**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

** **

**FORM 10-Q**

** **

** **

**þ**                                 QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**FOR THE QUARTER ENDEDJUNE 30, 2006**

** **

**o**                                 TRANSITIONREPORT 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 its charter)

 

| **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, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months and (2) has been subject tosuch filing requirements for the past 90 days. Yes  þNo o.

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

Large accelerated filero  Accelerated filer o  Non-accelerated filer þ

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

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date. Thenumber of shares of the issuer’s Common Stock, $0.001 par value, outstanding asof August 1, 2006 was 16,560,100.

 

 

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**GLADSTONEINVESTMENT CORPORATION**

**TABLE OF CONTENTS**

 
| PART I.    |   | FINANCIAL INFORMATION                                                                                                                                     |
|------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                      |
| Item 1.    |   | Financial Statements (Unaudited)                                                                                                                          |
|       |   |                                                                                                                                                      |
|       |   | Statements of Assets and Liabilities as of June 30,  2006 and March 31, 2006                                                                              |
|       |   | Schedule of Investments as of June 30, 2006                                                                                                               |
|       |   | Schedule of Investments as of March 31, 2006                                                                                                              |
|       |   | Statements  of Operations for the three months ended June 30, 2006 and for the period  June 22, 2005 (Commencement of Operations) to June 30, 2005        |
|       |   | Statements of Changes in Net Assets for three months  ended June 30, 2006 and for the period June 22, 2005 (Commencement of  Operations) to June 30, 2005 |
|       |   | Statements of Cash Flows for the three months ended  June 30, 2006 and for the period June 22, 2005 (Commencement of Operations)  to June 30, 2005        |
|       |   | Financial Highlights for the three months ended June  30, 2006 and for the period June 22, 2005 (Commencement of Operations) to June  30, 2005            |
|       |   | Notes  to Financial Statements                                                                                                                            |
|       |   |                                                                                                                                                      |
| Item 2.    |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                               |
|       |   |                                                                                                                                                      |
|       |   | Overview                                                                                                                                                  |
|       |   | Results of Operations                                                                                                                                     |
|       |   | Liquidity and Capital Resources                                                                                                                           |
|       |   |                                                                                                                                                      |
| Item 3.    |   | Quantitative and Qualitative Disclosure About Market  Risk                                                                                                |
|       |   |                                                                                                                                                      |
| Item 4.    |   | Controls and Procedures                                                                                                                                   |
|       |   |                                                                                                                                                      |
| PART  II.  |   | OTHER  INFORMATION                                                                                                                                        |
|       |   |                                                                                                                                                      |
| Item  1.   |   | Legal  Proceedings                                                                                                                                        |
|       |   |                                                                                                                                                      |
| Item 1A.   |   | Risk Factors                                                                                                                                              |
|       |   |                                                                                                                                                      |
| Item 2.    |   | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                              |
|       |   |                                                                                                                                                      |
| Item 3.    |   | Defaults Upon Senior Securities                                                                                                                           |
|       |   |                                                                                                                                                      |
| Item 4.    |   | Submission of Matters to a Vote of Security Holders                                                                                                       |
|       |   |                                                                                                                                                      |
| Item  5.   |   | Other  Information                                                                                                                                        |
|       |   |                                                                                                                                                      |
| Item 6.    |   | Exhibits                                                                                                                                                  |
|       |   |                                                                                                                                                      |
| SIGNATURES |

 

 

2

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**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF ASSETS AND LIABILITIES(UNAUDITED)**

** **
| ** **                                                                                                   | ** ** | **June 30, 2006** | ** **  | **March 31, 2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|------------------------------|------------|
| ASSETS                                                                                                       |       |                        |        |                         |       |
| Non-Control/Non-Affiliate  investments (Cost 6/30/06: $114,228,222; 3/31/06: $97,423,004)                    |       | $                           | 113,251,478 |                         | $          | 97,585,972 |   |
| Control  investments (Cost 6/30/06: $56,246,318; 3/31/06: $55,846,318)                                       |       | 56,028,640                  |        | 55,796,318                   |       |
| Total  investments at fair value (Cost 6/30/06: $170,474,540; 3/31/06: $153,269,322)                         |       | 169,280,118                 |        | 153,382,290                  |       |
| Cash and cash  equivalents                                                                                   |       | 58,283,609                  |        | 75,672,605                   |       |
| Interest  receivable                                                                                         |       | 911,817                     |        | 761,388                      |       |
| Prepaid  directors fees                                                                                      |       | 108,750                     |        | —                       |       |
| Prepaid  insurance                                                                                           |       | 27,262                      |        | 99,874                       |       |
| Due from Adviser                                                                                             |       | —                      |        | 234,551                      |       |
| Other assets                                                                                                 |       | 87,488                      |        | 173,099                      |       |
| TOTAL ASSETS                                                                                                 |       | $                           | 228,699,044 |                         | $          | 230,323,807 |   |
|                                                                                                         |       |                        |        |                         |       |
| LIABILITIES                                                                                                  |       |                        |        |                         |       |
| Accounts payable                                                                                             |       | $                           | 11,583      |                         | $          | — |   |
| Administration  fee payable to Gladstone Administration                                                      |       | 115,389                     |        | 110,002                      |       |
| Base management  fee payable to Gladstone Management                                                         |       | 801,309                     |        | —                       |       |
| Accrued expenses                                                                                             |       | 124,876                     |        | 367,031                      |       |
| Other  liabilities                                                                                           |       | 4,763                       |        | 5,077                        |       |
| Total  Liabilities                                                                                           |       | 1,057,920                   |        | 482,110                      |       |
| NET ASSETS                                                                                                   |       | $                           | 227,641,124 |                         | $          | 229,841,697 |   |
|                                                                                                         |       |                        |        |                         |       |
| ANALYSIS OF NET ASSETS:                                                                                      |       |                        |        |                         |       |
|                                                                                                         |       |                        |        |                         |       |
| Common stock,  $0.001 par value, 100,000,000 shares authorized and 16,560,100 shares issued  and outstanding |       | $                           | 16,560      |                         | $          | 16,560 |   |
| Capital in  excess of par value                                                                              |       | 230,229,279                 |        | 230,229,279                  |       |
| Net unrealized  (depreciation) appreciation of investment portfolio                                          |       | (1,194,421                  | )           | 112,968                      |       |
| Distributions in  excess of net investment income                                                            |       | (1,410,294                  | )           | (517,110                     | )          |
| Total Net Assets                                                                                             |       | $                           | 227,641,124 |                         | $          | 229,841,697 |   |
| Net assets per  share                                                                                        |       | $                           | 13.75       |                         | $          | 13.88 |   |
|                                                                                                         |       |                        |        |                         |       |

 

