senior Term Debt (10.0%, Due 5/2014)                           |       | 3,970    |        | 3,970      |     |
|                                               |       |                                                          |     | Common Stock Warrants (4)                                      |       | 300      |        | 265        |     |
|                                               |       |                                                          |     |                                                           |       | 11,769   |        | 11,734     |     |
| **Total Non-Control/Non-Affiliate Investments**    | ** ** | ** **                                                    | **$**    | **166,416**                                                    | ** ** | **$**    | **142,739** | ** ** |

 

9

----

Table of Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULES OF INVESTMENTS**

**AS OF MARCH 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**          | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                        | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| **CONTROL INVESTMENTS**       |       |                                                        |       |                                                           |       |       |        |            |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| A. Stucki Holding Corp.       |       | Manufacturing - railroad freight car  products              |       | Senior Term Debt (7.6%, Due 3/2012)                            |       | $          | 13,391      |            | $          | 13,391 |   |
|                          |       |                                                        |       | Senior Term Debt (9.8%, Due 3/2012) (6)                        |       | 11,000     |        | 11,000          |       |
|                          |       |                                                        |       | Senior Subordinated Term Debt (13%, Due  3/2014)               |       | 5,486      |        | 5,486           |       |
|                          |       |                                                        |       | Preferred Stock (4)                                            |       | 4,387      |        | 4,748           |       |
|                          |       |                                                        |       | Common Stock (4)                                               |       | 130        |        | 10,062          |       |
|                          |       |                                                        |       |                                                           |       | 34,394     |        | 44,687          |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| Acme Cryogenics, Inc.    |       | Manufacturing - manifolds and pipes for  industrial gasses  |       | Senior Subordinated Term Debt (11.5%, Due  3/2013)             |       | 14,500     |        | 14,500          |       |
|                          |       |                                                        |       | Redeemable Preferred Stock (4)                                 |       | 6,984      |        | 7,795           |       |
|                          |       |                                                        |       | Common Stock (4)                                               |       | 1,045      |        | 2,977           |       |
|                          |       |                                                        |       | Common Stock Warrants (4)                                      |       | 25         |        | 291             |       |
|                          |       |                                                        |       |                                                           |       | 22,554     |        | 25,563          |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| ASH Holdings Corp.            |       | Retail and Service - school buses and parts                 |       | Revolver, $1,250 available (non-accrual,  Due 3/2010)          |       | 750        |        | —          |       |
|                          |       |                                                        |       | Senior Subordinated Term Debt (non-accrual,  Due 1/2012)       |       | 5,250      |        | —          |       |
|                          |       |                                                        |       | Preferred Stock (4)                                            |       | 2,500      |        | —          |       |
|                          |       |                                                        |       | Common Stock Warrants (4)                                      |       | 4          |        | —          |       |
|                          |       |                                                        |       |                                                           |       | 8,504      |        | —          |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| Cavert II Holding Corp.       |       | Manufacturing - bailing wire                                |       | Revolving Credit Facility, $600 available  (8.0%, Due 10/2010) |       | 2,400      |        | 2,400           |       |
|                          |       |                                                        |       | Senior Term Debt (8.3%, Due 10/2012)                           |       | 6,337      |        | 6,337           |       |
|                          |       |                                                        |       | Senior Term Debt (10.0%, Due 10/2012) (6)                      |       | 3,000      |        | 3,000           |       |
|                          |       |                                                        |       | Senior Subordinated Term Debt (13%, Due  10/2014)              |       | 4,671      |        | 4,671           |       |
|                          |       |                                                        |       | Preferred Stock (4)                                            |       | 4,110      |        | 4,252           |       |
|                          |       |                                                        |       | Common Stock (4)                                               |       | 69         |        | 688             |       |
|                          |       |                                                        |       |                                                           |       | 20,587     |        | 21,348          |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| Chase II Holdings Corp.       |       | Manufacturing - traffic doors                               |       | Revolving Credit Facility, $220 available  (7.1%, Due 3/2008)  |       | 3,280      |        | 3,280           |       |
|                          |       |                                                        |       | Senior Term Debt (8.8%, Due 3/2011)                            |       | 9,900      |        | 9,900           |       |
|                          |       |                                                        |       | Senior Term Debt (12.0%, Due 3/2011) (6)                       |       | 7,840      |        | 7,840           |       |
|                          |       |                                                        |       | Senior Subordinated Term Debt (13.0%, Due  3/2013)             |       | 6,168      |        | 6,168           |       |
|                          |       |                                                        |       | Redeemable Preferred Stock (4)                                 |       | 6,961      |        | 8,455           |       |
|                          |       |                                                        |       | Common Stock (4)                                               |       | 61         |        | 3,508           |       |
|                          |       |                                                        |       |                                                           |       | 34,210     |        | 39,151          |       |
|                          |       |                                                        |       |                                                           |       |       |        |            |       |
| Quench Holdings Corp.         |       | Service - sales, installation and service  of water coolers |       | Revolving Credit Facility, $-0- available  (7.1%, Due 3/2009)  |       | 1,500      |        | 1,500           |       |
|                          |       |                                                        |       | Senior Term Debt (7.1%, Due 3/2011)                            |       | 4,250      |        | 4,250           |       |
|                          |       |                                                        |       | Senior Subordinated Term Debt (11.5%, Due  3/2011)             |       | 7,820      |        | 7,820           |       |
|                          |       |                                                        |       | Equipment Line Note (7)                                        |       | 1,088      |        | 1,088           |       |
|                          |       |                                                        |       | Preferred Stock (4)                                            |       | 3,000      |        | —          |       |
|                          |       |                                                        |       | Common Stock Warrants (4)                                      |       | 447        |        | —          |       |
|                          |       |                                                        |       |                                                           |       | 18,105     |        | 14,658          |       |
| ** **                    | ** ** | ** **                                                  | ** ** | ** **                                                     | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total Control Investments** | ** ** | ** **                                                  | ** ** | ** **                                                     | ** ** | **$**      | **138,354** | ** **      | **$**      | **145,407** | ** ** |

 

10

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULES OF INVESTMENTS**

**AS OF MARCH 31, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**            | ** ** | **Industry**                                             | ** ** | **Investment (2)**                                             | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
| ** **                      | ** ** | ** **                                               | ** ** | ** **                                                          | ** ** | ** ** | ** **  | ** **      | ** ** |
| **AFFILIATE INVESTMENTS**       |       |                                                     |       |                                                                |       |       |        |            |       |
|                            |       |                                                     |       |                                                                |       |       |        |            |       |
| Danco Acquisition Corp.         |       | Manufacturing - machining and sheet metal  work          |       | Revolving Credit Facility, $2,400 available  (9.3%, Due 10/2010)    |       | $          | 600         |            | $          | 600 |   |
|                            |       |                                                     |       | Senior Term Debt (9.3%, Due 10/2012)                                |       | 5,550      |        | 5,550           |       |
|                            |       |                                                     |       | Senior Term Debt (11.5%, Due 4/2013)                                |       | 8,578      |        | 8,578           |       |
|                            |       |                                                     |       | Redeemable Preferred Stock (4)                                      |       | 2,500      |        | 2,576           |       |
|                            |       |                                                     |       | Common Stock Warrants (4)                                           |       | 3          |        | 1,045           |       |
|                            |       |                                                     |       |                                                                |       | 17,231     |        | 18,349          |       |
|                            |       |                                                     |       |                                                                |       |       |        |            |       |
| Mathey Investments, Inc.   |       | Manufacturing - pipe-cutting and  pipe-fitting equipment |       | Revolving Credit Facility, $2,000 available  (9.0%, Due 3/2011) (8) |       | —     |        | —          |       |
|                            |       |                                                     |       | Senior Term Debt (9.0%, Due 3/2013) (8)                             |       | 2,500      |        | 2,500           |       |
|                            |       |                                                     |       | Senior Term Debt (12.0%, Due 3/2014) (8)                            |       | 7,300      |        | 7,300           |       |
|                            |       |                                                     |       | Common Stock (4), (8)                                               |       | 500        |        | 500             |       |
|                            |       |                                                     |       | Common Stock Warrants (4), (8)                                      |       | 277        |        | 277             |       |
|                            |       |                                                     |       |                                                                |       | 10,577     |        | 10,577          |       |
|                            |       |                                                     |       |                                                                |       |       |        |            |       |
| Noble Logistics, Inc.      |       | Service - aftermarket auto parts delivery                |       | Revolving Credit Facility, $100 available  (7.1%, Due 12/2009)      |       | 1,900      |        | 1,900           |       |
|                            |       |                                                     |       | Senior Term Debt (8.5%, Due 12/2011)                                |       | 6,077      |        | 6,077           |       |
|                            |       |                                                     |       | Senior Term Debt (10.5%, Due 3/2011) (6)                            |       | 7,000      |        | 7,000           |       |
|                            |       |                                                     |       | Preferred Stock (4)                                                 |       | 1,750      |        | 2,108           |       |
|                            |       |                                                     |       | Common Stock (4)                                                    |       | 1,500      |        | 1,447           |       |
|                            |       |                                                     |       |                                                                |       | 18,227     |        | 18,532          |       |
| **Total Affiliate Investments** |       |                                                     |       |                                                                | ** ** | **$**      | **46,035**  | ** **      | **$**      | **47,458** | ** ** |
|                            |       |                                                     | ** ** | ** **                                                          | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total Investments**           |       |                                                     |       |                                                                | ** ** | **$**      | **350,805** | ** **      | **$**      | **335,604** | ** ** |

 

----

| (1) | Certain  of the listed securities are issued by affiliate(s) of the indicated  portfolio company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Percentage  represents the weighted average interest rates in effect at March 31,  2008, and due date represents the contractual maturity date.                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3) | Marketable  securities, such as syndicated loans, are valued based on the indicative bid  price on or near March 31, 2008, offered by the respective syndication  agent’s trading desk, or secondary desk.                                                                                                                                                                                                                                                                                                                                                                               |
| (4) | Security  is non-income producing.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (5) | Fair  value based on opinions of value submitted by Standard & Poor’s  Securities Evaluations, Inc. at March 31, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (6) | Last  Out Tranche of senior debt, meaning if the portfolio company is liquidated  then the holder of the Last Out Tranche is paid after the senior debt.                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (7) | Total  available for future borrowing for the purposes of purchasing equipment is  $1,500. The undrawn amount of $411 may be drawn to purchase additional  equipment through 10/31/2010. The interest rate on all amounts drawn on the  equipment line note is 12% except for one draw of $188 whose interest rate is  15%. Each draw on the equipment line note is subject to its own amortization  and maturity, typically over a period of 20-24 months. At March 31,  2008, the last amortization payment due under current amounts drawn under the  equipment line note is 11/2009. |
| (8) | Valued  at cost due to recent acquisition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

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

 

11

----

Tableof Contents

 

**GLADSTONEINVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(DOLLAR AMOUNTS INTHOUSANDS, EXCEPT PER SHARE AMOUNTS)**

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months Ended December 31,** | ** ** | **Nine Months Ended   December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                           | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| INVESTMENT INCOME                                                                  |       |                                               |       |                                                |       |   |   |   |   |
| Interest income                                                                    |       |                                               |       |                                                |       |   |   |   |   |
| Non-Control/Non-Affiliate investments                                              |       | $                                                  | 2,339      |                                                | $          | 3,892 |   | $ | 6,797 |   | $ | 11,220 |   |
| Control investments                                                                |       | 3,068                                              |       | 2,866                                               |       | 8,372 |   | 8,043 |   |
| Affiliate investments                                                              |       | 1,478                                              |       | 700                                                 |       | 3,938 |   | 1,502 |   |
| Cash and cash equivalents                                                          |       | 21                                                 |       | 80                                                  |       | 67 |   | 194 |   |
| Total interest income                                                              |       | 6,906                                              |       | 7,538                                               |       | 19,174 |   | 20,959 |   |
| Other income                                                                       |       | 96                                                 |       | 6                                                   |       | 682 |   | 41 |   |
| Total investment income                                                            |       | 7,002                                              |       | 7,544                                               |       | 19,856 |   | 21,000 |   |
|                                                                               |       |                                               |       |                                                |       |   |   |   |   |
| EXPENSES                                                                           |       |                                               |       |                                                |       |   |   |   |   |
| Loan servicing fee (Refer to Note 4)                                               |       | 1,258                                              |       | 1,287                                               |       | 3,769 |   | 3,741 |   |
| Base management fee (Refer to Note 4)                                              |       | 442                                                |       | 498                                                 |       | 1,303 |   | 1,310 |   |
| Administration fee (Refer to Note 4)                                               |       | 195                                                |       | 211                                                 |       | 642 |   | 647 |   |
| Interest expense                                                                   |       | 1,823                                              |       | 2,381                                               |       | 4,009 |   | 5,819 |   |
| Amortization of deferred finance costs                                             |       | 46                                                 |       | 169                                                 |       | 324 |   | 595 |   |
| Professional fees                                                                  |       | 69                                                 |       | 90                                                  |       | 383 |   | 356 |   |
| Stockholder related costs                                                          |       | 112                                                |       | 25                                                  |       | 413 |   | 220 |   |
| Insurance expense                                                                  |       | 57                                                 |       | 47                                                  |       | 165 |   | 183 |   |
| Directors fees                                                                     |       | 50                                                 |       | 55                                                  |       | 145 |   | 177 |   |
| Taxes and licenses                                                                 |       | 16                                                 |       | 42                                                  |       | 83 |   | 125 |   |
| General and administrative expenses                                                |       | 41                                                 |       | 39                                                  |       | 163 |   | 130 |   |
| Expenses before credit from Adviser                                                |       | 4,109                                              |       | 4,844                                               |       | 11,399 |   | 13,303 |   |
| Credits to base management fee (Refer to  Note 4)                                  |       | (694                                               | )          | (1,046                                              | )          | (1,964 | ) | (1,932 | ) |
| Total expenses net of credit to base  management fee                               |       | 3,415                                              |       | 3,798                                               |       | 9,435 |   | 11,371 |   |
| NET INVESTMENT INCOME                                                              |       | 3,587                                              |       | 3,746                                               |       | 10,421 |   | 9,629 |   |
|                                                                               |       |                                               |       |                                                |       |   |   |   |   |
| REALIZED AND UNREALIZED (LOSS) GAIN ON  INVESTMENTS AND DERIVATIVE                 |       |                                               |       |                                                |       |   |   |   |   |
| Realized loss on sale of  Non-Control/Non-Affiliate investments                    |       | —                                             |       | (146                                                | )          | (4,215 | ) | (198 | ) |
| Net unrealized depreciation of  Non-Control/Non-Affiliate investments              |       | (6,988                                             | )          | (2,835                                              | )          | (7,714 | ) | (10,672 | ) |
| Net unrealized appreciation of Control  investments                                |       | 1,755                                              |       | 4,487                                               |       | 7,728 |   | 9,942 |   |
| Net unrealized (depreciation) appreciation  of Affiliate investments               |       | (2,294                                             | )          | (148                                                | )          | (13,687 | ) | 306 |   |
| Net unrealized appreciation of derivative                                          |       | —                                             |       | 5                                                   |       | — |   | 5 |   |
| Net (loss) gain on investments                                                     |       | (7,527                                             | )          | 1,363                                               |       | (17,888 | ) | (617 | ) |
|                                                                               |       |                                               |       |                                                |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS  RESULTING FROM OPERATIONS                   |       | $                                                  | (3,940     | )                                                   | $          | 5,109 |   | $ | (7,467 | ) | $ | 9,012 |   |
|                                                                               |       |                                               |       |                                                |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS  RESULTING FROM OPERATIONS PER COMMON SHARE: |       |                                               |       |                                                |       |   |   |   |   |
| Basic and Diluted                                                                  |       | $                                                  | (0.18      | )                                                   | $          | 0.31 |   | $ | (0.35 | ) | $ | 0.54 |   |
|                                                                               |       |                                               |       |                                                |       |   |   |   |   |
| SHARES OF COMMON STOCK OUTSTANDING:                                                |       |                                               |       |                                                |       |   |   |   |   |
| Basic and diluted weighted average shares                                          |       | 22,080,133                                         |       | 16,560,100                                          |       | 21,367,871 |   | 16,560,100 |   |

 

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

 

12

----

Tableof Contents

 

**GLADSTONEINVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                   | ** ** | **Nine Months Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Operations:                                                  |       |                                                   |       |   |   |
| Net investment income                                        |       | $                                                      | 10,421     |   | $ | 9,629 |   |
| Realized loss on sale of investments                         |       | (4,215                                                 | )          | (198 | ) |
| Net unrealized depreciation of portfolio                     |       | (13,673                                                | )          | (424 | ) |
| Unrealized appreciation of derivative                        |       | —                                                 |       | 5 |   |
| Net (decrease) increase in net assets from  operations       |       | (7,467                                                 | )          | 9,012 |   |
|                                                         |       |                                                   |       |   |   |
| Capital transactions:                                        |       |                                                   |       |   |   |
| Issuance of common stock                                     |       | 41,290                                                 |       | — |   |
| Shelf offering registration costs                            |       | (695                                                   | )          | (32 | ) |
| Distributions to stockholders                                |       | (15,456                                                | )          | (11,426 | ) |
| Increase (decrease) in net assets from  capital transactions |       | 25,139                                                 |       | (11,458 | ) |
|                                                         |       |                                                   |       |   |   |
| Total increase (decrease) in net assets                      |       | 17,672                                                 |       | (2,446 | ) |
|                                                         |       |                                                   |       |   |   |
| Net Assets                                                   |       |                                                   |       |   |   |
| Beginning of period                                          |       | 206,445                                                |       | 222,819 |   |
| End of period                                                |       | $                                                      | 224,117    |   | $ | 220,373 |   |

 

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

 

13

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                                                                                         | ** ** | **Nine Months Ended December31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                           |       |                                             |       |   |   |
| Net (decrease) increase in net assets  resulting from operations                                                                                   |       | $                                                | (7,467     | ) | $ | 9,012 |   |
| Adjustments to reconcile net (decrease)  increase in net assets resulting from operations to net cash provided by  (used in) operating activities: |       |                                             |       |   |   |
| Purchase of investments                                                                                                                            |       | (47,655                                          | )          | (157,335 | ) |
| Principal repayments of investments                                                                                                                |       | 26,753                                           |       | 59,723 |   |
| Proceeds from the sale of investments                                                                                                              |       | 13,296                                           |       | 15,697 |   |
| Net unrealized depreciation of investment  portfolio                                                                                               |       | 13,673                                           |       | 424 |   |
| Net unrealized appreciation of derivative                                                                                                          |       | —                                           |       | (5 | ) |
| Net realized loss on sales of investments                                                                                                          |       | 4,215                                            |       | 198 |   |
| Net amortization of premiums and discounts                                                                                                         |       | 27                                               |       | 209 |   |
| Amortization of deferred finance costs                                                                                                             |       | 324                                              |       | 596 |   |
| Decrease (increase) in interest receivable                                                                                                         |       | 46                                               |       | (660 | ) |
| Decrease in due from custodian                                                                                                                     |       | 1,969                                            |       | 9,282 |   |
| Increase in prepaid insurance                                                                                                                      |       | (63                                              | )          | (255 | ) |
| Decrease (increase) in other assets                                                                                                                |       | 295                                              |       | (150 | ) |
| Increase (decrease) in other liabilities                                                                                                           |       | 50                                               |       | (14 | ) |
| (Decrease) increase in administration fee  payable to Administrator (See Note 4)                                                                   |       | (13                                              | )          | 49 |   |
| Increase (decrease) in base management fee  payable to Adviser (See Note 4)                                                                        |       | 137                                              |       | (244 | ) |
| Increase in loan servicing fee payable to  Adviser (See Note 4)                                                                                    |       | 7                                                |       | 11 |   |
| Increase in accrued expenses                                                                                                                       |       | 1                                                |       | 387 |   |
| Net cash provided by (used in) operating  activities                                                                                               |       | 5,595                                            |       | (63,075 | ) |
|                                                                                                                                               |       |                                             |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                                                                           |       |                                             |       |   |   |
| Net proceeds from the issuance of common  stock                                                                                                    |       | 40,595                                           |       | (32 | ) |
| Borrowings from line of credit                                                                                                                     |       | 133,000                                          |       | 196,350 |   |
| Repayments of line of credit                                                                                                                       |       | (159,971                                         | )          | (145,887 | ) |
| Deferred finance costs                                                                                                                             |       | —                                           |       | (430 | ) |
| Distributions paid                                                                                                                                 |       | (15,456                                          | )          | (11,426 | ) |
| Net cash (used in) provided by financing  activities                                                                                               |       | (1,832                                           | )          | 38,575 |   |
|                                                                                                                                               |       |                                             |       |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                                                                                          |       | 3,763                                            |       | (24,500 | ) |
|                                                                                                                                               |       |                                             |       |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD**                                                                                                |       | 9,360                                            |       | 37,789 |   |
|                                                                                                                                               |       |                                             |       |   |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                                                                                       |       | $                                                | 13,123     |   | $ | 13,289 |   |

 

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

 

14

----

Tableof Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**CONDENSEDCONSOLIDATED FINANCIAL HIGHLIGHTS**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)**

**(UNAUDITED)**

 
| ** **                                                             | ** ** | **Three Months Ended December 31,** | ** ** | **Nine Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2008**                                                | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Per Share Data (1)                                                     |       |                                                    |       |                                                   |       |   |   |   |   |
| Balance at beginning of period                                         |       | $                                                       | 10.57      |                                                   | $          | 13.24 |   | $ | 12.47 |   | $ | 13.46 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| *Income from investment operations:*                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Net investment income (2)                                              |       | 0.16                                                    |       | 0.23                                                   |       | 0.49 |   | 0.58 |   |
| Realized loss on sale of investments (2)                               |       | —                                                  |       | (0.01                                                  | )          | (0.20 | ) | (0.01 | ) |
| Net unrealized (depreciation) appreciation  of investments (2)         |       | (0.34                                                   | )          | 0.09                                                   |       | (0.64 | ) | (0.03 | ) |
| Total from investment operations                                       |       | (0.18                                                   | )          | 0.31                                                   |       | (0.35 | ) | 0.54 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| *Distributions to stockholders:*                                       |       |                                                    |       |                                                   |       |   |   |   |   |
| Net investment income                                                  |       | (0.24                                                   | )          | (0.24                                                  | )          | (0.72 | ) | (0.69 | ) |
| Total distributions (3)                                                |       | (0.24                                                   | )          | (0.24                                                  | )          | (0.72 | ) | (0.69 | ) |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Rights offering costs                                                  |       | —                                                  |       | —                                                 |       | (0.03 | ) | — |   |
| Effect of distribution of stock rights  offering after record date (4) |       | —                                                  |       | —                                                 |       | (1.22 | ) | — |   |
| Net asset value at end of period                                       |       | $                                                       | 10.15      |                                                   | 13.31      |   | $ | 10.15 |   | $ | 13.31 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Per share market value at beginning of  period                         |       | $                                                       | 6.81       |                                                   | $          | 12.84 |   | $ | 9.32 |   | $ | 14.87 |   |
| Per share market value at end of period                                |       | $                                                       | 4.91       |                                                   | $          | 9.81 |   | $ | 4.91 |   | $ | 9.81 |   |
| Total return (5)                                                       |       | (19.59                                                  | )%         | (21.93                                                 | )%         | (41.23 | )% | (30.31 | )% |
| Shares outstanding at end of period                                    |       | 22,080,133                                              |       | 16,560,100                                             |       | 22,080,133 |   | 16,560,100 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Statement of Assets and Liabilities Data:                              |       |                                                    |       |                                                   |       |   |   |   |   |
| Net assets at end of period                                            |       | $                                                       | 224,117    |                                                   | $          | 220,373 |   | $ | 224,117 |   | $ | 220,373 |   |
| Average net assets (6)                                                 |       | $                                                       | 229,256    |                                                   | $          | 218,176 |   | $ | 232,053 |   | $ | 221,453 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Senior Securities Data:                                                |       |                                                    |       |                                                   |       |   |   |   |   |
| Borrowings under line of credit                                        |       | $                                                       | 117,864    |                                                   | $          | 150,463 |   | $ | 117,864 |   | $ | 150,463 |   |
| Asset coverage ratio (7) (8)                                      |       | 290                                                     | %          | 246                                                    | %          | 290 | % | 246 | % |
| Asset coverage per unit (8)                                            |       | $                                                       | 2,901      |                                                   | $          | 2,465 |   | $ | 2,901 |   | $ | 2,465 |   |
|                                                                   |       |                                                    |       |                                                   |       |   |   |   |   |
| Ratios/Supplemental Data:                                              |       |                                                    |       |                                                   |       |   |   |   |   |
| Ratio of expenses to average net assets (9) (10)                       |       | 7.17                                                    | %          | 8.88                                                   | %          | 6.55 | % | 8.01 | % |
| Ratio of net expenses to average net assets  (9) (11)                  |       | 5.96                                                    | %          | 6.96                                                   | %          | 5.42 | % | 6.85 | % |
| Ratio of net investment income to average  net assets (9)              |       | 6.26                                                    | %          | 6.87                                                   | %          | 5.99 | % | 5.80 | % |

 

----

| (1)  |   | Based  on actual shares outstanding at the end of the corresponding period.                                                                                                                                                                                                                                                                                                                                                                   |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Based  on weighted average basic per share data.                                                                                                                                                                                                                                                                                                                                                                                              |
| (3)  |   | Distributions  are determined based on taxable income calculated in accordance with income  tax regulations which may differ from amounts determined under accounting  principles generally accepted in the United States of America.                                                                                                                                                                                                         |
| (4)  |   | The  effect of distributions from the stock rights offering after the record date  represents the effect on net asset value of issuing additional shares after  the record date of a distribution.                                                                                                                                                                                                                                            |
| (5)  |   | Total return equals the change in the  market value of the Company’s common stock from the beginning of the period  taking into account distributions reinvested in accordance with the terms of  our dividend reinvestment plan. Total return does not take into account distributions that may  be characterized as a return of capital. For further information on estimated  character of our distributions, please refer to Note 9. |
| (6)  |   | Calculated  using the average of the ending monthly net assets for the respective  periods.                                                                                                                                                                                                                                                                                                                                                   |
| (7)  |   | As  a business development company, the Company is generally required to maintain  a ratio of at least 200% of total assets to total borrowings.                                                                                                                                                                                                                                                                                              |
| (8)  |   | Asset  coverage ratio is the ratio of the carrying value of the Company’s total  consolidated assets, less all liabilities and indebtedness not represented by  senior securities, to the aggregate amount of senior securities representing  indebtedness. Asset coverage per unit is expressed in terms of dollar amounts  per $1,000 of indebtedness.                                                                                 |
| (9)  |   | Amounts  are annualized.                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (10) |   | Ratio  of expenses to average net assets is computed using expenses before credit  from the Adviser.                                                                                                                                                                                                                                                                                                                                          |
| (11) |   | Ratio  of net expenses to average net assets is computed using total expenses net of  credits to the management fee.                                                                                                                                                                                                                                                                                                                          |

 

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

 

15

----

Table of Contents

 

**GLADSTONE INVESTMENT CORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISE INDICATED)**

**DECEMBER 31, 2008**

**(UNAUDITED)**

 

**NOTE 1. ORGANIZATION**

 

GladstoneInvestment Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Delaware on February 18, 2005, andcompleted an initial public offering on June 22, 2005. The Company is aclosed-end, non-diversified management investment company that has elected tobe treated as a business development company under the Investment Company Actof 1940, as amended (the “1940 Act”). In addition, the Company has elected tobe treated for tax purposes as a regulated investment company (“RIC”) under theInternal Revenue Code of 1986, as amended (the “Code”). The Company’sinvestment objectives are to achieve a high level of current income and capitalgains by investing in debt and equity securities of established private businesses.

 

GladstoneBusiness Investment, LLC (“Business Investment”) a wholly-owned subsidiaryof the Company, was established on August 11, 2006, for the sole purposeof owning the Company’s portfolio of investments in connection with theestablishment of its line of credit facility with Deutsche Bank AG. Thefinancial statements of Business Investment are consolidated with those of theCompany.

 

TheCompany is externally managed by Gladstone Management Corporation (the “Adviser”),an unconsolidated affiliate of the Company.

 

**NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

*Unaudited Interim Financial Statements*

 

Interimfinancial statements of the Company are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and pursuant to the requirements for reporting onForm 10-Q and Article 10 of Regulation S-X. Accordingly, certaindisclosures accompanying annual financial statements prepared in accordancewith GAAP are omitted. In the opinion of management, all adjustments,consisting solely of normal recurring accruals, necessary for the fairstatement of financial statements for the interim periods have been included.The current period’s results of operations are not necessarily indicative ofresults that ultimately may be achieved for the year. The interim financialstatements and notes thereto should be read in conjunction with the financialstatements and notes thereto included in the Company’s Form 10-K for thefiscal year ended March 31, 2008, as filed with the Securities andExchange Commission (“SEC”) on May 21, 2008.

 

Theyear-end condensed consolidated balance sheet data was derived from auditedfinancial statements, but does not include all of the disclosures required byGAAP.

 

*Reclassifications*

 

Certain amounts in the prior year’s financialstatements have been reclassified to conform to the current year presentationwith no effect to net (decrease) increase in net assets resulting fromoperations.

 

16

----

Tableof Contents

 

*InvestmentValuation Policy*

 

The Company carries its investments at market value to the extent thatmarket quotations are readily available and reliable, and otherwise at fairvalue, as determined in good faith by its Board of Directors.  In determining the fair value of the Company’sinvestments, the Adviser has established an investment valuation policy (the “Policy”).  The Policy is approved by the Company’s Boardof Directors and each quarter the Board of Directors reviews whether theAdviser has applied the Policy consistently, and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

 

The Company uses generally accepted valuation techniques to value itsportfolio unless the Company has specific information about the value of aninvestment to determine otherwise. From time to time the Company may accept anappraisal of a business in which the Company holds securities. These appraisalsare expensive and occur infrequently but provide a third party valuationopinion that may differ in results, techniques and scopes used to value theCompany’s investments.  When thesespecific third party appraisals are engaged or accepted, the Company would usesuch appraisals to value the investment the Company has in that business if itwas determined that the appraisals were the best estimate of fair value.

 

The Policy, which is summarized below, applies to publicly-tradedsecurities, securities for which a limited market exists, and securities forwhich no market exists.

 

**Publicly-traded securities:** The Companydetermines the value of publicly-traded securities based on the closing pricefor the security on the exchange or securities market on which it is listed andprimarily traded on the valuation date. To the extent that the Company owns restricted securities that are notfreely tradable, but for which a public market otherwise exists, the Companywill use the market value of that security adjusted for any decrease in valueresulting from the restrictive feature.

 

**Securities for which a limited market exists:**TheCompany values securities that are not traded on an established secondarysecurities market, but for which a limited market for the security exists, suchas certain participations in, or assignments of, syndicated loans, at thequoted price.  In valuing these assets,the Company assesses trading activity in an asset class, evaluates variances inprices and other market insights to determine if any available quote prices arereliable.  If the Company concludes thatquotes based on active markets or trading activity may be relied upon, firm bidprices are requested; however, if a firm bid price is unavailable, the Companybases the value of the security upon the indicative bid price offered by therespective originating syndication agent’s trading desk, or secondary desk, onor near the valuation date. To the extent that the Company uses the indicativebid price as a basis for valuing the security, the Adviser may take furthersteps to consider additional information to validate that price in accordancewith the Policy.

 

In the event these limited markets become illiquid such that marketprices are no longer readily available, the Company will value its syndicatedloans using estimated net present values of the future cash flows or discountedcash flows (“DCF”). The use of a DCF methodology follows that prescribed byFASB Staff Position No. 157-3, “*Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive”* (“FSP No. 157-3”), which provides guidance on the useof a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in the FSP No. 157-3 is the use ofvaluing investments based on DCF.  Forthe purposes of using DCF to provide fair value estimates, the Companyconsidered multiple inputs such as a risk-adjusted discount rate thatincorporates adjustments that market participants would make both fornonperformance and liquidity risks.  Assuch, the Company developed a modified discount rate approach that incorporatesrisk premiums including, among others, increased probability of default, orhigher loss given default, or increased liquidity risk.

 

The DCF valuations applied to the syndicatedloans provide an estimate of what the Company believes a market participantwould pay to purchase a syndicated loan in an active market, therebyestablishing a fair value.  The Companywill continue to apply the DCF methodology in illiquid markets until quotedprices based on trading activity are deemed reliable.

 

**Securities for which no market exists:** Thevaluation methodology for securities for which no market exists falls intothree categories: (1) portfolio investments comprised solely of debtsecurities; (2) portfolio investments in controlled companies comprised ofa bundle of securities, which can include debt and equity securities; and (3) portfolioinvestments in non-controlled companies comprised of a bundle of securities,which can include debt and/or equity securities.

 

**(1)****         Portfolio investmentscomprised solely of debt securities:** Debt securities that are not publiclytraded on an established securities market, or for which a limited market doesnot exist (“Non-Public Debt Securities”), and that are issued by 

 

17

----

Tableof Contents

 

portfolio companies where the Company has noequity, or equity-like securities, are fair valued in accordance with the termsof the Policy, which utilizes opinions of value submitted to the Company byStandard & Poor’s Securities Evaluations, Inc. (“SPSE”). TheCompany may also submit Paid in Kind (“PIK”) interest to SPSE for theirevaluation when it is determined the PIK interest is likely to be received.

 

**(2)****         Portfolio investments incontrolled companies comprised of a bundle of investments, which can includedebt and equity securities:** The Company values Non-Public Debt Securitiesand equity or equity-like securities (e.g. preferred equity, equity, or otherequity-like securities) that are purchased together as part of a package, wherewe have control or could gain control through an option or warrant security,both the debt and equity securities of the portfolio investment would exit inthe mergers and acquisition market as the principal market, generally through asale or recapitalization of the portfolio company.

 

**(3)****         Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and/or equity securities:**The Company values Non-Public DebtSecurities and equity or equity-like securities that are purchased togetherfrom the same “non-controlled” portfolio company, or issuer, by valuing thedebt portion with SPSE (as described above) and valuing the equity portionbased principally on the total enterprise value of the issuer, which iscalculated using a liquidity waterfall approach.

 

Due to the uncertainty inherent in the valuation process, suchestimates of fair value may differ significantly from the values that wouldhave been obtained had a ready market for the securities existed, and thedifferences could be material. Additionally, changes in the market environmentand other events that may occur over the life of the investments may cause thegains or losses ultimately realized on these investments to be different thanthe valuations currently assigned. There is no single standard for determiningfair value in good faith, as fair value depends upon circumstances of each individualcase. In general, fair value is the amount that the Company might reasonablyexpect to receive upon the current sale of the security in an arms-lengthtransaction in the security’s principal market.

 

*Interest and Dividend Income Recognition*

 

Interestincome, adjusted for amortization of premiums and acquisition costs and for theaccretion of discounts, is recorded on the accrual basis to the extent thatsuch amounts are expected to be collected. The Company stops accruing intereston its investments when it is determined that interest is no longercollectible. At December 31, 2008, one Non-Control/Non-Affiliateinvestment was on non-accrual with a cost basis of approximately$4.6 million and one Control investment was on non-accrual with a costbasis of approximately $6.9 million, or an aggregate of 3.7% of the cost basisof all loans in our portfolio. At March 31, 2008, oneNon-Control/Non-Affiliate investment was on non-accrual with a cost basis ofapproximately $2.9 million and one Control investment was on non-accrualwith a cost basis of approximately $6.0 million, or an aggregate of 2.8% of thecost basis of all loans in our portfolio. Conditional interest, or a successfee, is recorded upon full repayment of a loan investment. To date, the Companyhas not recorded any conditional interest. Dividend income on preferred equitysecurities is accrued to the extent that such amounts are expected to becollected and that the Company has the option to collect such amounts in cash.To date, the Company has not accrued any dividend income.

 

*ServicesProvided to Portfolio Companies*

 

Asa business development company under the 1940 Act, the Company is required tomake available significant managerial assistance to its portfolio companies.The Company provides these services through its Adviser, who provides theseservices on the Company’s behalf through its officers, who are also the Company’sofficers. Currently, neither the Company nor its Adviser charges a fee formanagerial assistance; however, if the Adviser does receive fees for suchmanagerial assistance, it will credit the managerial assistance fees to thebase management fee due from the Company to its Adviser.

 

TheAdviser receives fees for the other services it provides to the Company’sportfolio companies. These other fees are typically non-recurring, arerecognized as revenue when earned and are generally paid directly to theAdviser by the borrower or potential borrower upon the closing of theinvestment. The services the Adviser provides to the Company’s portfoliocompanies vary by investment, but generally include a broad array of servicessuch as investment banking services, arranging bank and equity financing,structuring financing from multiple lenders and investors, reviewing existingcredit facilities, restructuring existing investments, raising equity and debtcapital, turnaround management, merger and acquisition services and recruitingnew management personnel. When the Adviser receives fees for these services,50% of certain of those fees are voluntarily credited against the basemanagement fee that the Company pays to its Adviser. Any services of thisnature subsequent to the closing would typically generate a separate fee at thetime of completion.

 

18

----

Tableof Contents

 

TheAdviser also receives fees for monitoring and reviewing portfolio companyinvestments. These fees are recurring and are generally paid annually or quarterlyin advance to the Adviser throughout the life of the investment. Fees of thisnature are recorded as revenue by the Adviser when earned and are not creditedagainst the base management fee.

 

TheCompany may receive fees for the origination and closing services the Companyprovides to portfolio companies through the Adviser. These fees are paiddirectly to the Company and are recognized as revenue upon closing of theoriginated investment and are reported as fee income in the consolidatedstatements of operations.

 

*RecentAccounting Pronouncements*

 

In October 2008, the Financial Accounting Standards Board issuedFASB Staff Position (“FSP”) No. 157-3, *Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive (“FSP 157-3”)*.  FSP157-3 clarifies the application of SFAS 157 (defined below)  in a market that is not active. Morespecifically, FSP 157-3 states that significant judgment should be applied todetermine if observable data in a dislocated market represents forcedliquidations or distressed sales and are not representative of fair value in anorderly transaction.  FSP 157-3 alsoprovides further guidance that the use of a reporting entity’s own assumptionsabout future cash flows and appropriately risk-adjusted discount rates isacceptable when relevant observable inputs are not available.  In addition, FSP 157-3 provides guidance onthe level of reliance of broker quotes or pricing services when measuring fairvalue in a non active market stating that less reliance should be placed on aquote that does not reflect actual market transactions and a quote that is nota binding offer.  The guidance in FSP157-3 is effective upon issuance for all financial statements that have notbeen issued and any changes in valuation techniques as a result of applying FSP157-3 are accounted for as a change in accounting estimate. The Company adoptedthis pronouncement during the quarter ended December 31, 2008.

 

InMarch 2008, the FASB issued SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities* (“SFAS 161”),which is intended to help investors better understand how derivativeinstruments and hedging activities affect an entity’s financial position,financial performance and cash flows through enhanced disclosure requirements.The enhanced disclosures include disclosing the objectives and strategies forusing derivative instruments by their underlying risk as well as a tabularformat of the fair values of the derivative instruments and their gains andlosses. SFAS 161 is effective for financial statements issued for fiscal yearsand interim periods beginning after November 15, 2008. The Company doesnot believe the adoption of this pronouncement will have a material impact onthe reporting of its derivatives.

 

InDecember 2007, the FASB issued SFAS No. 141(R), *Business Combinations* (“SFAS 141(R)”).SFAS 141(R) establishes principles and requirements for how anacquirer recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, any noncontrolling interest in theacquiree and the goodwill acquired. SFAS 141(R) also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. SFAS 141(R) is effective forfiscal years beginning after December 15, 2008. TheCompany is currently evaluating the impact of this pronouncement on itsconsolidated financial statements.

 

**NOTE 3. INVESTMENTS**

 

InSeptember 2006, the FASB issued *Statementof Financial Accounting Standards No. 157—Fair Value Measurements*(“SFAS 157”), which, for financial assets, is effective for fiscal yearsbeginning after November 15, 2007, with early adoption permitted. TheCompany adopted SFAS 157 on April 1, 2008. In part, SFAS 157 defines fairvalue, establishes a framework for measuring fair value, and expandsdisclosures about assets and liabilities measured at fair value. The newstandard provides a consistent definition of fair value that focuses on exitprice in the principal, or most advantageous, market and prioritizes, within ameasurement of fair value, the use of market-based inputs over entity-specificinputs. The standard also establishes the following three-level hierarchy forfair value measurements based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date.

 

·                 *Level 1*— inputs to the valuation methodology are quoted prices(unadjusted) for identical assets or liabilities in active markets;

 

·                 *Level 2*— inputs to the valuation methodology include quoted prices for similarassets and liabilities in active markets, and inputs that are observable forthe asset or liability, either directly or indirectly, for substantially thefull term of the financial instrument. Level 2 inputs are in those markets forwhich there are few transactions, the prices are not current, little publicinformation exists or instances where prices vary substantially over time oramong brokered market makers; and

 

19

----

Tableof Contents

 

·                 *Level 3*— inputs to the valuation methodology are unobservable and significantto the fair value measurement. Unobservable inputs are those inputs thatreflect the Company’s own assumptions that market participants would use toprice the asset or liability based upon the best available information.

 

At December 31, 2008, all of the Company’s assets were valuedusing Level 3 inputs.

 

Thefollowing table presents the financial instruments carried at fair value as of December 31,2008, by caption on the accompanying condensed consolidated statements ofassets and liabilities for each of the three levels of hierarchy established bySFAS 157:

 
| ** **                            | ** ** | **As of December 31, 2008** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                            | ** ** | **Level 1**                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Non-Control/Non-Affiliate investments |       | $                                               | —     |   | $ | — |   | $ | 107,208 |   | $ | 107,208 |   |
| Control investments                   |       | —                                          |       | — |   | 167,175 |   | 167,175 |   |
| Affiliate investments                 |       | —                                          |       | — |   | 50,912 |   | 50,912 |   |
| Total investments at fair value       |       | $                                               | —     |   | $ | — |   | $ | 325,295 |   | $ | 325,295 |   |

 

*Changes in Level 3 Fair Value Measurements*

 

Thefollowing table provides a roll-forward in the changes in fair value during thenine-month period from March 31, 2008 to December 31, 2008, and forthe three-month period from September 30, 2008 through December 31,2008 for all investments for which the Company determines fair value usingunobservable (Level 3) factors. When a determination is made to classify afinancial instrument within Level 3 of the valuation hierarchy, thedetermination is based upon the significance of the unobservable factors to theoverall fair value measurement. However, Level 3 financial instrumentstypically include, in addition to the unobservable or Level 3 components,observable components (that is, components that are actively quoted and can bevalidated to external sources). Accordingly, the gains and losses in the tablebelow include changes in fair value due in part to observable factors that arepart of the valuation methodology.