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

3

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**GLADSTONEINVESTMENT CORPORATIONSCHEDULE OF INVESTMENTSJune 30, 2006(UNAUDITED)**

 
| **Company (1)**                            | ** ** | **Industry**                                                                                                            | ** ** | **Investment (2)**                       | ** ** | **Cost**        | ** ** | **Fair Value** |
|-------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|---------------------|
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS**      |       |                                                                                                                    |       |                                          |       |            |
| ** **                                      | ** ** | ** **                                                                                                              | ** ** | ** **                                    | ** ** | ** **      | ** ** | ** **          |
| Activant                                        |       | Service - enterprise  software and services                                                                             |       | Senior Term Debt (7.2%,  Due 5/2013) (3)      |       | $               | 4,011,648  |                | $ | 3,955,084 |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Compsych                                        |       | Service - independent  employee assistance programs                                                                     |       | Senior Term Debt (7.8%,  Due 2/2012) (3) (7)  |       | 3,987,621       |       | 3,970,000           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| CRC Health Group, Inc.                          |       | Service - substance  abuse treatment                                                                                    |       | Senior Term Debt (7.7%,  Due 2/2016) (3)      |       | 7,873,671       |       | 7,751,323           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Graham Packaging  Holdings Co.                  |       | Manufacturing - custom  blow molded                                                                                     |       | Senior Term Debt (7.3%,  Due 10/2011) (3)     |       | 10,812,573      |       | 10,672,535          |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Hertz Equipment Rental  Corp.                   |       | Service - car rentals                                                                                                   |       | Senior Term Debt (7.1%,  Due 12/2010) (3)     |       | 907,056         |       | 905,996             |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| J. Crew Operating Corp.                         |       | Retail - apparel                                                                                                        |       | Senior Term Debt (9.5%,  Due 5/2013) (3)      |       | 2,002,783       |       | 1,995,000           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Latham Manufacturing  Corp.                     |       | Manufacturing - swimming  pool components accessories                                                                   |       | Senior Term Debt (7.8%,  Due 6/2012) (3)      |       | 4,452,061       |       | 4,411,557           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Lexicon Marketing USA,  Inc.                    |       | Service - marketing to  Hispanic community                                                                              |       | Senior Term Debt (7.8%,  Due 5/2012) (3)      |       | 3,002,678       |       | 3,015,000           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| LVI Services, Inc.                              |       | Service - asbestos and  mold remediation                                                                                |       | Senior Term Debt (7.8%,  Due 11/2010) (3)     |       | 6,493,631       |       | 6,402,825           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Madison River Capital  LLC                      |       | Service - communications  and information                                                                               |       | Senior Term Debt (7.3%,  Due 7/2012) (3)      |       | 5,787,111       |       | 5,757,188           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Maidenform, Inc.                                |       | Manufacturing - intimate  apparel                                                                                       |       | Senior Term Debt (7.0%,  Due 5/2010) (3)      |       | 2,919,899       |       | 2,902,084           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| MedAssets, Inc.                                 |       | Service -  pharmaceuticals and healthcare GPO                                                                           |       | Senior Term Debt (8.5%,  Due 7/2010) (3) (7)  |       | 2,276,757       |       | 2,262,316           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| NPC International Inc.                          |       | Service - Pizza Hut franchisee                                                                                          |       | Senior Term Debt (6.9%,  Due 5/2013) (3)      |       | 3,379,643       |       | 3,342,198           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Nutro Products, Inc.                            |       | Manufacturing - pet food                                                                                                |       | Senior Term Debt (7.3%,  Due 4/2012) (3)      |       | 2,518,023       |       | 2,493,750           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Ozburn-Hessey Holding  Co. LLC                  |       | Service - third party  logistics                                                                                        |       | Senior Term Debt (7.3%,  Due 8/2012) (3)      |       | 6,117,829       |       | 6,036,407           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Patriot Media &  Communications CNJ, LLC    |       | Service -  telecommunications                                                                                           |       | Senior Term Debt (7.5%,  Due 3/2013) (3)      |       | 4,338,104       |       | 4,300,922           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| RPG Holdings, Inc.                              |       | Manufacturing and design  - greeting cards                                                                              |       | Senior Term Debt (8.6%,  Due 12/2011) (3)     |       | 5,001,274       |       | 5,000,000           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| SGS International, Inc.                         |       | Service - digital  imaging and graphics                                                                                 |       | Senior Term Debt (7.3%,  Due 12/2011) (3)     |       | 1,403,752       |       | 1,396,500           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| SunGard Data Systems,  Inc.                     |       | Service &  manufacturing — integrated software and processing solutions and information  availability services |       | Senior Term Debt (7.7%,  Due 2/2013) (3)      |       | 10,004,546      |       | 9,937,125           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Survey Sampling, LLC                            |       | Service - telecommunications-based  sampling                                                                            |       | Senior Term Debt (8.8%,  Due 5/2011) (3)      |       | 3,501,284       |       | 3,467,650           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Triad Laboratory  Alliance, LLC                 |       | Service - regional  medical laboratories                                                                                |       | Senior Term Debt (8.7%,  Due 12/2011) (3) (7) |       | 4,993,624       |       | 4,987,438           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| TexStar Operating, L.P.                         |       | Manufacturing -  midstream natural gas processing                                                                       |       | Senior Term Debt (8.3%,  Due 12/2011) (3) (7) |       | 2,992,315       |       | 2,970,075           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| US Investigative  Services, Inc.                |       | Service - background  investigations                                                                                    |       | Senior Term Debt (7.9%,  Due 10/2012) (3)     |       | 9,945,495       |       | 9,873,402           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| Wastequip, Inc.                                 |       | Manufacturing - waste  removal equipment                                                                                |       | Senior Term Debt (7.7%,  Due 7/2011) (3)      |       | 5,504,844       |       | 5,445,103           |
|                                            |       |                                                                                                                    |       |                                          |       |            |       |                |
| **Total Non-Control/Non-Affiliate Investments** | ** ** | ** **                                                                                                              | ** ** | **114,228,222**                               | ** ** | **113,251,478** |
|                                                 |            |                                                                                                                         |            |                                               |            |                 |            |                     |  |  |

 