 

**Fair value measurements using unobservabledata inputs (Level 3)**

 
| ** **                                         | ** ** | **Non-Control/**  | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|-----------------|------------|-----------------|------------|------------|------------|
| ** **                                         | ** ** | **Non-Affiliate** | ** ** | **Control**     | ** ** | **Affiliate**   | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Investments**   | ** ** | **Investments** | ** ** | **Investments** | ** ** | **Total**  | ** ** |
| **Nine months ended December 31, 2008:**      |       |              |       |            |       |            |       |       |       |
| Fair value at March 31, 2008                  |       | $                 | 142,739    |            | $          | 145,407         |       | $          | 47,458     |   | $ | 335,604 |   |
| Total realized/unrealized (losses) gains  (a)      |       | (11,929           | )          | 7,728           |       | (13,687         | )          | (17,888    | )          |
| New investments, repayments, and  settlements, net |       | (23,602           | )          | 14,040          |       | 17,141          |       | 7,579      |       |
| Transfers in (out) of Level 3                      |       | —            |       | —          |       | —          |       | —     |       |
| Fair value as of December 31, 2008            |       | $                 | 107,208    |            | $          | 167,175         |       | $          | 50,912     |   | $ | 325,295 |   |
|                                               |       |              |       |            |       |            |       |       |       |
| **Three months ended December 31, 2008:**     |       |              |       |            |       |            |       |       |       |
| Fair value at September 30, 2008              |       | $                 | 115,133    |            | $          | 157,246         |       | $          | 53,877     |   | $ | 326,256 |   |
| Total realized/unrealized (losses) gains  (a)      |       | (6,988            | )          | 1,755           |       | (2,294          | )          | (7,527     | )          |
| New investments, repayments, and  settlements, net |       | (937              | )          | 8,174           |       | (671            | )          | 6,566      |       |
| Transfers in (out) of Level 3                      |       | —            |       | —          |       | —          |       | —     |       |
| Fair value as of December 31, 2008            |       | $                 | 107,208    |            | $          | 167,175         |       | $          | 50,912     |   | $ | 325,295 |   |

 

----

(a) Realized/unrealizedgains and losses are reported on the accompanying condensed consolidatedstatements of operations for the three and nine months ended December 31,2008.

 

*Non-Control and Non-Affiliate Investments*

 

At December 31, 2008 and March 31, 2008, the Company heldinvestments in Non-Control/Non-Affiliates of approximately $107.2 millionand $142.7 million, at fair value, respectively. These investments werecomprised primarily of syndicated loan participations of senior notes ofprivate companies and also non-syndicated loan investments where the Companydoes not have a significant ownership interest in the portfolio company.Included in Non-Control/Non-Affiliate investments, at both December 31,2008 and March 31, 2008, the Company also held common stock warrants ofone Non-Control/Non-Affiliate company, which carried fair values of $-0- and$265, respectively. At December 31, 2008 and March 31, 2008, theCompany’s investments, at fair value, in Non-Control/Non-Affiliates representedapproximately 48% and 69%, respectively, of the Company’s net assets.

 

20

----

Table of Contents

 

*Control and Affiliate Investments*

 

At December 31, 2008 and March 31, 2008, the Company hadinvestments in Control and Affiliates, at fair value, of approximately $156.5million and $142.2 million, respectively, in revolving credit facilities,senior debt and subordinated debt. In addition, at December 31, 2008 and March 31,2008, the Company held, at fair value, approximately $61.6 million and$50.7 million, respectively, in preferred and common equity of thosecompanies.

 

At December 31, 2008 and March 31, 2008, the Company’sinvestments in Control investments, at fair value, represented approximately75% and 70%, respectively, of the Company’s net assets. Also, at both December 31,2008 and March 31, 2008, the Company’s investments in Affiliateinvestments, at fair value, represented approximately 23% of the Company’s netassets.

 

*Investment Activity*

 

OnMay 19, 2008, the Company invested approximately $5.75 million inTread Corporation (“Tread”) and its subsidiaries. The investment was comprisedof approximately $750 in preferred stock, $5.0 million of senior secondlien debt notes and a nominal amount in convertible common stock warrants.Tread, based in Roanoke, VA, was founded in 1957 and manufactures products thatstore, transport and mix the primary ingredients for liquid explosives, whichare ammonium nitrate and fuel oil.

 

OnAugust 22, 2008, the Company invested approximately $21.4 million inGalaxy Tool Holding Corporation (“Galaxy”) and its subsidiaries.  The investment was comprised of approximately$4.1 million and $48 in preferred stock and common stock, respectively, and$17.25 million in a senior second lien debt note.  Galaxy, based in Winfield, KS, was founded in1985 and is a manufacturer of specialized tooling for the aerospace industry,as well as blow and injection molds for the plastics industry.

 

On August 29, 2008, the Company restructured its investment withQuench USA, LLC (“Quench”), reaching a settlement on the revolving creditfacility and the Term A senior subordinated debt, and increasing the Term Bsenior subordinated debt to $8.0 million. In the restructuring, approximately $617 of dividends were received,$567 of which were recorded as ordinary income. The remaining $50 reduced the Company’s basis in Quench.  Furthermore, due to a decrease in the Company’sownership percentage in the investment, Quench has been reclassified in thesefinancial statements as an “Affiliate” investment, along with all unrealizedgains and losses and interest income associated with the investment since thedate of the restructuring.

 

On September 11, 2008, the Company invested approximately $3.1million in A. Stucki (“Stucki”) in the form of additional debt to the existingsenior subordinated term debt for Stucki’s acquisition of the assets of AlcoSpring Industries, Inc. (“Alco”).  Alco, located in Chicago, IL, isone of the last independent manufacturers of hot wound springs for thetransportation and heavy equipment industries.  This investment carriesthe same terms as the original senior subordinated term debt facility. TheCompany’s equity securities and ownership did not change as a result ofthis transaction.

 

OnNovember 10, 2008, the Company invested approximately $10.7 million inCountry Club Enterprises, LLC (“CCE”), comprised of approximately $3.7 millionin preferred stock and $7.0 million in subordinated term debt.  CCE, headquartered in Wareham, MA, wasfounded in 1975 and is one of the largest distributors of golf carts in theUnited States.

 

In October 2008, the Company executed a guaranty of a vehicle financefacility agreement between Ford Motor Credit Company (“FMC”) and Auto SafetyHouse, LLC (“ASH”), one of the Company’s control investments (the “FinanceFacility”).  The Finance Facilityprovides ASH with a line of credit of up to $500,000 for component Ford partsused by ASH to build truck bodies under a separate contract.  Title and ownership of the parts is retainedby Ford. The guaranty of the Finance Facility will expire upon termination ofthe separate parts supply contract with Ford or upon replacement of the Companyas guarantor.  The Finance Facility issecured by the assets of the Company.  Asof December 31, 2008, the Company has not been required to make any payments onthe guaranty of the Finance Facility. 

 

*Investment Concentrations*

 

Approximately 61.6% of the aggregate fair value of the Company’sinvestment portfolio at December 31, 2008 consisted of senior term debt,approximately 19.5% was senior subordinated term debt and approximately 18.9%was preferred and common equity securities. At December 31, 2008, theCompany had an aggregate of approximately $354.2 million, at cost, invested in47 portfolio companies. The following table outlines the Company’s investmentsby type at December 31, 2008 and March 31, 2008:

 
| ** **                                     | ** ** | **December 31, 2008** | ** **  | **March 31, 2008** | ** ** |
|------------------------------------------------|------------|---------------------------------|-------------|------------------------------|------------|
| ** **                                     | ** ** | **Cost**                        | ** **  | **Fair Value**          | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior Term Debt                               |       | $                               | 237,423     |                         | $          | 200,357 |   | $ | 269,270 |   | $ | 244,878 |   |
| Senior Subordinated Term Debt                  |       | 71,424                          |        | 63,374                       |       | 43,894 |   | 38,644 |   |
| Subordinated Term Debt                         |       | —                          |        | —                       |       | 1,089 |   | 1,089 |   |
| Preferred & Common Equity  Securities |       | 45,322                          |        | 61,564                       |       | 36,552 |   | 50,993 |   |
| **Total Investments**                          | ** ** | **$**                           | **354,169** | ** **                   | **$**      | **325,295** | ** ** | **$** | **350,805** | ** ** | **$** | **335,604** | ** ** |

 

21

----

Tableof Contents

 

Investments at fair value consisted of the following industryclassifications at December 31, 2008 and March 31, 2008:

 
| ** **                                | ** ** | **December 31, 2008** | ** **  | **March 31, 2008** | ** ** |
|-------------------------------------------|------------|---------------------------------|-------------|------------------------------|------------|
| ** **                                | ** ** | ** **                      | ** **  | **Percentage of**       | ** ** | ** ** | ** ** | **Percentage of** | ** ** |
| ** **                                | ** ** | **Fair Value**             | ** **  | **Total Investments**   | ** ** | **Net Assets** | ** ** | **Fair Value** | ** ** | **Total Investments** | ** ** | **Net Assets** | ** ** |
| Aerospace and Defense                     |       | $                               | 21,972      |                         | 6.8        | % | 9.8 | % | $ | — |   | 0.0 | % | 0.0 | % |
| Automobile                                |       | 12,494                          |        | 3.8                          | %          | 5.6 | % | 2,074 |   | 0.6 | % | 1.0 | % |
| Beverage, Food and Tobacco                |       | 1,367                           |        | 0.4                          | %          | 0.6 | % | 3,454 |   | 1.0 | % | 1.7 | % |
| Broadcasting and Entertainment            |       | 2,817                           |        | 0.9                          | %          | 1.3 | % | 3,499 |   | 1.1 | % | 1.7 | % |
| Buildings and Real Estate                 |       | 10,681                          |        | 3.3                          | %          | 4.8 | % | 11,734 |   | 3.5 | % | 5.7 | % |
| Cargo Transport                           |       | 14,142                          |        | 4.3                          | %          | 6.3 | % | 20,869 |   | 6.2 | % | 10.1 | % |
| Chemicals, Plastics and Rubber            |       | 22,057                          |        | 6.8                          | %          | 9.8 | % | 25,563 |   | 7.6 | % | 12.4 | % |
| Containers, Packaging and Glass           |       | 23,498                          |        | 7.2                          | %          | 10.5 | % | 26,286 |   | 7.8 | % | 12.7 | % |
| Diversified/Conglomerate Manufacturing    |       | 59,410                          |        | 18.3                         | %          | 26.5 | % | 57,500 |   | 17.1 | % | 27.9 | % |
| Diversified/Conglomerate Service          |       | 27,804                          |        | 8.6                          | %          | 12.4 | % | 30,742 |   | 9.2 | % | 14.9 | % |
| Ecological                                |       | —                          |        | 0.0                          | %          | 0.0 | % | 422 |   | 0.1 | % | 0.2 | % |
| Electronics                               |       | 7,545                           |        | 2.3                          | %          | 3.4 | % | 10,689 |   | 3.2 | % | 5.2 | % |
| Healthcare, Education and Childcare       |       | 34,866                          |        | 10.7                         | %          | 15.6 | % | 37,238 |   | 11.1 | % | 18.0 | % |
| Home and Office Furnishings               |       | —                          |        | 0.0                          | %          | 0.0 | % | 14,658 |   | 4.4 | % | 7.1 | % |
| Machinery                                 |       | 64,097                          |        | 19.7                         | %          | 28.6 | % | 66,439 |   | 19.8 | % | 32.2 | % |
| Oil and Gas                               |       | 5,622                           |        | 1.7                          | %          | 2.5 | % | — |   | 0.0 | % | 0.0 | % |
| Personal, Food and Miscellaneous Services |       | 4,011                           |        | 1.2                          | %          | 1.8 | % | 6,936 |   | 2.1 | % | 3.4 | % |
| Printing and Publishing                   |       | 3,274                           |        | 1.0                          | %          | 1.5 | % | 5,299 |   | 1.6 | % | 2.6 | % |
| Telecommunications                        |       | 9,638                           |        | 3.0                          | %          | 4.3 | % | 12,202 |   | 3.6 | % | 5.9 | % |
| **Total Investments**                     | ** ** | **$**                           | **325,295** | ** **                   | **100.0**  | **%** | ** ** | ** ** | **$** | **335,604** | ** ** | **100.0** | % |   |   |

 

The investments at fair value were included in the following geographicregions of the United States and Canada at December 31, 2008 and March 31,2008:

 
| ** **            | ** ** | **December 31, 2008** | ** **  | **March 31, 2008** | ** ** |
|-----------------------|------------|---------------------------------|-------------|------------------------------|------------|
| ** **            | ** ** | ** **                      | ** **  | **Percentage of**       | ** ** | ** ** | ** ** | **Percentage of** | ** ** |
| ** **            | ** ** | **Fair Value**             | ** **  | **Total Investments**   | ** ** | **Net Assets** | ** ** | **Fair Value** | ** ** | **Total Investments** | ** ** | **Net Assets** | ** ** |
| Mid-Atlantic          |       | $                               | 121,460     |                         | 37.4       | % | 54.2 | % | $ | 131,883 |   | 39.3 | % | 63.9 | % |
| Midwest               |       | 110,220                         |        | 33.9                         | %          | 49.2 | % | 106,811 |   | 31.8 | % | 51.7 | % |
| Northeast             |       | 18,968                          |        | 5.8                          | %          | 8.5 | % | 10,718 |   | 3.2 | % | 5.2 | % |
| Southeast             |       | 44,677                          |        | 13.7                         | %          | 19.9 | % | 49,780 |   | 14.8 | % | 24.1 | % |
| West                  |       | 29,970                          |        | 9.2                          | %          | 13.4 | % | 36,412 |   | 10.9 | % | 17.6 | % |
| **Total Investments** | ** ** | **$**                           | **325,295** | ** **                   | **100.0**  | **%** | ** ** | ** ** | **$** | **335,604** | ** ** | **100.0** | % |   |   |

 

The geographic region depicts the location of the headquarters for theCompany’s portfolio companies. A portfolio company may have a number of otherbusiness locations in other geographic regions.

 

*Investment Principal Repayments*

 

The following table summarizes the contractual principal repayment andmaturity of the Company’s investment portfolio by fiscal year, assuming novoluntary prepayments:

 

22

----

Table of Contents

 
| ** **                                            | ** **                               | ** ** | **Amount** |
|-------------------------------------------------------|------------------------------------------|------------|------------|
| For the  remaining three months ending March 31: | 2009                                     |       | $          | 5,499 |
| For the fiscal  year ending March 31:            | 2010                                     |       | 14,057     |
|                                                  | 2011                                     |       | 33,537     |
|                                                  | 2012                                     |       | 78,579     |
|                                                  | 2013                                     |       | 27,341     |
|                                                  | 2014                                     |       | 98,545     |
|                                                  | Thereafter                               |       | 51,239     |
| ** **                                            | **Total contractual repayments**         | ** ** | **$**      | **308,797** |
|                                                  | Investments  in equity securities        |       | 45,322     |
|                                                  | Unamortized  premiums on debt securities |       | 50         |
| ** **                                            | **Total**                                | ** ** | **$**      | **354,169** |

 

**NOTE 4. RELATED PARTY TRANSACTIONS**

 

**Investment Advisory and Management Agreement**

 

TheCompany has entered into an investment advisory and management agreement withthe Adviser (the “Advisory Agreement”), which is controlled by the Company’schairman and chief executive officer. In accordance with the AdvisoryAgreement, the Company pays the Adviser fees as compensation for its services,consisting of a base management fee and an incentive fee.

 

ThroughDecember 31, 2006, the base management fee was computed and payablequarterly and was assessed at an annual rate of 2.0% computed on the basis ofthe average value of the Company’s gross invested assets at the end of the twomost recently completed quarters, which were total assets less the cashproceeds and cash and cash equivalents from the proceeds of the Company’sinitial public offering that were not invested in debt and equity securities ofportfolio companies. Beginning on January 1, 2007, the base management feewas computed and payable quarterly and was assessed at an annual rate of 2.0%computed on the basis of the value of the Company’s average gross assets at theend of the two most recently completed quarters, which are total assets,including investments made with proceeds of borrowings, less any uninvestedcash or cash equivalents resulting from borrowings.

 

TheCompany’s Board of Directors accepted an unconditional and irrevocablevoluntary waiver from the Adviser to reduce the annual 2.0% base management feeon senior syndicated loan participations to 0.5%, to the extent that proceedsresulting from borrowings were used to purchase such syndicated loanparticipations, for the quarters and nine months ended December 31, 2008and 2007.

 

On July 9, 2008, the Company’s Board of Directors approved therenewal of its Advisory Agreement with the Adviser through August 31,2009.

 

Whenthe Adviser receives fees from portfolio companies, as discussed in Note 2under “Services Provided to Portfolio Companies,” 50% of certain of these feesare credited against the base management fee that the Company would otherwisebe required to pay to the Adviser.

 

Thefollowing tables summarize the management fees and associated credits reflectedin the accompanying consolidated statements of operations:

 

23

----

Tableof Contents

 
| ** **                                                                                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                  | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| **Base management fee**                                                                                     |       | $                                | 442        |                            | $          | 498 |   | $ | 1,303 |   | $ | 1,310 |   |
|                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Credits to base management fee from  Adviser:                                                               |       |                             |       |                            |       |   |   |   |   |
| Credit for fees received by Adviser from  the portfolio companies                                           |       | (281                             | )          | (536                            | )          | (744 | ) | (688 | ) |
| Fee reduction for the voluntary,  irrevocable waiver of 2% fee on senior syndicated loans to 0.5% per annum |       | (413                             | )          | (510                            | )          | (1,220 | ) | (1,244 | ) |
| **Credit to base management fee from Adviser**                                                              |       | (694                             | )          | (1,046                          | )          | (1,964 | ) | (1,932 | ) |
|                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| **Net base management fee**                                                                                 | ** ** | **$**                            | **(252**   | **)**                           | **$**      | **(548** | **)** | **$** | **(661** | **)** | **$** | **(622** | **)** |

 

AtDecember 31, 2008, a resulting base management fee credit of $252 wasunpaid and is included as a reduction in the Fee due to Adviser line item inthe accompanying condensed consolidated statements of assets andliabilities.  The Fee due to Adviser of$55 also includes loan servicing fees of $302, as discussed below, paid by theAdviser on behalf of the Company.  At March 31,2008, a base management fee credit of $384 was unpaid and included in Fee dueto Adviser in the accompanying condensed consolidated statements of assets andliabilities.  The amount due from Adviserof $89 also includes loan servicing fees of $295.

 

In addition, the Adviser services the loans held by BusinessInvestment, in return for which the Adviser receives a 2.0% annual fee based onthe monthly aggregate balance of loans held by Business Investment. Since theCompany owns these loans, all loan servicing fees paid to the Adviser aretreated as reductions against the 2.0% base management fee payable to the Adviser.Overall, the base management fee due to the Adviser cannot exceed 2.0% of totalassets (as reduced by cash and cash equivalents pledged to creditors) duringany given fiscal year.

 

For the three and nine months ended December 31, 2008, the Companyrecorded loan servicing fees due to the Adviser of $1,258 and $3,769,respectively.  At December 31, 2008,the Company owed $302 of unpaid loan servicing fees to the Adviser, which arenetted and recorded in Fee due to Adviser. At March 31, 2008, there were $295 of loan servicing fees due tothe Adviser that were included as a credit in Fee due from Adviser in theaccompanying consolidated statements of assets and liabilities, offsetting thebase management fee credit due to the Company from the Adviser at that date.

 

The incentive fee consists of two parts: an income-based incentive feeand a capital gains incentive fee. The income-based incentive fee rewards theAdviser if the Company’s quarterly net investment income (before giving effectto any incentive fee) exceeds 1.75% of our net assets (the “hurdle rate”). TheCompany will pay the Adviser an income incentive fee with respect to theCompany’s pre-incentive fee net investment income in each calendar quarter asfollows:

 

·                  no incentive fee in any calendar quarter in whichits pre-incentive fee net investment income does not exceed the hurdle rate (7%annualized);

 

·                  100% of the Company’s pre-incentive fee netinvestment income with respect to that portion of such pre-incentive fee netinvestment income, if any, that exceeds the hurdle rate but is less than2.1875% in any calendar quarter (8.75% annualized); and

 

·                  20% of the amount of the Company’s pre-incentive feenet investment income, if any, that exceeds 2.1875% in any calendar quarter(8.75% annualized).

 

The second part of the incentive fee is a capital gains incentive feethat will be determined and payable in arrears as of the end of each fiscalyear (or upon termination of the Advisory Agreement, as of the terminationdate), and equals 20% of the Company’s realized capital gains as of the end ofthe fiscal year. In determining the capital gains incentive fee payable to theAdviser, the Company will calculate the cumulative aggregate realized capitalgains and cumulative aggregate realized capital losses since the Company’sinception, and the aggregate unrealized capital depreciation as of the date ofthe calculation, as applicable, with respect to each of the investments in theCompany’s portfolio. For this purpose, cumulative aggregate realized capitalgains, if any, equals the sum of the differences between the net sales price ofeach investment, when sold, and the original cost of such investment since ourinception. Cumulative aggregate realized capital losses equals the sum of theamounts by which the net sales price of each investment, when sold, is lessthan the original cost of such investment since our inception. Aggregateunrealized capital depreciation equals the sum of the difference, if negative, 

 

24

----

Tableof Contents

 

betweenthe valuation of each investment as of the applicable calculation date and theoriginal cost of such investment. At the end of the applicable year, the amountof capital gains that serves as the basis for our calculation of the capitalgains incentive fee equals the cumulative aggregate realized capital gains lesscumulative aggregate realized capital losses, less aggregate unrealized capitaldepreciation, with respect to the Company’s portfolio of investments. If thisnumber is positive at the end of such year, then the capital gains incentivefee for such year equals 20% of such amount, less the aggregate amount of anycapital gains incentive fees paid in respect of our portfolio in all prioryears.

 

Becausepre-incentive fee net investment income was below the hurdle rate of 1.75% ofnet assets, no income-based incentive fee was recorded for the three monthsended December 31, 2008 or 2007. No capital gains incentive fee wasrecorded for the three months ended December 31, 2008 or 2007, ascumulative unrealized capital depreciation exceeded cumulative realized capitalgains net of cumulative realized capital losses.

 

**Administration Agreement**

 

TheCompany has entered into an administration agreement (the “AdministrationAgreement”) with Gladstone Administration, LLC (the “Administrator”), awholly-owned subsidiary of the Adviser whereby it pays separately foradministrative services. The Administration Agreement provides for paymentsequal to the Company’s allocable portion of its Administrator’s overheadexpenses in performing its obligations under the Administration Agreementincluding, but not limited to, rent for employees of the Administrator, and itsallocable portion of the salaries and benefits expenses of the Company’s chieffinancial officer, chief compliance officer, treasurer and their respectivestaffs. The Company’s allocable portion of expenses is derived by multiplyingthe Administrator’s total allocable expenses by the percentage of the Company’saverage total assets (the total assets at the beginning and end of eachquarter) in comparison to the average total assets of all companies managed bythe Adviser under similar agreements.

 

TheCompany recorded fees to the Administrator on the consolidated statements ofoperations of $195 and $642 for the three and nine months ended December 31,2008, respectively, as compared to administration fees of $211 and $647,respectively, for the three and nine months ended December 31, 2007. As ofDecember 31, 2008 and March 31, 2008, $195 and $208, respectively,was unpaid and included in Fee due to Administrator in the accompanyingconsolidated statements of assets and liabilities.

 

On July 9, 2008, the Company’s Board of Directors approved therenewal of its Administration Agreement with the Administrator through August 31,2009.

 

**LicenseAgreement**

 

TheCompany has entered into a license agreement with the Adviser, pursuant towhich the Adviser has granted the Company a non-exclusive license to use thename “Gladstone” and the Diamond G trademark. This license agreement requiredus to pay the Adviser a royalty fee of ten dollars per quarter through March 31,2009. The amount of the fee is negotiated on an annual basis by the Company’scompensation committee and must be approved by a majority of the Company’sindependent directors. The fee was increased to ten dollars per quartereffective as of April 1, 2008 and, as a result of the last negotiation, willremain at ten dollars for the next contract term which begins on April 1,2009. The license arrangement will terminate in the event that GladstoneManagement Corporation is no longer the Company’s investment adviser.

 

**NOTE 5. LINE OF CREDIT**

 

Through its wholly-ownedsubsidiary, Business Investment, the Company initially obtained a $100 millionrevolving credit facility, (the “Credit Facility”). On October 19, 2006,the Company executed a purchase and sale agreement pursuant to which theCompany agreed to sell certain loans to Business Investment in considerationfor a membership interest therein. Simultaneously, Business Investment executeda credit agreement, the Credit Agreement with Deutsche Bank AG, New YorkBranch, as administrative agent, and others, pursuant to which BusinessInvestment pledged the loans purchased from the Company to secure futureadvances by certain institutional lenders. Availability under the CreditFacility was subsequently amended and extended such that the borrowing capacitywas raised to $200 million.

 

On October 16, 2008,the Credit Facility was further amended and extended such that the borrowingcapacity was reduced to $125 million and availability under the Credit Facilitywas extended to April 16, 2009. Any advances under 

 

25

----

Tableof Contents

 

the Credit Facility willgenerally bear interest at the commercial paper rate plus 3.5% per annum, witha commitment fee of 0.75% per annum on the undrawn amounts. There was no fee inconnection with this renewal.

 

As of January 6, 2009,there was an outstanding principal balance of $115.9 million under the CreditFacility at an interest rate of 2.4%, plus an additional fee related toborrowings of 3.5%, for an aggregate rate of approximately 5.9%. Availableborrowings are subject to various constraints imposed under the CreditAgreement, based on the aggregate loan balance pledged by Business Investment,which varies as loans are added and repaid, regardless of whether suchrepayments are earlyprepaymentor are made as contractually required. At January 6, 2009, the remainingborrowing capacity available under the Credit Facility was approximately $9.1million.

 

The Credit Facility containscovenants that require Business Investment to maintain its status as a separateentity; prohibit certain significant corporate transactions (such as mergers,consolidations, liquidations or dissolutions); and restrict material changes toour credit and collection policies. The facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances. As of December 31, 2008, BusinessInvestment was in compliance with all of the facility covenants.

 

The administrative agentalso requires that any interest or principal payments on pledged loans beremitted directly by the borrower into lockbox accounts controlled by DeutscheBank. Once a month, Deutsche Bank remits the collected funds to the Companyafter payment of any interest and expenses provided for under the CreditAgreement.

 

The Adviser services theloans pledged under the Credit Facility. As a condition to this servicingarrangement, the Company executed a performance guaranty pursuant to which weguaranteed that the Adviser would comply fully with all of its obligationsunder the Credit Facility. The performance guaranty requires the Company tomaintain a minimum net worth of $100 million and to maintain ‘‘asset coverage’’with respect to ‘‘senior securities representing indebtedness’’ of at least200%, in accordance with Section 18 of the 1940 Act. As of December 31,2008, the Company was in compliance with its covenants under the performanceguaranty. However, continued compliance with these covenants depends on manyfactors, some of which are beyond the Company’s control. In particular,depreciation in the valuation of the Company’s assets, which valuation issubject to changing market conditions which are presently very volatile,affects the Company’s ability to comply with these covenants.

 

Availability under theCredit Facility will terminate on April 16, 2009. If the Credit Facilityis not renewed or extended by this date, all principal and outstanding interestwill be immediately due and payable.

 

**NOTE 6. INTEREST RATE CAP AGREEMENT**

 

InOctober 2007, the Company entered into an interest rate cap agreement thatwill effectively limit the interest rate on a portion of the borrowings underthe line of credit pursuant to the terms of the Credit Facility. The interestrate cap has a notional amount of $60 million at a cost of $53. The Companyrecords changes in the fair market value of the interest rate cap agreementmonthly based on the current market valuation at month end as unrealizeddepreciation or appreciation on derivative on the Company’s consolidatedstatement of operations. The interest rate cap agreement expires in October 2009.The agreement provides that the Company’s floating interest rate or cost offunds on a portion of the portfolio’s borrowings will be capped at 9% when theLIBOR rate is in excess of 9%. At December 31, 2008, the interest rate capagreement had a nominal fair market value.

 

Theuse of a cap involves risks that are different from those associated withordinary portfolio securities transactions. Cap agreements may be considered tobe illiquid. Although the Company will not enter into any such agreementsunless it believes that the other party to the transaction is creditworthy, theCompany does bear the risk of loss of the amount expected to be received undersuch agreements in the event of default or bankruptcy of the agreementcounterparty.

 

**NOTE 7. COMMON STOCK**

 
| ** **                                      | ** ** | **Shares** | ** ** | **Total Value** | ** ** |
|-------------------------------------------------|------------|------------|------------|----------------------|------------|
| Balance at March 31, 2008                  |       | 16,560,100 |       | $                    | 224,189    |   |
| Issuance of common stock under rights  offering |       | 5,520,033  |       | 40,595               |       |
| Balance at December 31, 2008               |       | 22,080,133 |       | $                    | 264,784    |   |

 

26

----

Tableof Contents

 

InApril 2008, the Company completed an offering of transferable subscriptionrights to purchase additional shares of common stock (the “Rights Offering”).Pursuant to the Rights Offering, the Company sold 5,520,033 shares of itscommon stock at a subscription price of $7.48, whichrepresented a purchase price equal to 93% of the weighted average closing priceof the Company’s stock in the last five trading days of the subscriptionperiod. Net proceeds of the offering, after offering expenses borne by theCompany, were approximately $40.6 million and were used to repay a portionof outstanding borrowings under the Company’s line of credit.

 

**NOTE 8. NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PERCOMMON SHARE**

 

The following table sets forth the computation of basic and diluted netincrease (decrease) in net assets per common share resulting from operations:

 
| ** **                                                                                                 | ** ** | **Three months ended  December 31,** | ** ** | **Nine months ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator for basic and diluted net  (decrease) increase in net assets resulting from operations per share |       | $                                                   | (3,940     | )                                                  | $          | 5,109 |   | $ | (7,467 | ) | $ | 9,012 |   |
| Denominator for basic and diluted shares                                                                   |       | 22,080,133                                          |       | 16,560,100                                         |       | 21,367,871 |   | 16,560,100 |   |
| Basic and diluted net (decrease) increase  in net assets resulting from operations per share               |       | $                                                   | (0.18      | )                                                  | $          | 0.31 |   | $ | (0.35 | ) | $ | 0.54 |   |

 

**NOTE 9. DIVIDENDS AND DISTRIBUTIONS**

 

Thefollowing table lists the per common share distributions paid for the ninemonths ended December 31, 2008 and 2007:

 

**Fiscal Year 2009**

 
| **Record Date**    | ** ** | **Payment Date**    | ** ** | **Distribution Per Share** | ** ** |
|-------------------------|------------|--------------------------|------------|--------------------------------------|------------|
| April 22, 2008     |       | April 30,  2008     |       | $                                    | 0.08       |   |
| May 21 2008        |       | May 30,  2008       |       | 0.08                                 |       |
| June 20, 2008      |       | June 30  2008       |       | 0.08                                 |       |
| July 23, 2008      |       | July 31,  2008      |       | 0.08                                 |       |
| August 21, 2008    |       | August 29,  2008    |       | 0.08                                 |       |
| September 22, 2008 |       | September 30,  2008 |       | 0.08                                 |       |
| October 23, 2008   |       | October 31,  2008   |       | 0.08                                 |       |
| November 19, 2008  |       | November 28,  2008  |       | 0.08                                 |       |
| December 22, 2008  |       | December 31,  2008  |       | 0.08                                 |       |
| ** **              | ** ** | **Total**                | ** ** | **$**                                | **0.72**   | ** ** |

 

**Fiscal Year 2008** 

 
| **Record Date**    | ** ** | **Payment Date**    | ** ** | **Distribution Per Share** | ** ** |
|-------------------------|------------|--------------------------|------------|--------------------------------------|------------|
| April 20, 2007     |       | April 30,  2007     |       | $                                    | 0.075      |   |
| May 22, 2007       |       | May 31,  2007       |       | 0.075                                |       |
| June 21, 2007      |       | June 29,  2007      |       | 0.075                                |       |
| July 23, 2007      |       | July 31,  2007      |       | 0.075                                |       |
| August 23, 2007    |       | August 31,  2007    |       | 0.075                                |       |
| September 20, 2007 |       | September 28,  2007 |       | 0.075                                |       |
| October 23, 2007   |       | October 31,  2007   |       | 0.08                                 |       |
| November 21, 2007  |       | November 30,  2007  |       | 0.08                                 |       |
| December 20, 2007  |       | December 31,  2007  |       | 0.08                                 |       |
| ** **              | ** ** | **Total**                |       | **$**                                | **0.69**   |   |

 

Aggregatedistributions declared and paid for the three months ended December 31,2008 and 2007 were approximately $5.3 million and $4.0 million,respectively.  Aggregate distributionsdeclared and paid for the nine months ended December 31, 

 

27

----

Tableof Contents

 

2008and 2007 were approximately $15.5 million and $11.4 million, respectively.  All distributions were declared based onestimates of net investment income for the respective fiscal years, and some ofthe distributions included a return of capital.

 

Thetiming and characterization of certain income and capital gains distributionsare determined annually in accordance with federal tax regulations which maydiffer from GAAP. These differences primarily relate to items recognized asincome for financial statement purposes and realized gains for tax purposes. Asa result, net investment income and net realized gain (loss) on investmenttransactions for a reporting period may differ significantly from distributionsduring such period. Accordingly, the Company may periodically makereclassifications among certain of its capital accounts without impacting thenet asset value of the Company.

 

***Section 19(a) Disclosure***

 

TheCompany’s Board of Directors estimates the source of the distributions at thetime of their declaration as required by Section 19(a) of the 1940Act. On a monthly basis, if required under Section 19(a), the Companyposts a Section 19(a) notice through the Depository Trust Company’sLegal Notice System (“LENS”) and also sends to its registered stockholders awritten Section 19(a) notice along with the payment of dividends for any paymentwhich includes a dividend estimated to be paid from any other source other thannet investment income. The estimates of the source of the distribution areinterim estimates based on GAAP that are subject to revision, and the exactcharacter of the distributions for tax purposes cannot be determined until thefinal books and records of the Company are finalized for the calendar year.Following the calendar year end, after definitive information has beendetermined by the Company, if the Company has made distributions of taxableincome (or return of capital), the Company will deliver a Form 1099-DIV toits stockholders specifying such amount and the tax characterization of suchamount. Therefore, these estimates are made solely in order to comply with therequirements of Section 19(a) of the 1940 Act and should not berelied upon for tax reporting or any other purposes and could differsignificantly from the actual character of distributions for tax purposes.

 

Thefollowing GAAP estimates were made by the Board of Directors during the quarterended December 31, 2008:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distributions** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|------------------------------|------------|
| December 31, 2008 |       | $                        | 0.068      |                            | $          | 0.012                        |       | $ | 0.08 |   |
| November 30, 2008 |       | 0.051                    |       | 0.029                           |       | 0.08                         |       |
| October 31, 2008  |       | 0.047                    |       | 0.033                           |       | 0.08                         |       |
|                        |            |                          |            |                                 |            |                              |            |  |  |  |

 

Becausethe Board of Directors declares distributions at the beginning of a quarter, itis difficult to estimate how much of the Company’s monthly distributions, basedon GAAP, will come from ordinary income, capital gains, and returns of capital.Subsequent to the quarter ended December 31, 2008, the followingcorrections were made to the above listed estimates for that quarter:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distributions** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|------------------------------|------------|
| December 31, 2008 |       | $                        | 0.061      |                            | $          | 0.019                        |       | $ | 0.08 |   |
| November 30, 2008 |       | 0.054                    |       | 0.026                           |       | 0.08                         |       |
| October 31, 2008  |       | 0.047                    |       | 0.033                           |       | 0.08                         |       |
|                        |            |                          |            |                                 |            |                              |            |  |  |  |

 

Fordistributions declared subsequent to quarter end, the following estimates,based on GAAP, have been made pursuant to Section 19(a) of the 1940Act:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distributions** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|------------------------------|------------|
| January 31, 2009  |       | $                        | 0.054      |                            | $          | 0.026                        |       | $ | 0.08 |   |
| February 28, 2009 |       | 0.054                    |       | 0.026                           |       | 0.08                         |       |
| March 31, 2009    |       | 0.088                    |       | (0.008                          | )          | 0.08                         |       |
|                        |            |                          |            |                                 |            |                              |            |  |  |  |

 

**NOTE 10. CONTRACTUAL OBLIGATIONS**

 

At December 31, 2008, the Company was not a party to any signedinvestments to be funded.

 

**NOTE 11. SUBSEQUENT EVENTS**

 

On January 13, 2009, the Company’sBoard of Directors declared the following monthly cash distributions:

 

28

----

Tableof Contents

 
| **Record Date**   | ** ** | **Payment Date**   | ** ** | **Distribution Per Share** | ** ** |
|------------------------|------------|-------------------------|------------|--------------------------------------|------------|
| January 22, 2009  |       | January 30,  2009  |       | $                                    | 0.08       |   |
| February 19, 2009 |       | February 27,  2009 |       | 0.08                                 |       |
| March 23, 2009    |       | March 31,  2009    |       | 0.08                                 |       |
|                        |            |                         |            |                                      |            |  |

 

29

----

Table of Contents

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.**

 

**All statements containedherein, other than historical facts, may constitute “forward-lookingstatements.” These statements may relate to, among other things, future eventsor our future performance or financial condition. In some cases, you canidentify forward-looking statements by terminology such as “may,” “might,” “believe,”“will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,”“expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” orthe negative 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. We caution readers not to place undue reliance onany such forward-looking statements. We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of new information,future events or otherwise, after the date of this Form 10-Q**.

 

**The following analysis of our financial condition and resultsof operations should be read in conjunction with our consolidated financialstatements and the notes thereto contained elsewhere in this report and ourannual report on Form 10-K for the fiscal year ended March 31, 2008.**

 

**OVERVIEW**

 

**General**

 

Wewere incorporated under the General Corporation Laws of the State of Delawareon February 18, 2005. We were primarily established for the purpose ofinvesting in subordinated loans, mezzanine debt, preferred stock and warrantsto purchase common stock of small and medium-sized companies in connection withbuyouts and other recapitalizations. We also invest in senior secured loans,common stock and 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 (the “1940 Act”).

 

**Business Environment**

 

The current economicconditions generally and the disruptions in the capital markets in particularhave decreased liquidity and increased our cost of debt and equity capital,where available. The longer these conditions persist, the greater theprobability that these factors could continue to increase our cost andsignificantly limit our access to debt and equity capital, and thus have anadverse effect on our operations and financial results, as well as our abilityto make new investments. Many of the companies in which we have made or willmake investments may also be susceptible to the economic downturn, which may affectthe ability of one or more of our portfolio companies to repay our loans orengage in a liquidity event, such as a sale, recapitalization or initial publicoffering. An economic downturn could also disproportionately impact some of theindustries in which we invest, causing us to be more vulnerable to losses inour portfolio. Therefore, the numbers of our non-performing assets are likelyto increase and the fair market value of our portfolio is likely to decreaseduring these periods.  The economic downturnhas affected the availability of credit generally and may prevent us fromreplacing or renewing our credit facility on reasonable terms, if at all.  We do not know when market conditions willstabilize, if adverse conditions will intensify or the full extent to which thedisruptions will affect us.  If marketinstability persists or intensifies, we may experience difficulty in raisingcapital.

 

Challenges in the currentmarket are intensified for us by certain regulatory limitations under the Internal Revenue Code of 1986, asamended (the “Code”) and the 1940 Act, as well as contractual restrictionsunder the agreement governing our credit facility that further constrain ourability to access the capital markets. To maintain our qualification as a RIC, we must satisfy, among otherrequirements, an annual distribution requirement to pay out at least 90% of ourordinary income and short-term capital gains to our stockholders on an annualbasis.  Because we are required todistribute our income in this manner, and because the illiquidity of many ofour investments makes it difficult for us to finance new investments throughthe sale of current investments, our ability to make new investments is highlydependent upon external financing.  Ourexternal financing sources include the issuance of equity securities, debtsecurities or other leverage such as borrowings under our line of credit.  Our ability to seek external debt financing,to the extent that it is available under current market conditions, is furthersubject to the asset coverage limitations of the 1940 Act, which require us tohave at least 200% asset coverage ratio, meaning generally that for everydollar of debt, we must have two dollars of assets.

 

30

----

Tableof Contents

 

The economic downturn mayalso continue to decrease the value of collateral securing some of our loans,as well as the value of our equity investments, which has impacted and maycontinue to impact our ability to borrow under our credit facility.  For the quarter ended December 31, 2008, we recorded netunrealized depreciation on our portfolio of investments of $7.5 million, whichwas mainly attributable to the decrease in fair value of ourNon-Control/Non-Affiliate investments.  We may seefurther decreases in the value of our overall portfolio, which will furtherlimit our ability to borrow under our current credit facility.  Additionally, our credit facility containscovenants regarding the maintenance of certain covenants which are affected bythe decrease in value of our portfolio. Failure to meet these requirements would result in a default which, ifwe were unable to obtain a waiver from our lenders, would result in theacceleration of our repayment obligations under the credit facility.

 

Weexpect that, given these regulatory and contractual constraints in conjunctionwith current market conditions, debt and equity capital may be costly ordifficult for us to access for some time. For so long as this is the case, our near-term strategy has becomesomewhat dependent upon retaining capital and building the value of ourexisting portfolio companies to increase the likelihood of maintaining thepotential of future returns.  We willalso, where prudent and possible, consider the sale of lower-yieldinginvestments.  This has resulted, and maycontinue to result, in significantly reduced investment activity, as ourability to make new investments under these conditions is largely dependent onavailability of proceeds from the sale or exit of existing portfolioinvestments, which events may be beyond our control.  As capital constraints improve, we intend tocontinue our strategy of making conservative investments in businesses that webelieve will weather the current economy and that are likely to produceattractive long-term returns for our stockholders.

 

**Use of Internally-Developed Discounted Cash-FlowMethodologies**

 

Given the continued economic downturn, themarket for syndicated loans has become increasingly illiquid with limited or notransactions for many of those securities which we hold. FASB Staff Position157-3 (“FSP 157-3”), *“Determining the FairValue of a Financial Asset When the Market for That Asset is Not Active,”*provides guidance on the use of a discounted cash flow (“DCF”) methodology tovalue investments in an illiquid market. Under FSP 157-3, indications of an illiquid market include cases wherethe volume and level of trading activity in the asset have declinedsignificantly, the available prices vary significantly over time or amongstmarket participants, or the prices are not current. The market place for whichwe obtain indicative bids for purposes of determining fair value for our syndicatedloan investments have recently shown these attributes of illiquidity.  In accordance with SFAS 157, our valuationprocedures specify the use of third-party indicative bid quotes for valuingsyndicated loans where there is a liquid public market for those loans andmarket pricing quotes are readily available. However, due to the marketilliquidity and the lack of transactions during the quarter ended December 31,2008, we determined that the current agent bank non-binding indicative bids forthe majority of our syndicated loans were unreliable and alternative procedureswould need to be performed until liquidity returns to the market place.  As such, we have valued the majority of oursyndicated loans using a DCF method for the quarter ended December 31,2008.  As of December 31, 2008, the portionof our investment portfolio that was valued using DCF was approximately $96.5million, or 30% of the fair value of our total portfolio of investments.