4

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**GLADSTONE INVESTMENTCORPORATIONSCHEDULE OF INVESTMENTS (Continued)June 30, 2006(UNAUDITED)**
| **Company (1)**                         | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                     | ** **      | **Cost**       | ** **      | **Fair Value** |
|----------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|-----------------|----------------|-----------------|---------------------|
| **CONTROL INVESTMENTS**                      | ** ** | ** **                                                  | ** ** | ** **                                                  | ** **      | ** **     | ** **      | ** **          |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| Chase II Holdings  Corporation               |       | Manufacturing - traffic  doors                              |       | Revolving Credit  Facility (5)                              |            | —         |            | —              |
|                                         |       |                                                        |       | Senior Term Debt (9.6%,  Due 3/2011) (7)                    |            | 12,900,000     |            | 12,900,000          |
|                                         |       |                                                        |       | Senior Term Debt (12.0%  Due 3/2011) (7)                    |            | 8,000,000      |            | 7,970,000           |
|                                         |       |                                                        |       | Subordinated Term Debt  (13% Due 3/2013) (7)                |            | 6,167,810      |            | 6,106,132           |
|                                         |       |                                                        |       | Redeemable Preferred  Stock (4) (8)                         |            | 6,960,806      |            | 6,960,806           |
|                                         |       |                                                        |       | Common Stock (4) (8)                                        |            | 61,384         |            | 61,384              |
|                                         |       |                                                        |       |                                                        |            | 34,090,000     |            | 33,998,322          |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| Hailey Transport  Corporation                |       | Retail and service -  school buses and parts                |       | Senior Subordinated Term  Debt (12.0%, Due 1/2012) (7) |            | 4,000,000      |            | 3,940,000           |
|                                         |       |                                                        |       | Common Stock (4) (8)                                        |            | 2,500,000      |            | 2,500,000           |
|                                         |       |                                                        |       |                                                        |            | 6,500,000      |            | 6,440,000           |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| Quench Holdings  Corporation                 |       | Service - sales,  installation and service of water coolers |       | Revolving Credit  Facility (9.1%, Due 3/2009) (6) (7)       |            | 400,000        |            | 394,000             |
|                                         |       |                                                        |       | Senior Term Debt (9.1%,  Due 3/2011) (7)                    |            | 4,000,000      |            | 4,000,000           |
|                                         |       |                                                        |       | Subordinated Term Debt  (11.5%, Due 3/2011) (7)             |            | 8,000,000      |            | 7,940,000           |
|                                         |       |                                                        |       | Common Stock (4) (8)                                        |            | 3,256,318      |            | 3,256,318           |
|                                         |       |                                                        |       |                                                        |            | 15,656,318     |            | 15,590,318          |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| **Total Control Investments**                | ** ** | ** **                                                  | ** ** | ** **                                                  | ** **      | **56,246,318** | ** **      | **56,028,640**      |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| **Total Investments**                        | ** ** | ** **                                                  | ** ** | ** **                                                  | ** **      | **$**          | **170,474,540** | ** **          | **$** | **169,280,118** |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| **Cash equivalents**                         | ** ** | ** **                                                  | ** ** | ** **                                                  | ** **      | ** **     | ** **      | ** **          |
|                                         |       | Government                                                  |       | US Treasury Bill                                            |            | 4,033,771      |            | 4,033,771           |
|                                         |       |                                                        |       | (4.4%, 7/13/2006)                                           |            |           |            |                |
| * *                                     | * *   | * *                                                    | * *   | * *                                                    | * *        | * *       | * *        | * *            |
|                                         |       | Government                                                  |       | US Treasury Bill                                            |            | 17,821,896     |            | 17,821,896          |
|                                         |       |                                                        |       | (4.5%, 8/3/2006)                                            |            |           |            |                |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
|                                         |       | Government                                                  |       | US Treasury Bill                                            |            | 17,702,440     |            | 17,702,440          |
|                                         |       |                                                        |       | (4.5%, 8/31/2006)                                           |            |           |            |                |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| **Total cash equivalents:**                  | ** ** | ** **                                                  | ** ** | ** **                                                  | ** **      | **39,558,107** | ** **      | **39,558,107**      |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| **Total  investments and cash equivalents:** | ** ** | ** **                                                  | ** ** | **$**                                                       | **210,032,647** | ** **     | **$**           | **208,838,225**     |

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(1)        Certain of the listed securities areissued by affiliate(s) of the indicated portfolio company.

(2)        Percentage represents the weightedaverage interest rates in effect at June 30, 2006 and due date represents thecontractual maturity date.

(3)        Marketable securities are valued basedon the indicative bid price, as of June 30, 2006, from the respectiveoriginating syndication agent’s trading desk.

(4)        Security is non-income producing.

(5)        Total available under the revolvingcredit facility is $500,000 which was undrawn as of June 30, 2006.

(6)        Total available under the revolvingcredit facility is $2,000,000, of which $1,600,000 remains undrawn at June 30,2006.

(7)        Valued using S&P estimates at June30, 2006.

(8)        Fairvalue is equal to cost due to recent acquisition.

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.*

5

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**GLADSTONEINVESTMENT CORPORATIONSCHEDULE OF INVESTMENTSMarch 31, 2006(UNAUDITED)**

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

 

6

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**GLADSTONEINVESTMENT CORPORATIONSCHEDULE OF INVESTMENTS (Continued)March 31, 2006(UNAUDITED)**

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

----

(1)        Certain of the listed securities areissued by affiliate(s) of the indicated portfolio company.

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

(3)        Marketable securities are valued basedon the indicative bid price, as of March 31, 2006, from the respectiveoriginating syndication agent’s trading desk.

(4)        Security is non-income producing.

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

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

(7)        Valued using S&P estimates at March31, 2006.

(8)        Fairvalue is equal to cost due to recent acquisition.

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.*

7

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**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                          | ** ** | **For the three  months ended  June 30, 2006** | ** ** | **For the period  June 22, 2005  (Commencement of  Operations) to  June 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| INVESTMENT INCOME                                                                   |       |                                                                    |       |                                                                                                                       |       |
| Interest income                                                                     |       |                                                                    |       |                                                                                                                       |       |
| Non-Control/Non-Affiliate investments                                               |       | $                                                                       | 1,964,480  |                                                                                                                       | $          | — |   |
| Control investments                                                                 |       | 1,190,302                                                               |       | —                                                                                                                     |       |
| Cash and cash equivalents                                                           |       | 708,340                                                                 |       | 48,198                                                                                                                     |       |
| Total interest income                                                               |       | 3,863,122                                                               |       | 48,198                                                                                                                     |       |
| Other income                                                                        |       | 316                                                                     |       | —                                                                                                                     |       |
| Total investment income                                                             |       | 3,863,438                                                               |       | 48,198                                                                                                                     |       |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
| EXPENSES                                                                            |       |                                                                    |       |                                                                                                                       |       |
| Administration fee                                                                  |       | 115,389                                                                 |       | 27,083                                                                                                                     |       |
| Base management fee                                                                 |       | 801,309                                                                 |       | —                                                                                                                     |       |
| Directors fees                                                                      |       | 43,250                                                                  |       | —                                                                                                                     |       |
| Insurance expense                                                                   |       | 72,611                                                                  |       | —                                                                                                                     |       |
| Professional fees                                                                   |       | 79,748                                                                  |       | —                                                                                                                     |       |
| Stockholder related costs                                                           |       | 93,766                                                                  |       | 635                                                                                                                        |       |
| Interest expense                                                                    |       | —                                                                  |       | 378                                                                                                                        |       |
| Taxes and licenses                                                                  |       | 57,107                                                                  |       | —                                                                                                                     |       |
| Other expenses                                                                      |       | 19,094                                                                  |       | 302                                                                                                                        |       |
| Total expenses                                                                      |       | 1,282,274                                                               |       | 28,398                                                                                                                     |       |
| NET INVESTMENT  INCOME                                                              |       | 2,581,164                                                               |       | 19,800                                                                                                                     |       |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS                                 |       |                                                                    |       |                                                                                                                       |       |
| Realized gain on sale of Non-Control/Non-Affiliate  investments                     |       | 3,273                                                                   |       | —                                                                                                                     |       |
| Net unrealized depreciation of investment portfolio                                 |       | (1,307,389                                                              | )          | —                                                                                                                     |       |
| Net loss on investments                                                             |       | (1,304,116                                                              | )          | —                                                                                                                     |       |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS (Refer to Note 5)   |       | $                                                                       | 1,277,048  |                                                                                                                       | $          | 19,800 |   |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:             |       |                                                                    |       |                                                                                                                       |       |
| Basic and Diluted                                                                   |       | $                                                                       | 0.08       |                                                                                                                       | $          | 0.00 |   |
|                                                                                |       |                                                                    |       |                                                                                                                       |       |
| SHARES OF COMMON STOCK  OUTSTANDING:                                                |       |                                                                    |       |                                                                                                                       |       |
| Basic and diluted weighted average shares                                           |       | 16,560,100                                                              |       | 14,400,100                                                                                                                 |       |