 

**RESULTS OF OPERATIONS(dollar amounts in thousands,unless otherwise indicated)**

 

***Comparison of thethree months ended December 31, 2008 to the three months ended December 31,2007***

 

**Investment Income**

 

Totalinvestment income for the three months ended December 31, 2008 was $7,002,as compared to $7,544 for the three months ended December 31, 2007.

 

Interest income from our investments in debt securities of privatecompanies was $6,885 for the three months ended December 31, 2008, ascompared to $7,458 for the comparable prior year period. The level of interestincome from investments is directly related to the balance, at cost, of theinterest-bearing investment portfolio outstanding during the period multipliedby the weighted average yield. The weighted average yield varies from period toperiod based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.Interest income from our investments decreased $573, or 7.7%, during the threemonths ended December 31, 2008 as compared to the prior year period. Thischange was due to the decrease in the weighted average yield of our portfolio,attributable mainly to a reduction in the average LIBOR during the comparabletime period, which was approximately 2.17% for the three months ended December 31,2008, compared to 4.92% in the prior year period.  Also contributing to the change was adecrease in the average cost basis of our interest-bearing investment portfolioduring the period, which was approximately 

 

31

----

Tableof Contents

 

$296.0million for the three months ended December 31, 2008, as compared toapproximately $311.2 million for the three months ended December 31, 2007.

 

Interestincome from Non-Control/Non-Affiliate investments was $2,339 for the threemonths ended December 31, 2008, as compared to $3,892 for the comparableprior year period. This decreasewas the result of an overall decrease in the number of Non-Control/Non-Affiliateinvestments held at December 31, 2008 compared to the prior year period,primarily due to sales and settlements of syndicated loans subsequent to December 2007.This decrease was further emphasized by drops in LIBOR, due to the instabilityand tightening of the credit markets.

 

Interestincome from Control investments was $3,068 for the three months ended December 31,2008, as compared to $2,866 for the comparable prior year period. The increase of $202 is attributable to twoadditional Control investments held during the quarter ended December 31,2008 as compared to the prior year period. However, this increase was partially offset by the reclassification ofQuench, a Control investment in the prior period, as an Affiliate investment.  This reclassification took place in thesecond quarter of fiscal year 2009.

 

Interestincome from Affiliate investments was $1,478 for the three months ended December 31,2008, as compared to $700 for the comparable prior year period. The increase of $778 was a result of twoadditional Affiliate investments held during the quarter ending December 31,2008 when compared to the prior year period, as well the change inreclassification of Quench as an Affiliate investment.

 

The following table lists the interest income from investments for thefive largest portfolio companies during the respective periods:

 

**Three months ended December 31, 2008**

 
| **Company**                         | ** ** | **Interest   Income** | ** ** | **%**  | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------|------------|
| A. Stucki Holding Corp.             |       | $                          | 764        |   | 11.1       | % |
| Chase II Holdings Corp.             |       | 708                        |       | 10.3   | %          |
| Galaxy Holdings Corp.               |       | 595                        |       | 8.6    | %          |
| Noble Logistics, Inc.          |       | 431                        |       | 6.3    | %          |
| Acme Cryogenics, Inc.          |       | 426                        |       | 6.2    | %          |
| **Subtotal**                        |       | $                          | 2,924      |   | 42.5       | % |
| Other companies                     |       | 3,961                      |       | 57.5   | %          |
| **Total portfolio interest income** |       | $                          | 6,885      |   | 100.0      | % |

 

**Three months ended December 31, 2007**

 
| **Company**                         | ** ** | **Interest   Income** | ** ** | **%**  | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------|------------|
| A. Stucki Holding Corp.             |       | $                          | 852        |   | 11.5       | % |
| Chase II Holdings Corp.             |       | 753                        |       | 10.1   | %          |
| Acme Cryogenics, Inc.          |       | 426                        |       | 5.7    | %          |
| Quench Holdings Corp.               |       | 381                        |       | 5.1    | %          |
| Noble Logistics, Inc.          |       | 367                        |       | 4.9    | %          |
| **Subtotal**                        |       | $                          | 2,779      |   | 37.3       | % |
| Other companies                     |       | 4,679                      |       | 62.7   | %          |
| **Total portfolio interest income** |       | $                          | 7,458      |   | 100.0      | % |

 

Theannualized weighted average yield on our portfolio of investments, excludingcash and cash equivalents, was 8.76% for the three months ended December 31,2008, compared to 9.05% for the three months ended December 31, 2007. Thedecrease in the annualized weighted average yield resulted primarily from areduction in the average LIBOR, due to the instability and tightening of thecredit markets. This decrease was accentuated by a slight decrease in theoverall size of the investment portfolio compared to the prior year period.

 

Interestincome from cash and cash equivalents was $21 for the three months ended December 31,2008, as compared to $80 for the comparable prior year period. This decrease is a result of lower interestrates offered by banks, as this income is derived mainly from interest earnedon overnight sweeps of cash held at financial institutions, in addition to ususing the 

 

32

----

Tableof Contents

 

proceedsfrom repayments on outstanding loans during the quarter to pay down our line ofcredit.

 

Otherincome was $96 for the three months ended December 31, 2008, as comparedto $6 for the comparable prior year period. This increase is primarily due to a payment received of $82 from apreviously recorded reimbursable account receivable that was written off andsubsequently repaid.

 

**Operating Expenses**

 

Totaloperating expenses, excluding any voluntary and irrevocable credits to the basemanagement fee, were $4,109 for the three months ended December 31, 2008,as compared to $4,844 for the comparable prior year period.

 

Loanservicing fees of $1,258 were incurred for the three months ended December 31,2008, as compared to $1,287 for the comparable prior year period. These fees were incurred in connection with aloan servicing agreement between Business Investment and our Adviser, which isbased on the size of the portfolio. These fees were reduced against the amountof the base management fee due to our Adviser. The consistency in loanservicing fees is the result of similar balances in our portfolio of loansbeing serviced by our Adviser during the prior year period.

 

Base management fee for the three months ended December 31, 2008was $442, as compared to $498 for the comparable prior year period. The basemanagement fee is computed quarterly, as described under “*InvestmentAdvisory and Management Agreement*” in Note 4 of the condensedconsolidated financial statements, and is summarized in the table below:

 
| ** **                                                                     | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                     | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007** | ** ** |
| **Base management fee**                                                        |       | $                                | 442        |   | $ | 498 |   |
|                                                                           |       |                             |       |   |   |
| Credits to base management fee from  Adviser:                                  |       |                             |       |   |   |
| Credit for fees received by Adviser from  the portfolio companies              |       | (281                             | )          | (536 | ) |
| Fee reduction for the waiver of 2% fee on  senior syndicated loans to 0.5% (1) |       | (413                             | )          | (510 | ) |
| **Credit to base management fee from Adviser**                                 |       | (694                             | )          | (1,046 | ) |
|                                                                           |       |                             |       |   |   |
| **n****et base management fee**                                                | ** ** | **$**                            | **(252**   | **)** | **$** | **(548** | **)** |

 

----

(1)                   Our Adviservoluntarily waived the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations to the extent that proceeds resulting fromborrowings were used to purchase such syndicated loan participations.

 

Administrationfees were $195 for the three months ended December 31, 2008, as comparedto $211 for the comparable prior year period. This fee consists of our allocable portionof our Administrator’s rent and other overhead expenses, and our allocableportion of the salaries and benefits of our chief financial officer, chiefcompliance officer, treasurer, 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 that are undersimilar administration agreements with our Administrator. The slight decreasewas attributable to a decrease in our total assets in relation to the otherfunds serviced by our Administrator during the prior quarter.

 

Interestexpense was $1,823 for the three months ended December 31, 2008, ascompared to $2,381 for the comparable prior year period. The decline was a direct result ofdecreased borrowings under our credit facility during the period from the prioryear period.  While there was an increasein the interest rate margin charged on the outstanding borrowings upon renewingthe facility on October 16, 2008, the LIBOR base rate decrease during theperiod offset this interest rate margin increase.

 

Amortizationof deferred finance costs were $46 for the three months ended December 31,2008, as compared to $169 for the comparable prior year period. The decrease is attributable to realizingthe full amortization of costs incurred in connection with the credit facilityagreement.  There was no fee associatedwith the October 16, 2008 renewal of the credit facility.  At December 31, 2008, all deferredfinance costs had been fully amortized.

 

Professionalfees were $69 for the three months ended December 31, 2008, as compared to$90 for the comparable prior year period. Professional fees primarily consist of legal fees and audit andaccounting fees. The decrease is primarily due to decreased direct consultingand legal fees incurred on potential investments.

 

33

----

Tableof Contents

 

Stockholderrelated costs were $112 for the three months ended December 31, 2008, ascompared to $25 for the comparable prior year period. Stockholder related costs consist of theamortization of annual Nasdaq listing fees, transfer agent fees, annual reportprinting and distribution and other annual meeting costs, costs associated withSEC filings and press release costs. The increase was primarily attributable tothe increase annual report printing fees.

 

Insuranceexpense was $57 for the three months ended December 31, 2008, as comparedto $47 for the comparable prior year period. Insurance expense consists of theamortization of the directors and officers insurance policy and professionalliability policy premiums. The increase is due to an escalation in the premiumsfor directors and officers’ insurance for the current policy period.

 

Directors’fees were $50 for the three months ended December 31, 2008, as compared to$55 for the comparable prior year period. Directors’ fees consist of the amortization of the directors’ annualstipend and individual meeting fees. The slight decrease is due to the timingof committee meetings, resulting in fewer meetings being held in the currentquarter.

 

Taxes and licenses expense was $16 for the three months ended December 31,2008, as compared to $42 for the comparable prior year period and theseexpenses consist primarily of franchise taxes due to the state of Delaware andother fees surrounding state and regulatory licensing, registration and othercorporate filing fees.  The decrease ismainly attributable to a reduction in the quarterly accrual for estimated taxesand license fees.

 

Generaland administrative expenses remained flat at $41 for three months ended December 31,2008, as compared to $39 for the comparable prior year period. General and administrative expenses consistprimarily of direct expenses such as travel related specifically to ourportfolio companies, loan evaluation services for our portfolio companies andbackup servicer expenses.

 

**Realized and Unrealized (Loss) Gainon Investments**

 

Forthe three months ended December 31, 2008, no investments were sold orwritten off.  We did, however, record netunrealized depreciation of investments in the aggregate amount of $7,527. Forthe three months ending December 31, 2007, we recognized a net loss of$146 resulting from the partial sale of two of our syndicated loans, and werecorded net unrealized appreciation of investments in the aggregate amount of$1,504.

 

AtDecember 31, 2008, the fair value of our investment portfolio was lessthan the cost basis of our portfolio by approximately $28.9 million,representing net unrealized depreciation of $7.5 million for the quarter.  At December 31, 2007, the fair value ofour investment portfolio was less than the cost basis of our portfolio byapproximately $15.2 million, representing net unrealized appreciation of $1.5million for the quarter ended December 31, 2008.  The majority of our unrealized depreciationfor the quarter occurred in our senior syndicated loans, which accounted forapproximately $7.0 million of the losses, specifically Interstate Fibernet, PTSAcquisition, HMT, and Network Solutions, while slightly offset by unrealizedappreciation in LVI and B-Dry.  Affiliateinvestments also experienced decreases in value of $2.3 million, specificallyDanco Acquisition and Noble Logistics. Our Control investments appreciated in value by an aggregate amount ofapproximately $1.7 million, driven by Chase and Galaxy.

 

We believe that our investment portfolio was valued at a depreciatedvalue due primarily to the general instability of the loan markets.Additionally, our equity investments in two Control investments with anaggregate cost of $3.6 million have been written down to $0 fair value.Although our investment portfolio has depreciated, our entire portfolio wasfair valued at 92% of cost as of December 31, 2008.  The unrealized depreciation of ourinvestments does not have an impact on our current ability to pay distributionsto stockholders; however, it may be an indication of future realized losses,which could ultimately reduce our income available for distribution.

 

**Derivatives**

 

Forboth the three months ended December 31, 2008 and 2007, we recordedunrealized appreciation of our interest rate cap agreements purchased in October 2007and February 2008 at nominal rates.

 

**Net Increase (Decrease) in NetAssets Resulting from Operations**

 

Forthe three months ended December 31, 2008, we recorded a net decrease innet assets resulting from operations of $3,940 as a result of the factorsdiscussed above. Our net (decrease) increase in net assets resulting fromoperations per basic and diluted weighted average common share for the quartersended December 31, 2008 and 2007 were $(0.18) and $0.31, respectively. Forthe three months ended December 31, 2007, we recorded a netincrease in net assets resulting from 

 

34

----

Tableof Contents

 

operations of $5,109. We will continue to incur base managementfees which are likely to increase to the extent our investment portfolio grows,and we may begin to incur incentive fees. Our administrative fee payable to ourAdministrator is also likely to grow during future periods to the extent ouraverage total assets grow in comparison to prior periods and as the expensesincurred by our Administrator to support our operations increase.

 

***Nine months ended December 31,2008 compared to the nine months ended December 31, 2007***

 

**Investment Income**

 

Investment income for the nine months ended December 31, 2008 was$19,856, as compared to investment income of $21,000 for the nine months ended December 31,2007.

 

Interest income from our investments in debt securities of privatecompanies was $19,107 for the nine months ended December 31, 2008, ascompared to $20,765 for the comparable prior year period. The level of interestincome from investments is directly related to the balance, at cost, of theinterest-bearing investment portfolio outstanding during the period multipliedby the weighted average yield. The weighted average yield varies from period toperiod based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.Interest income from our investments decreased $1.7 million, or 8.0%, duringthe nine months ended December 31, 2008 compared to the prior year period,due primarily to decreases in the average LIBOR during the respective periods,which was 2.46% for the nine months ended December 31, 2008 and 5.23% forthe prior year period.

 

Interest income from Non-Control/Non-Affiliate investments was $6,797for the nine months ended December 31, 2008, as compared to $11,220 forthe comparable prior year period. This decrease was mainly the result of anoverall decrease in the balance of Non-Control/Non-Affiliate investments heldduring the nine months ended December 31, 2008 as compared to the prioryear period, commensurate with our strategy to sell some of our syndicatedloans. Drops in LIBOR, due to the instability and tightening of the creditmarkets, during the current nine month period ended December 31, 2008accentuated this decrease.

 

Interest income from Control investments was $8,372 for the nine monthsended December 31, 2008, as compared to $8,043 for the comparable prioryear period. The addition of two Control investments during the nine monthsended December 31, 2008 drove this increase and helped to offset theimpact of lower interest rates and the reclassification of Quench as anAffiliate investment.

 

Interest income from Affiliate investments was $3,938 for the ninemonths ended December 31, 2008, as compared to $1,502 for the comparableprior year period. This increase is attributable to interest earned on threeadditional Affiliate investments held during the nine months ended December 31,2008 that were not held during the prior year period, as well as thereclassification of Quench as an Affiliate investment.

 

The interest-bearing investment portfolio had an average cost basis ofapproximately $297.9 million for the nine months ended December 31, 2008,as compared to an average cost basis of $289.8 million for the nine monthsended December 31, 2007. The following table lists the interest incomefrom investments for the five largest portfolio companies during the respectiveperiods:

 

**Nine months ended December 31, 2008**

 
| **Company**                         | ** ** | **Interest  Income** | ** ** | **%**  | ** ** |
|-------------------------------------|------------|----------------------|------------|--------|------------|
| Chase II Holdings Corp.             |       | $                    | 2,138      |   | 11.2       | % |
| A. Stucki Holding Corp.             |       | 2,110                |       | 11.0   | %          |
| Acme Cryogenics, Inc.          |       | 1,274                |       | 6.7    | %          |
| Cavert II Holding Corp.             |       | 1,230                |       | 6.4    | %          |
| Noble Logistics, Inc.          |       | 1,218                |       | 6.4    | %          |
| **Subtotal**                        |       | $                    | 7,970      |   | 41.7       | % |
| Other companies                     |       | 11,137               |       | 58.3   | %          |
| **Total portfolio interest income** |       | $                    | 19,107     |   | 100.0      | % |

 

35

----

Tableof Contents

 

**Ninemonths ended December 31, 2007**

 
| **Company**                         | ** ** | **Interest  Income** | ** ** | **%**  | ** ** |
|-------------------------------------|------------|----------------------|------------|--------|------------|
| A. Stucki Holding Corp.             |       | $                    | 2,634      |   | 12.7       | % |
| Chase II Holdings Corp.             |       | 2,300                |       | 11.1   | %          |
| Acme Cryogenics, Inc.          |       | 1,274                |       | 6.1    | %          |
| Noble Logistics, Inc.          |       | 1,168                |       | 5.6    | %          |
| Quench Holdings Corp.               |       | 1,127                |       | 5.4    | %          |
| **Subtotal**                        |       | $                    | 8,503      |   | 40.9       | % |
| Other companies                     |       | 12,262               |       | 59.1   | %          |
| **Total portfolio interest income** |       | $                    | 20,765     |   | 100.0      | % |

 

The annualized weighted average yield on our portfolio of investments,excluding cash and cash equivalents, was 8.12% for the nine months ended December 31,2008 and 9.05% for the nine months ended December 31, 2007. This decreaseis largely the result of declining interest rates. This has been offset, tosome extent, by the increase in the size of our portfolio of investments innon-syndicated loans that typically bear higher interest rates than those ofsyndicated loans.

 

Interest income from cash and equivalents was $67 for the nine monthsended December 31, 2008, as compared to $194 for the comparable prior yearperiod. This decrease is a result of lower interest rates offered bybanks, as this income is derived mainly from interest earned on overnightsweeps of cash held at financial institutions, in addition to our use of theproceeds from repayments on outstanding loans during the nine month period topay down our line of credit.

 

Other income was $682 for the nine months ended December 31, 2008,as compared to $41 for the comparable prior year period. Other income isnormally comprised of loan amendment fees that are received from portfoliocompanies and are amortized over the remaining life of the respective loans.However, in the second quarter of fiscal year 2009, we recognized as ordinaryincome $567 of dividends received on the restructuring of one of ourthen-Control investments (Quench). An additional $50 of dividends that werereceived was recorded as a reduction of our basis in the investment. Theresidual balance in other income is comprised of loan amendment fees that areamortized over the remaining lives of the respective loans and othermiscellaneous income amounts.  The resultof this restructuring was the reclassification of Quench from a Controlinvestment to an Affiliate investment. In addition, in the nine month period, $82 was received to coverexpenses incurred on behalf of a potential portfolio company that was writtenoff in a prior period which was recorded as other income.

 

**Operating Expenses**

 

Operating expenses, excluding any voluntary and irrevocable credits tothe base management fee, were $11,399 for the nine months ended December 31,2008, compared to $13,303 for the comparable prior year period.

 

Loan servicing fees of $3,769 were incurred for the nine months ended December 31,2008, as compared to $3,741 for the comparable prior year period. These feeswere incurred in connection with a loan servicing agreement between BusinessInvestment and our Adviser in connection with our credit facility, which is basedon the size of the aggregate outstanding loan portfolio. These fees reduced theamount of the management fee due to our Adviser as noted above. Loan servicingfees for the nine months ending December 31, 2008 remained steady whencompared to the prior year period in conjunction with comparable loan portfoliobalances for the two periods.

 

Base management fee was $1,303 for the nine months ended December 31,2008, as compared to $1,310 for the comparable prior year period. The basemanagement fee is computed quarterly as described under “*InvestmentAdvisory and Management Agreement*” in Note 4 of the condensedconsolidated financial statements, and is summarized in the table below:

 
| ** **                                                                     | ** ** | **Nine months ended** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                     | ** ** | **December 31,  2008**     | ** ** | **December 31,  2007** | ** ** |
| **Base management fee**                                                        |       | $                               | 1,303      |   | $ | 1,310 |   |
|                                                                           |       |                            |       |   |   |
| Credits to base management fee from  Adviser:                                  |       |                            |       |   |   |
| Credit for fees received by Adviser from  the portfolio companies              |       | (744                            | )          | (688 | ) |
| Fee reduction for the waiver of 2% fee on  senior syndicated loans to 0.5% (1) |       | (1,220                          | )          | (1,244 | ) |
| **Credit to base management fee from Adviser**                                 |       | (1,964                          | )          | (1,932 | ) |
|                                                                           |       |                            |       |   |   |
| **Net base management fee**                                                    | ** ** | **$**                           | **(661**   | **)** | **$** | **(622** | **)** |

 

----

(1)           The board of ourAdviser voluntarily waived the annual 2.0% base management fee to 0.5% forsenior syndicated 

 

36

----

Table of Contents

 

loanparticipations to the extent that proceeds resulting from borrowings were usedto purchase such syndicated loan participations.

 

The administration fee payable to our Administrator was $642 for thenine months ended December 31, 2008, as compared to $647 for thecomparable prior year period. 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 that are undersimilar administration agreements with our Administrator. Administration feesfor the comparable periods remained constant, as our total assets in relationto the other funds serviced by our Administrator were relatively even.

 

Interest expense for the nine months ended December 31, 2008 was$4,009, as compared to $5,819 for the comparable prior year period. Interestexpense results from borrowings on our credit facility. Interest expensedecreased during the current nine month period due to decreased borrowings onour credit facility when compared to the prior year period, as the majority ofthe proceeds from our rights offering were used to pay down the outstandingbalance. While there was an increase in the interest rate margin chargedon the outstanding borrowings upon renewing the facility on October 16,2008, the LIBOR base rate decrease during the period offset this interest ratemargin increase.

 

Amortization of deferred finance costs was $324 for the nine monthsended December 31, 2008, as compared to $595 for the comparable prior yearperiod. These costs are directly attributable to the amortization of thecapitalized finance costs associated with our credit facility, which have beenrealized in full and are no longer being amortized. At December 31,2008, all deferred finance costs had been fully amortized.

 

Professional fees were $383 for the nine months ended December 31,2008, as compared to $356 for the comparable prior year period. Professionalfees primarily consist of legal, fees and audit and accounting fees. The modestincrease is mainly due to an increase in direct consulting and legal feesincurred on potential investments, as well as a slight increase in audit feesfor the same comparable periods.

 

Stockholder related costs were $413 for the nine months ended December 31,2008, as compared to $220 for the comparable prior year period. Stockholderrelated costs consist of the amortization of annual Nasdaq listing fees,transfer agent fees, annual report printing and distribution, and other annualmeeting costs, costs associated with SEC filings and press release costs. Theincrease is primarily attributed to additional expenses incurred related to thesolicitation of stockholder proxy votes for our annual meeting of stockholdersin August 2008.

 

Insurance expense was $165 for the nine months ended December 31,2008, as compared to $183 for the comparable prior year period. Insuranceexpense consists of the amortization of the directors and officers insurancepolicy and professional liability policy premiums, and the decrease is directlyattributable to a reduction in these premiums for the current policy period.

 

Directors’ fees were $145 for the nine months ended December 31,2008, as compared to $177 for the comparable prior year period. Directors’ feesconsist of the amortization of the directors’ annual stipend and individualmeeting fees. The decrease is due to fewer committee meetings held in thecurrent year period.

 

Taxes and licenses expense was $83 for the nine months ended December 31,2008, as compared to $125 for the comparable prior year period. These expensesconsist primarily of franchise taxes due to the state of Delaware and otherfees surrounding state and regulatory licensing, registration and othercorporate filing fees.  The decrease ismainly attributable to a reduction in the quarterly accrual for estimated taxesand license fees.

 

General and administrative expenses were $163 for the nine months endedDecember 31, 2008, as compared to $130 for the comparable prior yearperiod. General and administrative expenses consist primarily of direct expensessuch as travel related specifically to our portfolio companies, loan evaluationservices for our portfolio companies and backup servicer expenses. The overallincrease is mainly due to capitalized costs incurred in relation to potentialinvestments that were not executed and were thus expensed in the currentperiod.

 

**Realized and Unrealized Loss on Investments**

 

For the nine months ended December 31, 2008, we recognized a netloss on the sale of nine syndicated loan participations and the write off ofanother senior syndicate loan for an aggregate net loss on sale ofnon-control/non-affiliate investments of 

 

37

----

Tableof Contents

 

$4.2 million, and we recorded net unrealized depreciation ofinvestments in the aggregate amount of $13.7 million. For the nine months endedDecember 31, 2007, we recognized a net loss of $198 resulting fromadditional legal expenses incurred in connection with the sale of one of oursenior syndicated loans during the first quarter of fiscal year 2008. Werecorded net unrealized depreciation of investments in the aggregate of $424for the nine months ended December 31, 2007.

 

Unrealizeddepreciation for the nine months ended December 31, 2008 of approximately$13.7 million was primarily from our Affiliate investments, which partially wasoffset by appreciation in our Control investments.  Our Affiliate investments depreciated invalue by approximately $13.7 million, particularly in Danco, Noble, andQuench.  Our Non-Control/Non-Affiliateinvestments also experienced decreases in value of $7.7 million, specificallyInterstate Fibernet, Kronos, and RPG. Our Control investments appreciated in value by an aggregate amount ofapproximately $7.7 million, led by Chase and Galaxy.

 

We believe that our investment portfolio was valued at a depreciatedvalue due primarily to the general instability of the loan markets.Additionally, our equity investments in two Control investments with anaggregate cost of $3.6 million have been written down to $0 fair value.Although our investment portfolio has depreciated, our entire portfolio wasfair valued at 92% of cost as of December 31, 2008.  The unrealized depreciation of our investmentsdoes not have an impact on our current ability to pay distributions tostockholders; however, it may be an indication of future realized losses, whichcould ultimately reduce our income available for distribution.

 

**Derivatives**

 

Forboth the nine months ended December 31, 2008 and 2007, we recordedunrealized appreciation of our interest rate cap agreements purchased in October 2007and February 2008 at nominal amounts.

 

**Net (Decrease) Increase in Net AssetsResulting from Operations**

 

Overall, we realized a net decrease in net assets resulting fromoperations of $7,467 for the nine months ended December 31, 2008 as aresult of the factors discussed above. Our net (decrease) increase in netassets resulting from operations per basic and diluted weighted average commonshare for the nine months ended December 31, 2008 and 2007 was ($0.35) and$0.54, respectively. For the nine months ended December 31, 2007, werealized a net increase in net assets resulting from operations of $9,012. Wewill continue to incur base management fees, which will increase with anygrowth in our investment portfolio, and we may begin to incur incentivefees.  Our administrative expensespayable to our Administrator could also grow during future periods if ouraverage assets increase and the expenses incurred by our Administrator tosupport our operations grow.

 

**LIQUIDITY AND CAPITALRESOURCES (dollar amounts inthousands, unless otherwise indicated)**

 

**Operating Activities**

 

Net cash provided by operating activities for the nine months ended December 31,2008 was approximately $5.6 million and consisted primarily of principal loanrepayments, net unrealized depreciation of our investments, and the sale ofexisting portfolio investments, offset by the purchase of two new Control investmentsand one new affiliate investment. Net cash used in operatingactivities for the nine months ended December 31, 2007 was approximately$63.1 million and consisted primarily of the purchase of new investments,offset by quarterly income, principal loan repayments, proceeds from sales ofportfolio investments and a decrease in the amount due from our custodian.

 

A summary of our investment activity for the nine months ended December 31,2008 and December 31, 2007 is as follows:

 

38

----

Table of Contents

 
| **Quarter Ended**  | ** ** | **New Investments** | ** ** | **Principal Repayments** | ** ** | **Investments Sold** | ** ** | **Realized Losses** | ** ** |
|-------------------------|------------|--------------------------|------------|-------------------------------|------------|---------------------------|------------|--------------------------|------------|
| June 30, 2008      |       | $                        | 8,980      |                          | $          | 3,493                     |       | $                        | 13,246     |   | $ | (1,717 | ) |
| September 30, 2008 |       | 27,632                   |       | 18,791                        |       | 50                        |       | (2,498                   | )          |
| December 31, 2008  |       | 11,043                   |       | 4,469                         |       | —                    |       | —                   |       |
| **Total**               |       | $                        | 47,655     |                          | $          | 26,753                    |       | $                        | 13,296     |   | $ | (4,215 | ) |

 
|                    |       |                     |       |                          |       |                      |       |                     |       |
|-------------------------|------------|--------------------------|------------|-------------------------------|------------|---------------------------|------------|--------------------------|------------|
| **Quarter Ended**  | ** ** | **New Investments** | ** ** | **Principal Repayments** | ** ** | **Investments Sold** | ** ** | **Realized Losses** | ** ** |
| June 30, 2007      |       | $                        | 72,601     |                          | $          | 21,358                    |       | $                        | 5,810      |   | $ | (48 | ) |
| September 30, 2007 |       | 41,183                   |       | 16,948                        |       | —                    |       | (4                       | )          |
| December 31, 2007  |       | 43,551                   |       | 21,417                        |       | 9,887                     |       | (146                     | )          |
| **Total**               |       | $                        | 157,335    |                          | $          | 59,723                    |       | $                        | 15,697     |   | $ | (198 | ) |

 

The following table summarizes the contractual principal repayment andmaturity of our investment portfolio by fiscal year, assuming no voluntaryprepayments:
| ** **                                            |       |                                    |       |       |        |   |   |   |   |   |   |   |   |
|-------------------------------------------------------|------------|-----------------------------------------|------------|------------|-------------|--------|--------|--------|--------|--------|--------|--------|--------|
| ** **                                            | ** ** | ** **                              | ** ** | **Amount** | ** **  |
| For the remaining three months ending  March 31: |       | 2009                                    |       | $          | 5,499       |   |
| For the fiscal year ending March 31:             |       | 2010                                    |       | 14,057     |        |
|                                                  |       | 2011                                    |       | 33,537     |        |
|                                                  |       | 2012                                    |       | 78,579     |        |
|                                                  |       | 2013                                    |       | 27,341     |        |
|                                                  |       | 2014                                    |       | 98,545     |        |
|                                                  |       | Thereafter                              |       | 51,239     |        |
| ** **                                            | ** ** | **Total contractual repayments**        |       | **$**      | **308,797** |   |
|                                                  |       | Investments in equity securities        |       | 45,322     |        |
|                                                  |       | Unamortized premiums on debt securities |       | 50         |        |
| ** **                                            | ** ** | **Total**                               |       | **$**      | **354,169** |   |
|                                                       |            |                                         |            |            |             |        |        |        |        |        |        |        |        |  |  |  |  |  |  |

 

**Financing Activities**

 

Duringthe nine months ended December 31, 2008, net cash used in financingactivities was approximately $1.8 million, which was primarily a result ofrepayments on our line of credit in excess of borrowings by approximately $27.0million, in addition to our distributions paid to stockholders of $15.5million.  This was partially offset,however, by the Rights Offering (defined below), which provided net proceeds of$40.6 million.

 

*Issuance of Equity*

 

During fiscal year 2007, wefiled a registration statement with the SEC, (“the Registration Statement”),that permits us to issue, through one or more transactions, up to an aggregateof $300 million in securities, consisting of common stock, preferred stock,subscription rights and/or debt securities, of which, to date, we have issued$41.3 million in common stock, which leaves a remaining capacity of $258.7million. To date, we have incurred approximately $695,000 of costs inconnection with the Registration Statement.

 

We anticipate issuing equitysecurities to obtain additional capital in the future. However, we cannotdetermine the terms of any future equity issuances or whether we will be ableto issue equity on terms favorable to us, or at all. Additionally, when ourcommon stock is trading below net asset value, we will have regulatoryconstraints under the 1940 Act on our ability to obtain additional capital inthis manner. At December 31, 2008, our stock closed trading at $4.91,representing a 48% discount to our net asset value of $10.15 per share.Generally, the 1940 Act provides that we may not issue stock for a price belownet asset value per share, without first obtaining the approval of ourstockholders and our independent directors or through a rights offering.

 

We raised additional capitalwithin these regulatory constraints in April 2008 through an offering oftransferable subscription rights to purchase additional shares of common stock,which we refer to as the Rights Offering. Pursuant to the Rights Offering, wesold 5,520,033 shares of our common stock at a subscription price of $7.48,which represented a purchase price equal to 93% of the weighted average closingprice of our stock in the last five trading days of the subscription period.Net proceeds of the offering, after offering expenses borne by us, wereapproximately $40.6 million and were used to repay outstanding borrowings underour line of credit. Should our common stock continue to trade below its netasset value per share, we may seek to conduct similar offerings in the futurein order to raise additional capital, although there can be no assurance thatwe will be successful in our efforts to raise capital.

 

39

----

Table of Contents

 

*Future Capital Resources*

 

During our annual stockholders meeting on August 7, 2008, ourstockholders approved a proposal that allows us to issue long-term rights,including warrants to purchase shares of our common stock at an exercise priceper share that will not be less than the greater of the market value or netasset value of our common stock at a time such rights may be issued.

 

During our annualstockholders meeting on August 7, 2008, our stockholders also approved aproposal that now allows us to sell shares of our common stock at a price belowour then current net asset value per share should we choose to do so. Thisproposal is in effect until our next annual stockholders meeting.

 

**Revolving Credit Facility**

 

Through our wholly-ownedsubsidiary, Business Investment, we initially obtained a $100 million revolvingcredit facility (the “Credit Facility”). On October 19, 2006, we executeda purchase and sale agreement pursuant to which we agreed to sell certain loansto Business Investment in consideration for a membership interest therein.Simultaneously, Business Investment executed a credit agreement the (“CreditAgreement”) with Deutsche Bank AG, New York Branch, as administrative agent,and others, pursuant to which Business Investment pledged the loans purchasedfrom us to secure future advances by certain institutional lenders.Availability under the Credit Facility was subsequently amended and extendedsuch that the borrowing capacity was raised to $200 million.

 

On October 16, 2008,the Credit Facility was further amended and extended such that the borrowingcapacity was reduced to $125 million and availability under the Credit Facilitywas extended to April 16, 2009. If the Credit Facility is not renewed orextended, all principal and interest will be immediately due and payable on April 16,2009. There can be no guarantee that we will be able to renew, extend orreplace the credit facility on terms that are favorable to us, or at all. Ourability to obtain replacement financing will be constrained by current economicconditions affecting the credit markets, which have  significantly deteriorated over the lastseveral months and may further decline. Consequently, any renewal, extension orrefinancing of the credit facility will likely result in significantly higherinterest rates and related charges and may impose significant restrictions onthe use of borrowed funds with regard to our ability to fund investments. Anyadvances under the Credit Facility will generally bear interest at thecommercial paper rate plus 3.5% per annum, with a commitment fee of 0.75% perannum on the undrawn amounts. There was no fee in connection with this renewal.As of January 6, 2009, there was an outstanding principal balance of$115.8 million under the Credit Facility at an interest rate of 2.4%, plus anadditional fee related to borrowings of 3.5%, for an aggregate rate ofapproximately 5.9%. Available borrowings are subject to various constraintsimposed under the Credit Agreement, based on the aggregate loan balance pledgedby Business Investment, which varies as loans are added and repaid, regardlessof whether such repayments are early prepayment or are made as contractuallyrequired. At January 6, 2009, the remaining borrowing capacity availableunder the Credit Facility was approximately $9.2 million.

 

The Credit Facility containscovenants that require Business Investment to maintain its status as a separateentity; prohibit certain significant corporate transactions (such as mergers,consolidations, liquidations or dissolutions); and restrict material changes toour credit and collection policies. The facility also restricts some of theterms and provisions (including interest rates, terms to maturity and secureadvances. As of December 31, 2008, Business Investment was in compliancewith all of the facility covenants.

 

The administrative agentalso requires that any interest or principal payments on pledged loans beremitted directly by the borrower into lockbox accounts controlled by DeutscheBank. Once a month, Deutsche Bank remits the collected funds to the Companyafter payment of any interest and expenses provided for under the CreditAgreement.

 

Our Adviser services theloans pledged under the Credit Facility. As a condition to this servicingarrangement, we executed a performance guaranty pursuant to which we guaranteedthat our Adviser would comply fully with all of its obligations under theCredit Facility. The performance guaranty requires us to maintain a minimum networth of $100 million and to maintain ‘‘asset coverage’’ with respect to ‘‘seniorsecurities representing indebtedness’’ of at least 200%, in accordance with Section 18if the 1940 Act. As of December 31, 2008, we were in compliance with ourcovenants under the performance guaranty.

 

However, our continuedcompliance with these covenants depends on many factors, some of which arebeyond our control. In particular, depreciation in the valuation of our assets,which valuation is subject to changing market 

 

40

----

Table of Contents

 

conditions which arepresently very volatile, affects our ability to comply with these covenants. Duringthe nine months ended December 31, 2008, net unrealized depreciation onour investments was approximately $13.7 million, compared to $424 during thecomparable period in the prior year. Given the continued deterioration in thecapital markets, net unrealized depreciation in our portfolio may continue toincrease in future periods and threaten our ability to comply with thecovenants under our Credit Facility. Accordingly, there are no assurances thatwe will continue to comply with these covenants. Failure to comply with thesecovenants would result in a default which, if we were unable to obtain a waiverfrom the lenders, could accelerate our repayment obligations under the CreditFacility and thereby have a material adverse impact on our liquidity, financialcondition, results of operations and ability to pay dividends.

 

Availability under theCredit Facility will terminate on April 16, 2009.  If the Credit Facility is not renewed orextended by this date, all principal and interest will be immediately due andpayable.  There can be no guarantee thatwe will be able to renew, extend or replace the credit facility on terms thatare favorable to us, or at all.  Ourability to obtain replacement financing will be constrained by current economicconditions affecting the credit markets, which have significantly deterioratedover the last several months and may decline further.  Consequently, any renewal, extension orrefinancing of the Credit Facility will likely result in significantly higherinterest rates and related charges and may impose significant restrictions onthe use of borrowed funds with regard to our ability to fund investments ormaintain dividends.  For instance, inconnection with our most recent renewal, the size of the Credit Facility was reducedfrom $200 million to $125 million.  If weare not able to renew, extend or refinance the Credit Facility, this wouldlikely have a material adverse effect on our liquidity and ability to fund newinvestments or maintain our dividends.  Ourinability to pay dividends could result in us failing to qualify as a RIC.  Consequently, any income or gains couldbecome taxable at corporate rates. Ifwe are unable to secure replacement financing, we may be forced to sell certainassets on disadvantageous terms, which may result in realized losses, and suchrealized losses could materially exceed the amount of any unrealizeddepreciation on these assets as of our most recent balance sheet date, whichwould have a material adverse effect on our results of operations.  In addition to selling assets, or as analternative, we may issue equity in order to repay amounts outstanding underthe Credit Facility.  Based on the recenttrading prices of our stock, such an equity offering may have a substantialdilutive impact on our existing stockholders’ interest in our earnings andassets and voting interest in us.

 

**Distributions**

 

Inorder to qualify as a RIC, we are required, under Subchapter M of the Code, todistribute at least 90% of our ordinary income and short-term capital gains toour stockholders on an annual basis. In accordance with these requirements, wedeclared and paid monthly cash distributions of $0.08 per common share forOctober, November and December 2008. In January 2009, our Boardof Directors declared a monthly distribution of $0.08 per common share for eachof January, February and March 2009.

 

Forthe three months ended December 31, 2008, our distribution payments ofapproximately $5.3 million exceeded our net investment income by approximately$1.7 million. We declared these distributions based on our estimates of netinvestment income for the fiscal year. Our investment pace continues to beslower than expected in our third year of operations and, consequently, our netinvestment income was lower than our original estimates.

 

**Contractual Obligations and Off-Balance Sheet Arrangements**

 

Wewere not a party to any signed term sheets for potential investments or anyoff-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K as of December 31, 2008.

 

InOctober 2008, the Company executed a guaranty of a vehicle financefacility agreement between Ford Motor Credit Company (“FMC”) and Auto SafetyHouse, LLC (“ASH”), one of the Company’s control investments (the “FinanceFacility”).  The Finance Facility provides ASH with a line of credit of upto $500,000 for component Ford parts used by ASH to build truck bodies under aseparate contract.  Title and ownership of the parts is retained by Ford.The guaranty of the Finance Facility will expire upon termination of theseparate parts supply contract with Ford or upon replacement of the Company asguarantor.  The Finance Facility is secured by the assets of theCompany.  As of December 31, 2008, the Company has not been requiredto make any payments on the guaranty of the Finance Facility.

 

**Critical Accounting Policies**

 

The preparation of financial statements and related disclosures inconformity with accounting principles generally accepted in the United States (“GAAP”)requires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, and disclosure of contingent assets andliabilities at the date of the financial statements, and revenues and expensesduring the period reported. Actual results could differ materially from thoseestimates. We have identified our investment valuation process which wasamended for the quarter ended December 31, 2008, which is presented below,as our most critical accounting policy.

 

41

----

Table of Contents

 

***Investment Valuation***

 

Themost significant estimate inherent in the preparation of our condensedconsolidated financial statements is the valuation of investments and therelated amounts of unrealized appreciation and depreciation of investmentsrecorded.

 

GeneralValuation Policy:  We value ourinvestments in accordance with the requirements of the 1940 Act.  As discussed more fully below, we valuesecurities for which market quotations are readily available and reliable attheir market value.  We value all othersecurities and assets at fair value as determined in good faith by our Board ofDirectors.

 

*Investment Valuation Policy*

 

The most significant estimate inherent in the preparation of ourconsolidated financial statements is the valuation of investments and therelated amounts of unrealized appreciation and depreciation of investmentsrecorded.

 

*General Valuation Policy:*  We value our investments in accordance withthe requirements of the 1940 Act.  Asdiscussed more fully below, we value securities for which market quotations arereadily available and reliable at their market value.  We value all other securities and assets atfair value as determined in good faith by our Board of Directors.

 

We use generally accepted valuation techniques to value our portfoliounless we have specific information about the value of an investment todetermine otherwise. From time to time we may accept an appraisal of a businessin which we hold securities. These appraisals are expensive and occurinfrequently but provide a third-party valuation opinion that may differ inresults, techniques and scopes used to value our investments.  When these specific third-party appraisalsare engaged or accepted, we would use such appraisals to value the investmentwe have in that business if we determined that the appraisals were the bestestimate of fair value.