 

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

8

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**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**

 
| ** **                                           | ** ** | **For the three  months ended  June 30, 2006** | ** **  | **For the period  June 22, 2005  (Commencement of  Operations) to  June 30, 2005** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------------------------|-------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| *Operations:*                                        |       |                                                                    |        |                                                                                                                       |       |
| Net investment income                                |       | $                                                                       | 2,581,164   |                                                                                                                       | $          | 19,800 |   |
| Realized gain on sale of investments                 |       | 3,273                                                                   |        | —                                                                                                                     |       |
| Unrealized depreciation of portfolio                 |       | (1,307,389                                                              | )           | —                                                                                                                     |       |
| Increase in net  assets from operations              |       | 1,277,048                                                               |        | 19,800                                                                                                                     |       |
|                                                 |       |                                                                    |        |                                                                                                                       |       |
| *Capital transactions:*                              |       |                                                                    |        |                                                                                                                       |       |
| Issuance of common stock                             |       | —                                                                  |        | 200,116,680                                                                                                                |       |
| Dividends from net investment income                 |       | (3,477,621                                                              | )           | —                                                                                                                     |       |
| Total change in net assets from capital transactions |       | (3,477,621                                                              | )           | 200,116,680                                                                                                                |       |
|                                                 |       |                                                                    |        |                                                                                                                       |       |
| Total change in  net assets                          |       | (2,200,573                                                              | )           | 200,136,480                                                                                                                |       |
|                                                 |       |                                                                    |        |                                                                                                                       |       |
| Net Assets                                           |       |                                                                    |        |                                                                                                                       |       |
| Beginning of period                                  |       | 229,841,697                                                             |        | 1,500                                                                                                                      |       |
| End of period                                        |       | $                                                                       | 227,641,124 |                                                                                                                       | $          | 200,137,980 |   |

 

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

9

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**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF CASH FLOWS(UNAUDITED)**

** **
| ** **                                                                                                                | ** ** | **For the three  months ended  June 30, 2006** | ** ** | **For the period  June 22, 2005  (Commencement of  Operations) to  June 30, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                 |       |                                                                    |       |                                                                                                                       |       |
| ** **                                                                                                                |       |                                                                    |       |                                                                                                                       |       |
| Net increase in net assets resulting from operations                                                                      |       | $                                                                       | 1,277,048  |                                                                                                                       | $          | 19,800 |   |
| Adjustments to  reconcile net increase in net assets resulting from operations to net cash  used in operating activities: |       |                                                                    |       |                                                                                                                       |       |
| Purchase of investments                                                                                                   |       | (33,665,549                                                             | )          | —                                                                                                                     |       |
| Principal repayments of investments                                                                                       |       | 874,222                                                                 |       | —                                                                                                                     |       |
| Proceeds from the sale of debt investments                                                                                |       | 15,551,727                                                              |       | —                                                                                                                     |       |
| Net unrealized depreciation of investment portfolio                                                                       |       | 1,307,389                                                               |       | —                                                                                                                     |       |
| Net realized gains on sales of investments                                                                                |       | (3,273                                                                  | )          | —                                                                                                                     |       |
| Net amortization of premiums and discounts                                                                                |       | 37,656                                                                  |       | —                                                                                                                     |       |
| Increase in interest receivable                                                                                           |       | (150,429                                                                | )          | —                                                                                                                     |       |
| Increase in prepaid assets                                                                                                |       | (36,138                                                                 | )          | (17,792                                                                                                                    | )          |
| Decrease in other assets                                                                                                  |       | 85,611                                                                  |       | —                                                                                                                     |       |
| Decrease in other liabilities                                                                                             |       | (314                                                                    | )          | —                                                                                                                     |       |
| Increase in administration fee payable to Gladstone  Administration                                                       |       | 5,387                                                                   |       | 27,083                                                                                                                     |       |
| Increase in base management fee payable to Gladstone  Management                                                          |       | 1,035,860                                                               |       | —                                                                                                                     |       |
| Increase in accounts payable                                                                                              |       | 11,583                                                                  |       | 128,029                                                                                                                    |       |
| (Decrease) increase in accrued expenses                                                                                   |       | (242,155                                                                | )          | 335,711                                                                                                                    |       |
| Net cash (used in) provided by operating activities                                                                       |       | (13,911,375                                                             | )          | 492,831                                                                                                                    |       |
|                                                                                                                      |       |                                                                    |       |                                                                                                                       |       |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                                                |       |                                                                    |       |                                                                                                                       |       |
| ** **                                                                                                                |       |                                                                    |       |                                                                                                                       |       |
| Net proceeds from the issuance of common stock                                                                            |       | —                                                                  |       | 200,164,544                                                                                                                |       |
| Distributions paid                                                                                                        |       | (3,477,621                                                              | )          | —                                                                                                                     |       |
| Decrease in loan payable to affiliate                                                                                     |       | —                                                                  |       | (50,000                                                                                                                    | )          |
| Net cash (used in) provided by financing activities                                                                       |       | (3,477,621                                                              | )          | 200,114,544                                                                                                                |       |
|                                                                                                                      |       |                                                                    |       |                                                                                                                       |       |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1)**                                                             |       | (17,388,996                                                             | )          | 200,607,375                                                                                                                |       |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                       |       | 75,672,605                                                              |       | 3,636                                                                                                                      |       |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                                                             |       | $                                                                       | 58,283,609 |                                                                                                                       | $          | 200,611,011 |   |
|                                                                                                                      |       |                                                                    |       |                                                                                                                       |       |
| **CASH PAID DURING PERIOD FOR  INTEREST TO AFFILIATE**                                                                    |       | $                                                                       | —     |                                                                                                                       | $          | 378 |   |

----

(1)    Cash andcash equivalents consist of demand deposits and highly liquid investments withoriginal maturities of three months or less when purchased.

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

10

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**GLADSTONEINVESTMENT CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**

** **
| ** **                                                         | ** ** | **For the three  months ended  June 30, 2006** | ** **  | **For the period  June 22, 2005  (Commencement of  Operations) to  June 30, 2005** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------|-------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| Per Share Data (1)                                                 |       |                                                                    |        |                                                                                                                       |       |
| Balance at beginning of period                                     |       | $                                                                       | 13.88       |                                                                                                                       | $          | — |   |
| Net proceeds from initial public offering (2)                      |       | —                                                                  |        | 13.95                                                                                                                      |       |
| Offering costs                                                     |       | —                                                                  |        | (0.05                                                                                                                      | )          |
|                                                               |       |                                                                    |        |                                                                                                                       |       |
| *Income from investment  operations:*                              |       |                                                                    |        |                                                                                                                       |       |
| Net investment income (3)                                          |       | 0.16                                                                    |        | —                                                                                                                     |       |
| Realized gain on sale of investments (3)                           |       | —                                                                  |        | —                                                                                                                     |       |
| Net unrealized appreciation of investments (3)                     |       | (0.08                                                                   | )           | —                                                                                                                     |       |
| Total from  investment operations                                  |       | 0.08                                                                    |        | —                                                                                                                     |       |
| Distributions                                                      |       | (0.21                                                                   | )           | —                                                                                                                     |       |
| Net asset value  at end of period                                  |       | $                                                                       | 13.75       |                                                                                                                       | $          | 13.90 |   |
|                                                               |       |                                                                    |        |                                                                                                                       |       |
| Per share market  value at beginning of period                     |       | $                                                                       | 14.90       |                                                                                                                       | $          | 15.00 |   |
| Per share market  value at end of period                           |       | $                                                                       | 15.00       |                                                                                                                       | $          | 15.05 |   |
| Total return (4)                                                   |       | 2.13%                                                                   |        | 0.33%                                                                                                                      |       |
| Shares  outstanding at end of period                               |       | 16,560,100                                                              |        | 14,400,100                                                                                                                 |       |
|                                                               |       |                                                                    |        |                                                                                                                       |       |
| Ratios/Supplemental  Data                                          |       |                                                                    |        |                                                                                                                       |       |
| Net assets at  end of period                                       |       | $                                                                       | 227,641,124 |                                                                                                                       | $          | 200,137,980 |   |
| Average net  assets (5)                                            |       | $                                                                       | 227,718,666 |                                                                                                                       | $          | 200,137,980 |   |
| Ratio of  expenses to average net assets (annualized)              |       | 2.25%                                                                   |        | 0.06%                                                                                                                      |       |
| Ratio of net investment  income to average net assets (annualized) |       | 4.53%                                                                   |        | 0.04%                                                                                                                      |       |

----

(1)    Based on actual shares outstanding.

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

(3)    Based on weighted average basic per sharedata.

(4)    Total return equals the change in the marketvalue of the Company’s common stock from the beginning of the period takinginto account dividends reinvested in accordance with the terms of our dividendreinvestment plan.

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

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

11

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**GLADSTONEINVESTMENT CORPORATION**

**NOTESTO FINANCIAL STATEMENTSJUNE 30, 2006(UNAUDITED)**

NOTE 1. ORGANIZATION

GladstoneInvestment Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Delaware on February 18, 2005 and completed aninitial public offering on June 22, 2005.  The Company is a closed-end, non-diversified management investmentcompany that has elected to be treated as a business development company underthe Investment Company Act of 1940, as amended (the “1940 Act”). In addition,the Company has elected to be treated for tax purposes as a regulatedinvestment company, or RIC, under the Internal Revenue Code of 1986, as amended(the “Code”). The Company’s investment objectives are to achieve a high levelof current income and capital gains by investing in debt and equity securitiesof established private businesses.

The Company isexternally managed by Gladstone Management Corporation (“GMC”), anunconsolidated affiliate of the Company.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

*Interim Financial Statements*

Interim financial statements of the Company areprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) for interim financial information andpursuant to the requirements for reporting on Form 10-Q and Article 10 ofRegulation S-X. Accordingly, certain disclosures accompanying annual financialstatements prepared in accordance with GAAP are omitted. In the opinion ofmanagement, all adjustments, consisting solely of normal recurring accruals,necessary for the fair statement of financial statements for the interimperiods have been included. The current period’s results of operations are notnecessarily indicative of results that ultimately may be achieved for theyear.  The interim financial statementsand notes thereto should be read in conjunction with the financial statementsand notes thereto included in the Company’s Form 10-K for the fiscal year endedMarch 31, 2006, as filed with the Securities and Exchange Commission on June14, 2006.

*Use of Estimates*

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

*Classificationof Investments*

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

*Investment Valuation*

TheCompany carries its investments at fair value, as determined by its Board ofDirectors.  Securities that are publiclytraded are valued at the closing price on the valuation date.  Securities for which a limited market exists,such as participations in syndicated loans, are valued at the indicative bidprice on the valuation date from the respective originating syndication agent’strading desk.  Debt and equity securitiesthat are not publicly traded are valued at fair value as determined in goodfaith by the Board of Directors. The Company currently engages Standard &Poor’s Loan Evaluation Service (S&P) to perform independent valuations ofsome of  its

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investments.  The Board of Directors uses the recommendedvaluations as prepared by S&P as a component of the foundation for thefinal fair value determination.  Inmaking such determination, the Board of Directors values non-convertible debtsecurities at cost plus amortized original issue discount plus payment in kind(“PIK”) interest, if any, unless adverse factors lead to a determination of alesser valuation.  In valuing convertibledebt, equity, success or exit fees or other equity-like securities, the Boardof Directors determines the fair value based on the collateral, the issuer’sability to make payments, the earnings of the issuer, sales to third parties ofsimilar securities, the comparison to publicly traded securities, discountedcash flow and other pertinent factors. Due to the uncertainty inherent in the valuation process, such estimatesof fair value may differ significantly from the values that would have resultedhad a ready market for the securities existed, and the differences could bematerial. Additionally, changes in the market environment and other events thatmay occur over the life of the investments may cause the gains ultimatelyrealized on these investments to be different than the valuation currentlyassigned.  Because there is a delaybetween when the Company closes a loan and when the loan can be evaluated byS&P, new loans are not valued immediately by S&P; rather, the Board ofDirectors makes its own independent determination about the value of the loanin accordance with the Company’s valuation policy without the input ofS&P.  Because S&P does notperform independent valuations of equity securities, the Board of Directorsalso determines the fair value of these investments without the input ofS&P.  The Board of Directorsconsiders a number of qualitative and quantitative factors in current marketconditions when performing valuations and is ultimately responsible for thefair value and disclosure of investments in the financial statements.

*InterestIncome Recognition*

Interest income,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.  Conditional interest or asuccess fee is recorded upon full repayment of a loan investment.

*Fee Income*

The 1940 Actrequires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objectives andpolicies of the respective portfolio company. The Company provides these andother services through its adviser, GMC.  Currently, neither the Company nor GMC receives fees in connection withmanagerial assistance. GMC provides managerial assistance to the Company’sportfolio companies and currently does not charge for those services.  If GMC does charge managerial assistance feesin the future, any such fees will be credited to the base management feeotherwise due to GMC from the Company under the Advisory Agreement.  However, GMC also receives fees for the otherservices it provides, and 50% of those fees for other services are credited tothe investment advisory fees due to GMC. These other fees are generally paid to GMC upon the closing of theinvestment.  These fees are generallynon-recurring, are recognized as revenue when earned and are paid directly toGMC by the borrower or potential borrower upon closing of the investment.  The services GMC provides vary by investment,but generally include a wide variety of services to the portfolio companiessuch as investment banking services, arranging bank financing, arranging equityfinancing, structuring financing from multiple lenders and investors, reviewingexisting credit facilities, restructuring existing loans, raising equity anddebt capital, turnaround management, merger and acquisition services andrecruiting new management personnel.  Anyservices of this nature subsequent to the closing would generally generate aseparate fee at the time of completion which is payable either to the Companyor GMC. From time to time, the Company is invited to participate as a co-lenderin a transaction. In the event that the Company does not provide significantservices in connection with our investment, loan fees paid directly to GMC insuch situations are deferred and amortized over the life of the loan.