 

In determining the value of our investments, our Adviser has establishedan investment valuation policy (the “Policy”). The Policy has been approved by our Board of Directors and each quarterthe Board of Directors reviews whether our Adviser has applied the Policyconsistently, and votes whether or not to accept the recommended valuation ofour investment portfolio.

 

The Policy, which is summarized below, applies to the followingcategories of securities:

 
| · | Publicly-traded securities;                       |
|--------|---------------------------------------------------|
| · | Securities for which a limited market exists; and |
| · | Securities for which no market exists.            |

 

*Valuation Methods*

 

**Publicly-traded securities:** We determine thevalue of publicly-traded securities based on the closing price for the securityon the exchange or securities market on which it is listed and primarily tradedon the valuation date. To the extent that we own restricted securities that arenot freely tradable, but for which a public market otherwise exists, we willuse the market value of that security adjusted for any decrease in valueresulting from the restrictive feature.

 

**Securities for which a limited market exists:**Wevalue securities that are not traded on an established secondary securitiesmarket, but for which a limited market for the security exists, such as certainparticipations in, or assignments of, syndicated loans, at the quoted bidprice.  In valuing these assets, weassess trading activity in an asset class, evaluate variances in prices andother market insights to determine if any available quote prices are reliable.  If we conclude that quotes based on activemarkets or trading activity may be relied upon, firm bid prices are requested;however, if a firm bid price is unavailable, we base the value of the securityupon the indicative bid price offered by the respective originating syndicationagent’s trading desk, or secondary desk, on or near the valuation date.  To the extent that we use the indicative bidprice as a basis for valuing the security, our Adviser may take further stepsto consider additional information to validate that price in accordance withthe Policy.

 

In the event these limited markets become illiquid such that marketprices are no longer readily available, we will value our syndicated loansusing estimated net present values of the future cash flows or discounted cashflows (“DCF”). The use of a DCF methodology follows that prescribed by FASBStaff Position No. 157-3, “*Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive”* (“FSP No. 157-3”), which provides guidance on the useof a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in the FSP No. 157-3 is the use ofvaluing investments based on DCF.  Forthe purposes of using DCF to provide fair value 

 

42

----

Table of Contents

 

estimates, we considered multiple inputs such as a risk-adjusteddiscount rate that incorporates adjustments that market participants would makeboth for nonperformance and liquidity risks. As such, we developed a modified discount rate approach that incorporatesrisk premiums including, among others, increased probability of default, orhigher loss given default, or increased liquidity risk.

 

The DCF valuations applied to the syndicatedloans provide an estimate of what we believe a market participant would pay topurchase a syndicated loan in an active market, thereby establishing a fairvalue.  We will continue to apply the DCFmethodology in illiquid markets until quoted prices based on trading activityare deemed reliable.

 

**Securities for which no market exists:** The valuation methodology for securities forwhich no market exists falls into three categories: (1) portfolioinvestments comprised solely of debt securities; (2) portfolio investmentsin controlled companies comprised of a bundle of securities, which can includedebt and equity securities; and (3) portfolio investments innon-controlled companies comprised of a bundle of securities, which can includedebt and/or equity securities.

 

(1)         **Portfolio investments comprisedsolely of debt securities:**Debt securities that are not publicly traded on an established securitiesmarket, or for which a limited market does not exist (“Non-Public DebtSecurities”), and that are issued by portfolio companies where we have noequity, or equity-like securities, are fair valued in accordance with the termsof the policy, which utilizes opinions of value submitted to us by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”).

 

In the case of Non-Public Debt Securities, we haveengaged SPSE to submit opinions of value for our debt securities that areissued by portfolio companies in which we own no equity, or equity-likesecurities. SPSE’s opinions of value are based on the valuations prepared byour portfolio management team as described below. We request that SPSE also evaluateand assign values to success fees (conditional interest included in some loansecurities) when we determine that the probability of receiving a success feeon a given loan is above 6-8%, a threshold of significance. SPSE will onlyevaluate the debt portion of our investments for which we specifically requestevaluation, and may decline to make requested evaluations for any reason at itssole discretion. Upon completing our collection of data with respect to theinvestments (which may include the information described below under “CreditInformation,” the risk ratings of the loans described below under “Loan Gradingand Risk Rating” and the factors described hereunder), this valuation data isforwarded to SPSE for review and analysis. SPSE makes its independentassessment of the data that we have assembled and assesses its independent datato form an opinion 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 arereflective of what SPSE believes the bid side of the market would be for eachloan after careful review and analysis of descriptive, market and creditinformation. Each price reflects SPSE’s best judgment based upon carefulexamination of a variety of market factors. Because of fluctuation in themarket and in other factors beyond its control, SPSE cannot guarantee theseevaluations. The evaluations reflect the market prices, or estimates thereof,on the date specified. The prices are based on comparable market prices forsimilar securities. Market information has been obtained from reputablesecondary market sources. Although these sources are considered reliable, SPSEcannot guarantee their accuracy.

 

SPSE opinions of value of our debt securities thatare issued by portfolio companies where we have no equity, or equity-likesecurities are submitted to our Board of Directors along with our Adviser’ssupplemental assessment and recommendation regarding valuation of each of theseinvestments. Our Adviser generally accepts the opinion of value given by SPSE,however, in certain limited circumstances, such as when our Adviser may learnnew information regarding an investment between the time of submission to SPSEand the date of the Board assessment, our Adviser’s conclusions as to value maydiffer from the opinion of value delivered by SPSE. Our Board of Directors thenreviews whether our Adviser has followed its established procedures fordeterminations of fair value, and votes to accept or reject the recommendedvaluation of our investment portfolio. Our Adviser and our managementrecommended, and the Board of Directors voted to accept, the opinions of valuedelivered by SPSE on the loans in our portfolio as denoted on the Schedule ofInvestments as of December 31, 2008 included in our accompanyingconsolidated financial statements.

 

Because there is a delay between when we close aninvestment and when the investment can be evaluated by SPSE, new loans are notvalued immediately by SPSE; rather, management makes its own determinationabout the value of these investments in accordance with our valuation policyusing the methods described herein.

 

(2)         **Portfolio investments incontrolled companies comprised of a bundle of investments, which can includedebt and/or equity securities:**For our Non-Public Debt Securities and equity or equity-like securities (e.g.preferred equity, equity, or other equity-like securities) that are purchasedtogether as part of a package, where the we have control or 

 

43

----

Table of Contents

 

could gain control throughan option or warrant security, both the debt and equity securities of theportfolio investment would exit in the mergers and acquisition market as theprincipal market, generally through a sale or recapitalization of the portfoliocompany. Further, we believe that the in-use premise of value (as defined inSFAS 157), which assumes the debt and equity securities are sold together,is appropriate as this would provide maximum proceeds to the seller. As aresult, we will continue to use the enterprise value methodology utilizing aliquidity waterfall approach to determine the fair value of these investmentsunder SFAS 157 if we have the ability to initiate a sale of a portfoliocompany as of the measurement date. Under this approach, we first calculate thetotal enterprise value of the issuer by incorporating some or all of thefollowing factors:

 
| · | the issuer’s ability to make payments;          |
|--------|------------------------------------------------------|
| · | the earnings of the issuer;                          |
| · | recent sales to third parties of similar securities; |
| · | the comparison to publicly traded securities; and    |
| · | discounted cash flow or other pertinent factors.     |

 

In gathering the sales to third parties of similarsecurities, we may reference industry statistics and use outside experts. Oncewe have estimated the total enterprise value of the issuer, we subtract thevalue of all the debt securities of the issuer; which are valued at thecontractual principal balance. Fair values of these debt securities arediscounted for any shortfall of total enterprise value over the total debtoutstanding for the issuer. Once the values for all outstanding seniorsecurities (which include the debt securities) have been subtracted from thetotal enterprise value of the issuer, the remaining amount, if any, is used todetermine the value of the issuer’s equity or equity like securities.

 

(3)         **Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and/or equity securities:** We value Non-Public Debt Securities that are purchased together withequity and equity-like securities from the same portfolio company, or issuer,for which the we do not control or cannot gain control as of the measurementdate, using a hypothetical secondary market as our principal market. Inaccordance with SFAS 157, we determine the fair value of these debt securitiesof non-control investments assuming the sale of an individual debt securityusing the in-exchange premise of value (as defined in SFAS 157). As such, weestimate the fair value of the debt component using estimates of value providedby SPSE and our own assumptions in the absence of market observable data,including synthetic credit ratings, estimated remaining life, current marketyield and interest rate spreads of similar securities as of the measurementdate. For equity and equity-like securities of investments for which we do notcontrol or cannot gain control as of the measurement date, we value the equityportion based principally on the total enterprise value of the issuer, which iscalculated using a liquidity waterfall approach.

 

Due to the uncertainty inherent in the valuationprocess, such estimates of fair value may differ significantly from the valuesthat would have been obtained had a ready market for the securities existed,and the differences could be material. Additionally, changes in the marketenvironment and other events that may occur over the life of the investmentsmay cause the gains or losses ultimately realized on these investments to bedifferent than the valuations currently assigned. There is no single standardfor determining fair value in good faith, as fair value depends uponcircumstances of each individual case. In general, fair value is the amountthat we might reasonably expect to receive upon the current sale of thesecurity in an arms-length transaction in the security’s principal market.

 

*Valuation Considerations: *From time to time, depending on certain circumstances, the Adviser mayuse the following valuation considerations, including but not limited to:

 
| · | the nature and realizable  value of any collateral;                                                        |
|--------|------------------------------------------------------------------------------------------------------------|
| · | the portfolio company’s  earnings and cash flows and its ability to make payments on its obligations; |
| · | the markets in which the  portfolio company does business;                                                 |
| · | the comparison to publicly  traded companies; and                                                          |
| · | discounted cash flow and  other relevant factors.                                                          |

 

Because such valuations,particularly valuations of private securities and private companies, are notsusceptible to precise determination, may fluctuate over short periods of time,and may be based on estimates, our determinations of fair value may differ fromthe values that might have actually resulted had a readily available market forthese securities been available.

 

44

----

Table of Contents

 

*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 our Adviser participate in the periodic boardmeetings of our portfolio companies in which we hold Control and Affiliateinvestments and also require them to provide annual audited and monthlyunaudited financial statements. Using these statements and board discussions,our Adviser calculates and evaluates the credit statistics.

 

*Loan Grading and Risk Rating:*  Aspart of our valuation procedures above, we risk rate all of our investments indebt securities. For syndicated loans that have been rated by a NRSRO (asdefined in Rule 2a-7 under the 1940 Act), we use the NRSRO’s risk ratingfor such security. For all other debt securities, we use a proprietary riskrating system. Our risk rating system uses a scale of 0 to 10, with 10 beingthe lowest probability of default. This system is used to estimate theprobability of default on debt securities and the probability of loss if thereis a default. These types of systems are referred to as risk rating systems andare used by banks and rating agencies. The risk rating system covers bothqualitative and quantitative aspects of the business and the securities wehold.

 

Forthe debt securities for which we do not use a third-party NRSRO risk rating, weseek to have our risk rating system mirror the risk rating systems of majorrisk rating organizations, such as those provided by a NRSRO. While we seek tomirror the NRSRO systems, we cannot provide any assurance that our risk ratingsystem will provide the same risk rating as a NRSRO for these securities. Thefollowing chart is an estimate of the relationship of our risk rating system tothe designations used by two NRSROs as they risk rate debt securities of majorcompanies. Because our system rates debt securities of companies that are unratedby any NRSRO, there can be no assurance that the correlation to the NRSRO setout below is accurate. We believe our risk rating would be significantly higherthan a typical NRSRO risk rating because the risk rating of the typical NRSROis designed for larger businesses. However, our risk rating has been designedto risk rate the securities of smaller businesses that are not rated by atypical NRSRO. Therefore, when we use our risk rating on larger businesssecurities, the risk rating is higher than a typical NRSRO rating. The primarydifference between our risk rating and the rating of a typical NRSRO is thatour risk rating uses more quantitative determinants and includes qualitativedeterminants that we believe are not used in the NRSRO rating. It is ourunderstanding that most debt securities of medium-sized companies do not exceedthe grade of BBB on a NRSRO scale, so there would be no debt securities in themiddle market that would meet the definition of AAA, AA or A. Therefore, ourscale begins with the designation 10 as the best risk rating which may beequivalent to a BBB from a NRSRO, however, no assurance can be given that a 10on our scale is equal to a BBB on a NRSRO scale.

 

45

----

Table of Contents

 
| **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% 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% 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 of default and the EL is greater than  20%                            |

 

----

| (a) | *The default rates set forth are for a ten year term  debt security. If a debt security is less than ten years, then the PD is  adjusted to a lower percentage for the shorter period, which may move the  security higher on our risk rating scale.* |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Theabove scale gives an indication of the probability of default and the magnitudeof the loss if there is a default. Our policy is to stop accruing interest onan investment if we determine that interest is no longer collectible. At December 31,2008 and March 31, 2008, two investments were on non-accrual for anaggregate, at cost, of approximately $11.5 million and $8.9 million,respectively. Additionally, we do not risk rate our equity securities.

 

Thefollowing table lists the risk ratings for all non-syndicated loans in ourportfolio at December 31, 2008 and March 31, 2008, representingapproximately 59% and 51%, respectively, of all loans in our portfolio at theend of each period:

 
| **Rating**       | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|------------------|------------|---------------------------------|------------|------------------------------|------------|
| Highest          |       | 7.0                             |       | 7.0                          |       |
| Average          |       | 5.4                             |       | 5.5                          |       |
| Weighted Average |       | 5.0                             |       | 5.1                          |       |
| Lowest           |       | 2.0                             |       | 1.0                          |       |

 

Thefollowing table lists the risk ratings for syndicated loans in our portfoliothat were not rated by a NRSRO at December 31, 2008 and March 31,2008, representing approximately 12% and 13%, respectively, of all loans in ourportfolio at the end of each period:

 
| **Rating**       |   | **December 31, 2008** |   | **March 31, 2008** |   |
|------------------|--------|---------------------------------|--------|------------------------------|--------|
| Highest          |   | 9.0                             |   | 9.0                          |   |
| Average          |   | 7.9                             |   | 7.1                          |   |
| Weighted Average |   | 7.8                             |   | 7.3                          |   |
| Lowest           |   | 7.0                             |   | 1.0                          |   |

 

Forsyndicated loans that are currently rated by a NRSRO, we risk rate such loansin accordance with the risk rating systems of major risk rating organizations,such as those provided by a NRSRO. The following table lists the risk ratingsfor all syndicated loans in our portfolio that were rated by a NRSRO at December 31,2008 and March 31, 2008, representing approximately 29% and 36%,respectively, of all loans in our portfolio at the end of each period:

 
| **Rating**       |   | **December 31, 2008** |   | **March 31, 2008** |   |
|------------------|--------|---------------------------------|--------|------------------------------|--------|
| Highest          |   | BB/Ba2                          |   | BB/Ba2                       |   |
| Average          |   | B/B2                            |   | B+/B1                        |   |
| Weighted Average |   | B/B2                            |   | B+/B1                        |   |
| Lowest           |   | CCC+/D                          |   | CCC+/B2                      |   |

 

**Tax Status**

 

Weintend to continue to qualify for treatment as a RIC under Subtitle A,Chapter 1 of Subchapter M of the Code. As a RIC, we are not subjectto 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 distribution up to 100% of thoseamounts.

 

46

----

Tableof Contents

 

Inan effort to avoid certain excise taxes imposed on RICs, we currently intend todistribute during each calendar year, an amount at least equal the sum of (1) 98%of our ordinary income for the calendar year, (2) 98% of our capital gainsin excess of capital losses for the one-year period ending on October 31of the calendar year, and (3) any ordinary income and net capital gainsfor preceding years that were not distributed during such years.

 

**Revenue Recognition**

 

*Interest and Dividend Income Recognition*

 

Interestincome is recorded on the accrual basis to the extent that such amounts areexpected to be collected. We will stop accruing interest on investments when itis determined that interest is no longer collectible. At December 31,2008, one Non-Control/Non-Affiliate investment was on non-accrual with a costbasis of approximately $4.6 million, or 1.5% of the cost basis of allloans in our portfolio, and one Control investment was on non-accrual with acost basis of approximately $6.9 million, or 2.2% of the cost basis of allloans in our portfolio. At March 31, 2008, one Non-Control/Non-Affiliateinvestment was on non-accrual with a cost basis of approximately$2.9 million, or 0.9% of the cost basis of all loans in our portfolio, andone Control investment was on non-accrual with a cost basis of approximately$6.0 million, or 1.9% of the cost basis of all loans in our portfolio.Conditional interest, or a success fee, is recorded when earned upon fullrepayment of a loan investment. To date we have not recorded any conditionalinterest. Dividend income on preferred equity securities is accrued to theextent that such amounts are expected to be collected and that we have theoption to collect such amounts in cash. To date, we have not accrued anydividend income.

 

*Services Provided to Portfolio Companies*

 

Asa business development company under the 1940 Act, we are required to makeavailable significant managerial assistance to our portfolio companies. Weprovide these services through our Adviser, who provides these services on ourbehalf through its officers who are also our officers. Currently, neither wenor our Adviser charges a fee for managerial assistance, however, if ourAdviser does receive fees for such managerial assistance, our Adviser willcredit the managerial assistance fees to the base management fee due from us toour Adviser.

 

OurAdviser receives fees for the other services it provides to our portfoliocompanies. These other fees are typically non-recurring, are recognized asrevenue when earned and are generally paid directly to our Adviser by theborrower or potential borrower upon the closing of the investment. The servicesour Adviser provides to our portfolio companies vary by investment, butgenerally include a broad array of services such as investment bankingservices, arranging bank and equity financing, structuring financing frommultiple 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 receives fees for these services, 50% of certain ofthose fees are voluntarily credited against the base management fee that we payto our Adviser. Any services of this nature subsequent to the closing wouldtypically generate a separate fee at the time of completion.

 

OurAdviser also receives fees for monitoring and reviewing portfolio companyinvestments. These fees are recurring and are generally paid annually orquarterly in advance to our Adviser throughout the life of the investment. Feesof this nature are recorded as revenue by our Adviser when earned and are notcredited 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 andare recognized as revenue upon closing of the originated investment and arereported as fee income in the consolidated statements of operations.

 

**RecentAccounting Pronouncements**

 

Referto Note 2 in the accompanying condensed consolidated financial statements for asummary of all recently issued accounting pronouncements.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

 

Weare subject to financial market risks, including changes in interest rates. We estimate that ultimately approximately 20% of the loans in ourportfolio will be made at fixed rates and approximately 80% will be made atvariable rates. As of December 31, 2008, our portfolio consisted of thefollowing breakdown in relation to all outstanding debt:

 

47

----

Table of Contents

 
| 50  | % | Variable  rates              |
|-----|---|------------------------------|
| 30  | % | Variable  rates with a floor |
| 20  | % | Fixed rates                  |
| 100 | % | Total                        |

 

Therehave been no material changes in the quantitative and qualitative market riskdisclosures for the nine months ended December 31, 2008 from thosedisclosed in our Annual Report on Form 10-K for the fiscal year ended March 31,2008, as filed with the Securities and Exchange Commission on May 21,2008.

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

As of December 31, 2008, we, including our Chief Executive Officerand Chief Financial Officer, evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Exchange ActRules 13a-15(e) and 15d-15(e)). Based on that evaluation, ourmanagement, including the Chief Executive Officer and Chief Financial Officer,concluded that our disclosure controls and procedures were effective in timelyalerting management, including the Chief Executive Officer and Chief FinancialOfficer, of material information about us required to be included in periodicSecurities and Exchange Commission filings. However, in evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement 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 control over financialreporting that occurred during the quarter ended December 31, 2008 thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II—OTHERINFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

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

 

**ITEM 1A. RISK FACTORS.**

 

Our business is subject to certain risks and events that, if theyoccur, could adversely affect our financial condition and results of operationsand the trading price of our common stock. For a discussion of these risks,please refer to the “Risk Factors” sections of our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2008, filed by us with the Securitiesand Exchange Commission on May 21, 2008 and our Quarterly Report on Form 10-Qfor the quarter ended September 30, 2008 (the “Form 10-Q”), filed byus with the Securities and Exchange Commission on November 4, 2008. Inconnection with our preparation of this quarterly report, management hasreviewed and considered these risk factors and has determined that the followingrisk factors should be read in connection with the existing risk factorsdisclosed in our Form 10-K and the Form 10-Q.

 

***Risks related to economic conditions***

 

*Thecurrent state of the economy and the capital markets increases the possibilityof adverse effects on our financial position and results of operations.Continued economic adversity could impair our portfolio companies’ financialpositions and operating results and affect the industries in which we invest,which could, in turn, harm our operating results. Continued adversity in thecapital markets could impact our ability to raise capital and reduce our volumeof new investments.*

 

TheUnited States has entered into an economic downturn. The economic downturngenerally and the disruptions in the capital markets in particular havedecreased liquidity and increased our cost of debt and equity capital, whereavailable. The longer these conditions persist, the greater the probabilitythat these factors could continue to increase our costs of, and significantlylimit our access to, debt and equity capital and, thus, have an adverse effecton our operations and financial results. Many of the companies in which we havemade or will make investments may also be susceptible to the economic downturn,which may affect the ability of one or more of our portfolio companies to repayour loans or engage in a liquidity event, such as a sale, recapitalization orinitial public offering. An economic downturn could also disproportionatelyimpact some of the industries in which we invest, causing us to be morevulnerable to losses in our portfolio, therefore the number of ournon-performing assets are likely to increase and the fair market value of ourportfolio is likely to decrease during these 

 

48

----

Tableof Contents

 

periods. The economicdownturn may also decrease the value of collateral securing some of our loansas well as the value of our equity investments which would decrease our abilityto borrow under our credit facility or raise equity capital thereby reducingour ability to make new investments. The economic downturn has affected theavailability of credit generally and may prevent us from replacing or renewingour credit facility on reasonable terms, or at all. We do not know when marketconditions will stabilize, if adverse conditions will intensify or the fullextent to which the disruptions will affect us. Also, it is possible that continuedinstability of the financial markets could have other unforeseen materialeffects on our business.