*Cash and Cash Equivalents*

The Company considers all short-term, highly liquidinvestments that are both readily convertible to cash and have a maturity ofthree months or less at the time of purchase to be cash equivalents. Itemsclassified as cash equivalents include temporary investments in US Treasurybills and can also include commercial paper and money-market funds. All of theCompany’s cash at June 30, 2006 was deposited with two financial institutions,and the Company’s balances exceed federally insurable limits. The Company seeksto mitigate this risk by depositing funds with major financial institutions.

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*RealizedGain or Loss and Unrealized Appreciation or Depreciation of PortfolioInvestments*

Realized gain or loss is recognized when an investment is sold and iscomputed as the difference between the Company’s cost basis in the investmentat the date of sale and the net proceeds received from such sale.  Unrealized appreciation or depreciationreflects the difference between the fair market value of the investment and thecost basis of such investment.

*Income Taxes*

The Company intends to qualify for treatment as a RICunder subchapter M of the Code. As a RIC, the Company will not be subject tofederal income tax on the portion of its taxable income and gains distributedto stockholders. To qualify as a RIC, the Company is required to distribute atleast 90% of investment company taxable income, as defined by the Code. TheCompany intends to distribute at least 90% of its ordinary income. The Companymay, but does not intend to, pay out a return of capital.

NOTE 3. RELATED PARTY TRANSACTIONS

**Investment Advisory and ManagementAgreement**

We have entered into aninvestment advisory and management agreement with GMC (the “Advisory Agreement”),which is controlled by our chairman and chief executive officer. In accordancewith the Advisory Agreement, we pay GMC a fee, as compensation for itsservices, consisting of a base management fee and an incentive fee.

The base management feeis assessed at an annual rate of 2% computed on the basis of the average valueof the Company’s gross invested assets at the end of the two most recentlycompleted quarters, which are total assets less the cash proceeds and cash andcash equivalents from the proceeds of the Company’s initial public offeringthat are not invested in debt and equity securities of portfoliocompanies.  Through December 31, 2005,the base management fee was computed and payable monthly in arrears. Subsequentto December 31, 2005, the base management fee has and will be computed and payable quarterly in arrears.  Beginning in periods subsequent to September30, 2006, the base management fee will be assessed at an annual rate of 2%computed on the basis of the average value of the Company’s average grossassets at the end of the two most recently completed quarters, which are totalassets, including investments made with proceeds of borrowings, less anyuninvested cash or cash equivalents resulting from borrowings.  This new calculation was originally scheduledto begin in periods after March 31, 2006; however, on April 11, 2006, theCompany’s Board of Directors accepted a voluntary waiver from GMC that allowedthe current calculation of the base management fee to be effective through June30, 2006.  In addition, on July 11, 2006,the Company’s Board of Directors accepted another voluntary waiver from GMCthat will allow the current calculation of the base management fee to beeffective through September 30, 2006.

When GMC receives feesfrom the Company’s portfolio companies, such as investment banking fees,structuring fees or executive recruiting services fees, one half of these feeswill be credited against the base management fee that the Company wouldotherwise be required to pay to GMC.  Forthe three months ended June 30, 2006, the Company recognized a base managementfee of $801,309 which was unpaid at June 30, 2006 and is reflected in theaccompanying statements of assets and liabilities as a base management feepayable to GMC.  No base management feewas recorded in for the period from June 22, 2005 (Commencement of operations)through June 30, 2005 as the Company had no gross invested assets as of June30, 2005.

The incentive feeconsists of two parts: an income-based incentive fee and a capital gainsincentive fee. The income-based incentive fee is calculated and payablequarterly in arrears based on our pre-incentive fee net investment income forthe immediately preceding calendar quarter. The capital gains incentive feewill be determined and payable annually in arrears as of the end of each fiscalyear (or upon termination of the Advisory Agreement, as of the terminationdate), commencing on March 31, 2006, and will equal 20.0% of the realizedcapital gains since inception through the end of the current fiscal year, ifany, computed net of all realized capital losses, and net unrealized capitaldepreciation  since inception at the endof each fiscal year. Refer to the Company’s Form 10-K for the fiscal year endedMarch 31, 2006 for more information regarding the calculation of the incentivefee.

Because pre-incentive feenet investment income was below the hurdle rate of 1.75% of net assets, noincome-based incentive fee was recorded for the three months ended June 30,2006 and the period June 22, 2005 (Commencement of operations) to June 30, 2005.

**Administration Agreement**

The Company has entered into an administrationagreement (the “Administration Agreement”) with Gladstone Administration, LLC (“GladstoneAdministration”), a wholly owned subsidiary of GMC, which is controlled by theCompany’s chairman and chief executive officer. Pursuant to the AdministrationAgreement, Gladstone Administration furnishes the Company with officefacilities, equipment and clerical, bookkeeping and record keeping services atsuch facilities and performs, or oversees the performance of the 

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Company’s required administrative services. Suchrequired administrative services include, among other things, being responsiblefor the financial records which we are required to maintain and preparingreports to our stockholders and reports filed with the Securities and ExchangeCommission (the “SEC”).

The Administration Agreement requires the Company toreimburse Gladstone Administration for the performance of its obligations underthe Administration Agreement. The reimbursement is based upon the allocableportion of Gladstone Administration’s overhead, including, but not limited to,rent and the allocable portion of salaries and benefits of the Company’s chieffinancial officer, controller, chief compliance officer and their respectivestaff. The Company recorded fees to Gladstone Administration on the statementof operations of $115,389 for the three months ended June 30, 2006 and $27,083for the period June 22, 2005 (Commencement of operations) to June 30, 2005. Asof June 30, 2006, $115,389 was unpaid and included in the administration feepayable to Gladstone Administration in the accompanying statements of assetsand liabilities.

**Loan Payable to Affiliate**

On June 30, 2005, the Company repaid a $50,000 loanpayable to its chairman and chief executive officer. The demand recoursepromissory note accrued interest at the rate of 3% per annum and was repaidwith accrued interest of $378 using a portion of the net proceeds from theCompany’s initial public offering.

NOTE 4. COMMON STOCK

As of June 30, 2006 and March 31, 2006, 100,000,000shares of $0.001 par value common stock were authorized and 16,560,100 shareswere outstanding.

NOTE 5. INCREASE IN NETASSETS PER SHARE RESULTING FROM OPERATIONS

The following table sets forth the computation ofbasic and diluted net increase in net assets per share resulting fromoperations for the three months ended June 30, 2006 and the period June 22,2005 (Commencement of Operations) to June 30, 2005:

 
| ** **                                                                                       | ** ** | **For the three  months ended  June 30, 2006** | ** ** | **For the period  June 22, 2005  (Commencement of  Operations) to  June 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                             |       |                                                                    |       |                                                                                                                       |       |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                                                       | 1,277,048  |                                                                                                                       | $          | 19,800 |   |
|                                                                                             |       |                                                                    |       |                                                                                                                       |       |
| Denominator for  basic and diluted shares                                                        |       | 16,560,100                                                              |       | 14,400,100                                                                                                                 |       |
|                                                                                             |       |                                                                    |       |                                                                                                                       |       |
|                                                                                             |       |                                                                    |       |                                                                                                                       |       |
| Basic and  diluted net increase in net assets per share resulting from operations                |       | $                                                                       | 0.08       |                                                                                                                       | $          | 0.00 |   |

 

NOTE 6. DIVIDENDS

The Company is required to pay out as a dividend, 90%of its ordinary income and realized net short-term capital gains in excess ofrealized net short-term capital losses, if any, for each taxable year in orderto maintain its status as a RIC under Subtitle A, Chapter 1 of Subchapter M ofthe Code. It is the policy of the Company to pay out as a dividend up to 100%of those amounts. The amount to be paid out monthly as a dividend is determinedby the Board of Directors each quarter and is based on the annual earningsestimated by the management of the Company. At year-end the Company may pay abonus dividend, in addition to the monthly dividends, to ensure that it haspaid out at least 90% of its ordinary income and realized net short-termcapital gains for the year. The Company’s Board of Directors declared thefollowing monthly dividends which it believes were paid from ordinary income:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| April 11, 2006            |       | June  22, 2006       |       | June  30, 2006        |       | $0.07                            |       |
| April 11, 2006            |       | May  22, 2006        |       | May  31, 2006         |       | $0.07                            |       |
| April 11, 2006            |       | April 20, 2006       |       | April 28, 2006        |       | $0.07                            |       |

 

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**NOTE 7. SUBSEQUENT EVENTS**

*Loan Participations*

In July 2006, the Company purchased additional loanparticipations of two portfolio companies of approximately $0.5 million and aloan participation of two companies not currently in our investment portfolioof approximately $5.0 million. In addition, the Company sold one of its loanparticipations of $1.0 million realizing a nominal loss on the transaction andone loan participation repaid in full for $3.0 million.

*Quench USA, LLC*

In July 2006, Quench USA, LLC borrowed $500,000 underits revolving credit facility leaving $1.1 million available for futureborrowings.

*Dividends*

On July 11, 2006, the Company’s Board of Directorsdeclared the following monthly dividends which it believes were and will bepaid, as applicable, from ordinary income:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| July 11, 2006             |       | July  19, 2006       |       | July  31, 2006        |       | $0.07                            |       |
| July 11, 2006             |       | August  21, 2006     |       | August  31, 2006      |       | $0.07                            |       |
| July 11, 2006             |       | September 21, 2006   |       | September 29, 2006    |       | $0.07                            |       |

 

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.**

**All statements contained herein,other than historical facts, may constitute****“forward-looking statements” within the meaning ofSection 27A of the****Securities Actof 1933, as amended, and Section 21E of the Securities Exchange****Act of 1934, as amended. These statements may relateto, among other things,****futureevents or our future performance or financial condition. In some cases,****you can identify forward-looking statementsby terminology such as “may,”****“might,”“believe,” “will,” “provided,” “anticipate,” “future,” “could,”****“growth,” “plan,” “intend,” “expect,” “should,” “would,”“if,” “seek,”****“possible,” “potential,”“likely” or the negative of such terms or comparable****terminology. These forward-looking statements involveknown and unknown risks,****uncertaintiesand other factors that may cause our actual results, levels of****activity, performance or achievements to be materiallydifferent from any****future results,levels of activity, performance or achievements expressed or****implied by such forward-looking statements. Suchfactors include, among others:****(1)our future operating results as we are a company with a limited operating****history; (2) the loss of one or more of ourexecutive officers, in particular,****DavidGladstone, Terry Lee Brubaker, or George Stelljes, III; (3) the impact of****the investments that we make and the abilityof these investments to achieve****theirobjectives; (4) our contractual relationships with third parties; (5) the****adequacy of our cash resources and workingcapital; (6) our ability to obtain****futurefinancing, if at all; and (7) those factors listed under the caption****“Risk Factors” of the Company’s Annual Reporton Form 10-K dated March 31, 2006, as filed with****the Securities and Exchange Commission on June 14,2006. We caution readers not****toplace undue reliance on any such forward-looking statements, which are made****pursuant to the Private Securities LitigationReform Act of 1995 and, as such,****speakonly as of the date made. We undertake no obligation to publicly update****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 ourfinancial condition and results of operations**should be read in conjunction with our financialstatements and the notes**theretocontained elsewhere in this report and our annual report on Form 10-K for thefiscal year ended March 31, 2006.*

**OVERVIEW**

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

Our primary investmentfocuses are situations involving buyouts and recapitalizations of small andmid-sized companies with established management teams. We expect that ourinvestments will generally range between $10 million and $30 million each,although this investment size may vary proportionately as the size of ourcapital base changes. We intend to invest either by ourselves or jointly withother buyout funds, depending on the opportunity. If we are participating in aninvestment with one or more co-investors, then our investment is likely to besmaller than if we were to be investing alone.

Following the completionof our initial public offering in June 2005, we began investing the proceeds ofour initial public offering in senior secured syndicated loans because theseinvestments typically may be originated more quickly than investments incompanies undergoing a buyout or recapitalization. We employed this strategy inorder to more quickly invest our initial capital to generate current income.Senior secured syndicated loans typically involve a number of banks or otherfinancial institutions and are generally more marketable than loans that arenot syndicated. We believe we will be able to sell our interests in seniorsecured syndicated loans and reinvest the proceeds in subordinated debt,mezzanine debt, preferred stock and other higher yielding investments when suchinvestment opportunities are more readily available. In order to invest incertain senior secured syndicated loans, we may purchase these investments at apremium or discount. We amortize premiums and discounts over the contractuallife of the investment. In the event that an investment is sold prior to itscontractual maturity date, we recognize a loss on any unamortized premium or again on any unamortized discount. While the majority of our portfolio currentlyconsists of senior secured loans, over time we expect that it will consistprimarily of subordinated debt, mezzanine debt and preferred stock that wereceive when making investments in connection with buyouts andrecapitalizations. To date, we have acquired interests in 24 such syndicatedloans in the aggregate principal amount, net of any repayments, ofapproximately $113.3 million.  We expect tocontinue purchasing syndicated loans using the proceeds from our initial publicoffering.