 

***Risks related to our external financing***

 

*Anyinability to renew, extend or replace our credit facility on terms favorable tous, or at all, could adversely impact our liquidity and ability to fund newinvestments or maintain dividends.*

 

Availabilityunder our credit facility will terminate on April 16, 2009. If thefacility is not renewed or extended by April 16, 2009, all principal andinterest will be immediately due and payable. There can be no guarantee that wewill be able to renew, extend or replace the credit facility on terms that arefavorable to us, or at all. Our ability to obtain replacement financing will beconstrained by current economic conditions affecting the credit markets, whichhave significantly deteriorated over the last several months and may furtherdecline. Consequently, any renewal, extension or refinancing of the creditfacility will likely result in significantly higher interest rates and relatedcharges and may impose significant restrictions on the use of borrowed fundswith regard to our ability to fund investments or maintain dividends. Forinstance, in connection with our most recent renewal, the size of our creditfacility was reduced from $200 million to $125 million. If we are not able torenew, extend or refinance the credit facility, this would likely have amaterial adverse effect on our liquidity and ability to fund new investments ormaintain our dividends. If we are unable to secure replacement financing, wemay be forced to sell certain assets on disadvantageous terms, which may resultin realized losses and such realized losses could materially exceed the amountof any unrealized depreciation on these assets as of our most recent balancesheet date, which would have a material adverse effect on our results ofoperations. In addition to selling assets, or as an alternative, we may issueequity in order to repay amounts outstanding under the credit facility. Based onthe recent trading prices of our stock, such an equity offering may have asubstantial dilutive impact on our existing stockholders’ interest in ourearnings and assets and voting interest in us.

 

*Inaddition to regulatory limitations on our ability to raise capital, our creditfacility contains various covenants which, if not complied with, couldaccelerate our repayment obligations under the facility, thereby materially andadversely affecting our liquidity, financial condition, results of operations andability to pay dividends.*

 

Theagreement governing our credit facility requires us to comply with certainfinancial and operational covenants. These covenants require us to, among otherthings, maintain certain financial ratios, including asset coverage, debt toequity and interest coverage, and a minimum net worth. As of December 31,2008, we were in compliance with these covenants. However, our continuedcompliance with these covenants depends on many factors, some of which arebeyond our control. In particular, depreciation in the valuation of our assets,which valuation is subject to changing market conditions which are presentlyvery volatile, affects our ability to comply with these covenants. During thenine months ended December 31, 2008, net unrealized depreciation on ourinvestments was approximately $13.7 million, compared to $424,000 during thecomparable period in the prior year. Given the continued deterioration in thecapital markets, net unrealized depreciation in our portfolio may continue toincrease in future periods and threaten our ability to comply with thecovenants under our credit facility.

 

Accordingly,there are no assurances that we will continue to comply with these covenants.Failure to comply with these covenants would result in a default which, if wewere unable to obtain a waiver from the lenders, could accelerate our repaymentobligations under the facility and thereby have a material adverse impact onour liquidity, financial condition, results of operations and ability to paydividends.

 

*Ourbusiness plan is dependent upon external financing, which is constrained by thelimitations of the 1940 Act.*

 

Ourbusiness requires a substantial amount of cash to operate and grow. We mayacquire such additional capital from the following sources:

 

·                  *Senior Securities.*  We intend toissue debt securities, other evidences of indebtedness (including borrowingsunder our line of credit) and possibly preferred stock, up to the maximumamount permitted by the 1940 Act. The 1940 Act currently permits us, as abusiness development company, to issue debt securities and preferred stock, towhich we refer collectively as senior securities, in amounts such that ourasset coverage, as defined in the 1940 Act, is at least 200% after eachissuance of senior securities. As a result of issuing senior securities, wewill be exposed to the risks associated with leverage. Although borrowing moneyfor investments increases the potential for gain, it also 

 

49

----

Tableof Contents

 

increases the risk of aloss. A decrease in the value of our investments will have a greater impact onthe value of our common stock to the extent that we have borrowed money to makeinvestments. There is a possibility that the costs of borrowing could exceedthe income we receive on the investments we make with such borrowed funds. Inaddition, our ability to pay dividends or incur additional indebtedness wouldbe restricted if asset coverage is not at least twice our indebtedness. If thevalue of our assets declines, we might be unable to satisfy that test. If thishappens, we may be required to liquidate a portion of our loan portfolio andrepay a portion of our indebtedness at a time when a sale, to the extentpossible given the limited market for many of our investments, may bedisadvantageous. Furthermore, any amounts that we use to service ourindebtedness will not be available for distributions to our stockholders.

 

·                  *Common Stock.*  Because we areconstrained in our ability to issue debt for the reasons given above, we aredependent on the issuance of equity as a financing source. If we raiseadditional funds by issuing more common stock or debt securities convertibleinto or exchangeable for our common stock, the percentage ownership of ourstockholders at the time of the issuance would decrease and our common stockmay experience dilution. In addition, any convertible or exchangeablesecurities that we issue in the future may have rights, preferences andprivileges more favorable than those of our common stock. In addition, underthe 1940 Act, we will generally not be able to issue additional shares of ourcommon stock at a price below net asset value per share to purchasers otherthan our existing stockholders through a rights offering without firstobtaining the approval of our stockholders and our independent directors. If wewere to sell shares of our common stock below our then current net asset valueper share, such sales would result in an immediate dilution to the net assetvalue per share. This dilution would occur as a result of the sale of shares ata price below the then current net asset value per share of our common stockand a proportionately greater decrease in a stockholder’s interest in ourearnings and assets and voting interest in us than the increase in our assetsresulting from such issuance. This imposes constraints on our ability to raisecapital when our common stock is trading at below net asset value, as it hasfor the last year.

 

*Ourcredit facility imposes certain limitations on us.*

 

Wewill have a continuing need for capital to finance our loans. In order tomaintain RIC status, we will be required to distribute to our stockholders atleast 90% of our ordinary income and short-term capital gains on an annualbasis. Accordingly, such earnings will not be available to fund additionalloans. Therefore, through our wholly-owned subsidiary, we are party to a creditagreement arranged by Deutsche Bank AG as the structuring agent. The agreementprovides us with a revolving credit line facility of $125 million. Theline of credit facility will permit us to fund additional loans and investmentsas long as we are within the conditions set out in the credit agreement.Current market conditions have forced us to write down the value of a portionof our assets as required by fair value accounting rules. These are notrealized losses, but constitute adjustment in asset values for purposes offinancial reporting and for collateral value for our credit facility. As assetsare marked down in value, the amount we can borrow on our credit facilitydecreases.

 

As aresult of the line of credit facility, we are subject to certain limitations onthe type of loan investments we make, including restrictions on geographicconcentrations, sector concentrations, loan size, payment frequency and status,and average life. Our failure to satisfy these limitations could result inforeclosure by our lenders which would have a material adverse effect on ourbusiness, financial condition and results of operations.

 

***Risks related to ourinvestments***

 

*Ourinvestments in small and medium-sized portfolio companies are extremely riskyand you could lose all or a part of your investment.*

 

Investmentsin small and medium-sized portfolio companies are subject to a number ofsignificant risks including the following:

 

·                  *Small and medium-sized businesses are likely to havegreater exposure to economic downturns than larger businesses.*  Ourportfolio companies may have fewer resources than larger businesses, and thusthe current state of the economy, and any further economic downturns orrecessions are more likely to have a material adverse effect on them. If one ofour portfolio companies is adversely impacted by an economic downturn, itsability to repay our loan or engage in a liquidity event, such as a sale,recapitalization or initial public offering would be diminished.

 

·                  *Small and medium-sized businesses may have limitedfinancial resources and may not be able to repay the loans we make to them.*  Ourstrategy includes providing financing to portfolio companies that typically isnot readily available to them. While we believe that this provides anattractive opportunity for us to generate profits, this may make it difficultfor the portfolio companies to repay their loans to us upon maturity. Aborrower’s ability to repay its loan may be adversely affected by numerous factors,including the failure to meet its business plan, a downturn in 

 

50

----

Tableof Contents

 

its industry or negativeeconomic conditions. A deterioration in a borrower’s financial condition andprospects usually will be accompanied by deterioration in the value of anycollateral and a reduction in the likelihood of us realizing on any guaranteeswe may have obtained from the borrower’s management. Although we will sometimesseek to be the senior, secured lender to a borrower, in most of our loans weexpect to be subordinated to a senior lender, and our interest in anycollateral would, accordingly, likely be subordinate to another lender’ssecurity interest.

 

·                  *Small and medium-sized businesses typically havenarrower product lines and smaller market shares than large businesses.*  Becauseour target portfolio companies are smaller businesses, they will tend to bemore vulnerable to competitors’ actions and market conditions, as well asgeneral economic downturns. In addition, our portfolio companies may faceintense competition, including competition from companies with greaterfinancial resources, more extensive development, manufacturing, marketing andother capabilities and a larger number of qualified managerial and technicalpersonnel.

 

·                  *There is generally little or no publicly availableinformation about these businesses.*  Because we seek toinvest in privately owned businesses, there is generally little or no publiclyavailable operating and financial information about our potential portfoliocompanies. As a result, we rely on our officers, our Adviser and its employeesand consultants to perform due diligence investigations of these portfoliocompanies, their operations and their prospects. We may not learn all of thematerial information we need to know regarding these businesses through ourinvestigations.

 

·                  *Small and medium-sized businesses generally have lesspredictable operating results.*  We expect that ourportfolio companies may have significant variations in their operating results,may from time to time be parties to litigation, may be engaged in rapidlychanging businesses with products subject to a substantial risk ofobsolescence, may require substantial additional capital to support theiroperations, to finance expansion or to maintain their competitive position, mayotherwise have a weak financial position or may be adversely affected bychanges in the business cycle. Our portfolio companies may not meet net income,cash flow and other coverage tests typically imposed by their senior lenders. Aborrower’s failure to satisfy financial or operating covenants imposed bysenior lenders could lead to defaults and, potentially, foreclosure on itssenior credit facility, which could additionally trigger cross-defaults inother agreements. If this were to occur, it is possible that the borrower’sability to repay our loan would be jeopardized.

 

·                  *Small and medium-sized businesses are more likely tobe dependent on one or two persons.*  Typically, thesuccess of a small or medium-sized business also depends on the managementtalents and efforts of one or two persons or a small group of persons. Thedeath, disability or resignation of one or more of these persons could have amaterial adverse impact on our borrower and, in turn, on us.

 

·                  *Small and medium-sized businesses may have limitedoperating histories.*  While we intend to target stablecompanies with proven track records, we may make loans to new companies thatmeet our other investment criteria. Portfolio companies with limited operatinghistories will be exposed to all of the operating risks that new businessesface and may be particularly susceptible to, among other risks, marketdownturns, competitive pressures and the departure of key executive officers.

 

*Becausethe loans we make and equity securities we receive when we make loans are notpublicly traded, there will be uncertainty regarding the value of our privatelyheld securities that could adversely affect our determination of our net assetvalue.*

 

Ourportfolio investments are, and we expect will continue to be, in the form ofsecurities that are not publicly traded. The fair value of securities and otherinvestments that are not publicly traded may not be readily determinable. OurBoard of Directors has established an investment valuation policy andconsistently applied valuation procedures used to determine the fair value ofthese securities quarterly. These procedures for the determination of value ofmany of our debt securities rely on the opinions of value submitted to us byStandard and Poor’s Securities Evaluations, Inc (“SPSE”) or the use ofinternally developed discounted cash flow methodologies (“DCF”), specificallyfor our syndicated loans. SPSE will only evaluate the debt portion of ourinvestments for which we specifically request evaluation, and SPSE may declineto make requested evaluations for any reason in its sole discretion.  However, to date, SPSE has accepted each ofour requests for evaluation.  Our use ofDCF is inherently subjective and is based on our perceived estimates andassumptions of each syndicated loan.  Inthe event that we are required to sell a loan, which likelihood is heightenedas we approach the maturity of our credit facility in April 2009, we may ultimatelysell a loan for an amount materially less than the estimated fair value calculatedeither by SPSE, TEV or under the DCF methodology.

 

51

----

Tableof Contents

 

Ourprocedures also include provisions whereby our Adviser will establish the fairvalue of any equity securities we may hold where SPSE or third party agentbanks are unable to provide evaluations. The types of factors that may beconsidered in determining the fair value of our debt and equity securitiesinclude some or all of the following:

 

·  the nature and realizable value of anycollateral;

·  the portfolio company’s earnings and cashflows and its ability to make payments on its obligations;

·  the markets in which the portfolio companydoes business;

·  the comparison to publicly traded companies;and

·  discounted cash flow and other relevantfactors.

 

Becausesuch valuations, particularly valuations of private securities and privatecompanies, are not susceptible to precise determination, may fluctuate overshort periods of time, and may be based on estimates, our determinations offair value may differ from the values that might have actually resulted had areadily available market for these securities been available.

 

Aportion of our assets are, and will continue to be, comprised of equitysecurities that are valued based on internal assessment using our own valuationmethods approved by our Board of Directors, without the input of SPSE, the useof a DCF or any other third-party evaluator. We believe that our equityvaluation methods reflect those regularly used as standards by otherprofessionals in our industry who value equity securities. However,determination of fair value for securities that are not publicly traded,whether or not we use the recommendations of an independent third-partyevaluator, necessarily involves the exercise of subjective judgment. Our netasset value could be adversely affected if our determinations regarding thefair value of our investments were materially higher than the values that weultimately realize upon the disposal of such securities.

 

In April 2008,we adopted the provisions of FASB Statement No. 157, *Fair Value Measurements*and we have followed the guidance of FASBStaff Position No. 157-3, *Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive,*which focused on**fair market value accounting. Theimpact on our consolidated financial statements for future periods cannot bedetermined at this time as it will be influenced by the estimates of fair valuefor those periods, the number and amount of investments we originate, acquireor exit and the effect of any additional guidance or any changes in theinterpretation of this statement. If we are required to make further writedownsof our investment portfolio due to changes in market conditions, this couldnegatively impact the availability under our line of credit and our ability todraw on the line of credit.

 

*Ourportfolio is concentrated in a limited number of companies and industries,which subjects us to an increased risk of significant loss if any one of thesecompanies does not repay us or if the industries experience downturns.*

 

As of December 31,2008, we had investments in 47 portfolio companies. A consequence of a limitednumber of investments is that the aggregate returns we realize may besubstantially adversely affected by the unfavorable performance of a smallnumber of such loans or a substantial write-down of any one investment. Beyondour regulatory and income tax diversification requirements, we do not havefixed guidelines for industry concentration and our investments couldpotentially be concentrated in relatively few industries. In addition, while wedo not intend to invest 25% or more of our total assets in a particularindustry or group of industries at the time of investment, it is possible thatas the values of our portfolio companies change, one industry or a group ofindustries may comprise in excess of 25% of the value of our total assets. Asof December 31, 2008, 19.7% of our total assets were invested in machinerycompanies, 18.3% were invested in diversified conglomerate manufacturingcompanies and 10.7% were invested in health, education and childcare companies.As a result, a downturn in an industry in which we have invested a significant portionof our total assets could have a materially adverse effect on us.

 

***Risks related to an investment in ourcommon stock***

 

*Wemay experience fluctuations in our quarterly and annual operating results.*

 

We mayexperience fluctuations in our quarterly and annual operating results due to anumber of factors, including, among others, variations in our investmentincome, the interest rates payable on the debt securities we acquire, thedefault rates on such securities, the level of our expenses, variations in andthe timing of the recognition of realized and unrealized gains or losses, thelevel of our expenses, the degree to which we encounter competition in ourmarkets, and general economic conditions, including the impacts of inflation.The majority of our portfolio companies are in industries that are directlyimpacted by inflation, such as manufacturing and consumer goods and services.Our portfolio companies may not be able to pass on to customers increases intheir costs of production which could greatly affect their operating results,impacting their ability to repay our loans. In addition, any projected futuredecreases in our portfolio companies’ operating results due to inflation couldadversely impact the fair value of those investments. Any decreases in the fairvalue of our investments could 

 

52

----

Tableof Contents

 

result in future realizedand unrealized losses and therefore reduce our net assets resulting fromoperations. As a result of these factors, results for any period should not berelied upon as being indicative of performance in future periods.

 

*Sharesof closed-end investment companies frequently trade at a discount from netasset value.*

 

Sharesof closed-end investment companies frequently trade at a discount from netasset value. Since our inception, our common stock has at times traded abovenet asset value, and at times traded below net asset value. During the pastyear, our common stock has traded consistently, and at times significantly,below net asset value. Subsequent to December 31, 2008, our stock hastraded at discounts of up to 48% of our net asset value as of December 31,2008. This characteristic of shares of closed-end investment companies isseparate and distinct from the risk that our net asset value per share willdecline. As with any stock, the price of our shares will fluctuate with marketconditions and other factors. If shares are sold, the price received may bemore or less than the original investment. Whether investors will realize gainsor losses upon the sale of our shares will not depend directly upon our netasset value, but will depend upon the market price of the shares at the time ofsale. Since the market price of our shares will be affected by such factors asthe relative demand for and supply of the shares in the market, general marketand economic conditions and other factors beyond our control, we cannot predictwhether the shares will trade at, below or above our net asset value. Under the1940 Act, we are generally not able to issue additional shares of our commonstock at a price below net asset value per share to purchasers other than ourexisting stockholders through a rights offering without first obtaining theapproval of our stockholders and our independent directors. Additionally, attimes when our stock is trading below its net asset value per share, ourdividend yield may exceed the weighted average returns that we would expect torealize on new investments that would be made with the proceeds from the saleof such stock, making it unlikely that we would determine to issue additionalshares in such circumstances. Thus, for so long as our common stock tradesbelow its net asset value we will be subject to significant constraints on ourability to raise capital. Additionally, an extended period of time in which weare unable to raise capital may restrict our ability to grow and adverselyimpact our ability to increase or maintain our dividend.

 

*Stockholdersmay incur dilution if we sell shares of our common stock in one or moreofferings at prices below the then current net asset value per share of ourcommon stock.*

 

At our2008 annual meeting of stockholders, our stockholders approved a proposaldesigned to allow us to access the capital markets in a way that we werepreviously unable to as a result of restrictions that, absent stockholderapproval, apply to business development companies under the 1940 Act.Specifically, our stockholders approved a proposal that authorizes us to sellshares of our common stock below the then current net asset value per share ofour common stock in one or more offerings for a period of one year. During thepast year, our common stock has traded consistently, and at timessignificantly, below net asset value. Any decision to sell shares of our commonstock below the then current net asset value per share of our common stockwould be subject to the determination by our Board of Directors that such issuanceis in our and our stockholders’ best interests.

 

If we were to sell shares of our common stock below net asset value pershare, such sales would result in an immediate dilution to the net asset valueper share. This dilution would occur as a result of the sale of shares at aprice below the then current net asset value per share of our common stock anda proportionately greater decrease in a stockholder’s interest in our earningsand assets and voting interest in us than the increase in our assets resultingfrom such issuance. The greater the difference between the sale price and thenet asset value per share at the time of the offering, the more significant thedilutive impact would be. Because the number of shares of common stock thatcould be so issued and the timing of any issuance is not currently known, theactual dilutive effect, if any, cannot be currently predicted.

 

**ITEM 2. UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS.**

 

 Not applicable.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES.**

 

 Not applicable.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

 Not applicable.

 

**ITEM 5. OTHER INFORMATION.**

 

 Not applicable.

 

53

----

Table of Contents

 

**ITEM 6. EXHIBITS**

 

 See the exhibit index.

 

**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| ** ** | **GLADSTONE INVESTMENT CORPORATION** |
|------------|--------------------------------------|
|       |                                 |   |
|       | By:                                  | /s/ Mark Perrigo |
|       |                                 | Mark Perrigo |
| * *   | * *                             | *Chief Financial Officer* |

 

Date: February 2, 2009

 

54

----

Table of Contents

 

**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.                                                                                                 |
| 3.3         |       | First Amendment to Amended and Restated Bylaws, incorporated by  reference to Exhibit 99.1 to the Company’s Current Report on  Form 8-K (File No. 814-00704), filed on July 10, 2007.                                                                                                           |
| 4.1         |       | Specimen Stock Certificate, incorporated by reference to  Exhibit 99.1 to Pre-Effective Amendment No. 3 to the Registration  Statement on Form N-2 (File No. 333-123699), filed June 21,  2005.                                                                                                 |
| 10.1        |       | Amended  and Restated Credit Agreement by and among Gladstone Business Investment LLC,  Deutsche Bank AG and certain other parties, dated as of October 16,  2008, incorporated by reference to Exhibit 10.1 to the Current Report on  Form 8-K (File No. 814-00704) filed on October 17, 2008. |
| 11          |       | Computation of Per Share Earnings (included in the notes to the  unaudited condensed consolidated 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 the applicableregulations of the Securities and Exchange Commission are not required underthe related instruction or are inapplicable and therefore have been omitted.

 

55

----