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At June 30, 2006, we haveinvestments of approximately $43.5 million in revolving credit facilities, seniorand subordinated debt of three portfolio companies, including borrowings underrevolving credit facilities.  Inaddition, at June 30, 2006 we have invested approximately $12.8 million inpreferred and common equity of those companies. These investments are theresult of buyout and recapitalization transactions and represent our primaryinvestment focus.   We intend to continueto invest in such investments using the remaining proceeds from our initialpublic offering or by the potential future sale of our existing seniorsyndicated loans, however, from time to time we may continue to invest insyndicated loans.

Certain loan investmentsmay have a form of interest that is not paid currently but is accrued and addedto the loan balance and paid at the end of the term. This interest is called “paidin kind” interest or “PIK.” We will generally seek investments that do notgenerate PIK interest as we have to pay out this accrued interest as dividendsto our stockholders and we may have to borrow money or raise additional capitalin order to meet the tax test for a regulated investment company (“RIC”) byhaving to pay out at least 90% of our income. As of June 30, 2006, none of our investments bear PIK interest.

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

Asa business development company under the 1940 Act, we are required to makeavailable significant managerial assistance to our portfolio companies. Weprovide these services through Gladstone Management Corporation (the “Adviser”or “GMC”),who provides these services on our behalf through its officers whoare also our officers.  GMC providesadditional services to our portfolio companies, for which it receives fees, inconnection with our investments.  Thesefees are generally non-recurring, however in some instances they may have arecurring component that is also paid to GMC. One half of any such fees received, with the exception of any recurringfees, by GMC are credited against the management advisory fee payable to GMCpursuant to the terms of our advisory agreement, which has the effect ofreducing our expenses to the extent of any such fees received by GMC.  The specific services GMC provides vary byportfolio company, but generally include a wide variety of services such asinvestment banking, arranging bank financing and equity financing, structuringfinancing from multiple lenders and investors, reviewing existing creditfacilities, restructuring existing loans, raising equity and debt capital,turnaround management, merger and acquisition services and recruiting newmanagement personnel.

Inthe event that we expend significant effort in considering and negotiating apotential investment that ultimately is not consummated, we generally will seekreimbursement from the proposed borrower for our reasonable expenses incurredin connection with the proposed transaction. Any amounts collected for expenses incurred by GMC in connection withunconsummated investments will be reimbursed to GMC. Amounts collected forthese expenses incurred by us will be reimbursed to us and will be recognizedin the period in which such reimbursement is received.  Also, in the event that we have incurredsignificant legal fees in connection with the transaction, we will typicallyseek reimbursement for these expenses from the proposed borrower.  However, there can be no guarantee that wewill be successful in collecting any such reimbursements.

**Our Adviser**

Ouraffiliate, GMC, is our investment adviser and is led by a management team,which has extensive experience in our lines of business.  GMC is controlled by David Gladstone, ourchairman and chief executive officer. Mr. Gladstone is also the chairman and chief executive officer ofGMC.  Terry Lee Brubaker, our vicechairman, chief operating officer and director, is a member of the Board ofDirectors of GMC and is its vice chairman and chief operating officer.  George Stelljes III, our president, chiefinvestment officer and director, is a member of the Board of Directors of GMCand is its president and chief investment officer.  Harry Brill, our chief financial officer, isthe chief financial officer of GMC.

GMCalso provides investment advisory and administrative services to our affiliatesGladstone Commercial Corporation, a publicly traded real estate investmenttrust; Gladstone Capital Corporation, a publicly traded business developmentcompany; and Gladstone Land Corporation, an agricultural real estate companyowned by Mr. Gladstone.  All of ourdirectors and executive officers serve as either directors or executiveofficers, or both, of Gladstone Commercial Corporation and Gladstone CapitalCorporation.  In the future, GMC mayprovide investment advisory and administrative services to other funds, bothpublic and private, of which it is the sponsor.

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Wehave been externally managed by GMC pursuant to an advisory agreement since ourinception.  GMC was organized as acorporation under the laws of the State of Delaware on July 2, 2002, and is aregistered investment adviser under the 1940 Act.  GMC is headquartered in McLean, Virginia, asuburb of Washington, DC, and has offices in New York, New York, Chicago,Illinois, Pittsburgh, Pennsylvania, Morristown, New Jersey, Lexington, Kentuckyand Dallas, Texas.

**InvestmentAdvisory and Management Agreement**

Pursuant to the advisoryagreement with GMC we pay GMC a fee, as compensation for its services,consisting of a base management fee and an incentive fee.

The base management feeis assessed at an annual rate of 2% computed on the basis of the average valueof our gross invested assets at the end of the two most recently completedquarters, which are total assets less the cash proceeds and cash and cashequivalent investments from the proceeds of our initial public offering thatare not invested in debt and equity securities of portfolio companies.  Through June 30, 2006, the base managementfee was computed and payable quarterly. Beginning in periods subsequent to September 30, 2006, the basemanagement fee will be assessed at an annual rate of 2% computed on the basisof the average value of our gross assets at the end of the two most recentlycompleted quarters, which are total assets, including investments made withproceeds of borrowings, less any uninvested cash or cash equivalents resultingfrom borrowings.  This calculation wasoriginally scheduled to begin in periods after March 31, 2006, however, onApril 11, 2006 our Board of Directors accepted a voluntary waiver from GMC thatallowed the current calculation of the base management fee to be effectivethrough June 30, 2006.  Further, on July11, 2006 our Board of Directors accepted an additional voluntary waiver from GMCallowing the current calculation of the base management fee to extend toSeptember 30, 2006.   When GMC alsoreceives fees from our portfolio companies, such as investment banking fees,structuring fees or executive recruiting services fees, one half of these feeswill be credited against the base management fee that we would otherwise berequired to pay to GMC.

The incentive feeconsists of two parts: an income-based incentive fee and a capital gainsincentive fee. The income-based incentive fee will reward GMC if our quarterlynet investment income (before giving effect to the incentive fee) exceeds 1.75%of our net assets.  GMC will receive acapital gains incentive fee of 20% of our realized capital gains (net ofrealized capital losses and unrealized capital depreciation).

**Administration Agreement**

We have entered into anadministration agreement with Gladstone Administration, LLC (“GladstoneAdministration”), a wholly owned subsidiary of GMC. Pursuant to theadministration agreement, Gladstone Administration furnishes us with officefacilities, equipment and clerical, bookkeeping and record keeping services atsuch facilities and performs, or oversees the performance of our requiredadministrative services. Such required administrative services include, amongother things, being responsible for the financial records which we are requiredto maintain and preparing reports to our stockholders and reports filed withthe Securities and Exchange Commission.

The administrationagreement requires us to reimburse Gladstone Administration for the performanceof its obligations under the administration agreement based upon our allocableportion of Gladstone Administration’s overhead, including, but not limited to,rent and our allocable portion of the salaries and benefits of our chieffinancial officer, chief compliance officer, controller and their respectivestaffs. Our allocable portion of expenses is derived by multiplying GladstoneAdministration’s total expenses by the percentage of our average total assets(the total assets at the beginning and ending of each quarter) in comparison tothe average total assets of all companies managed by GMC.

**Our Investment Strategy**

We seek to achievereturns from current income and capital gains from senior, subordinated andmezzanine debt, as well as preferred stock and warrants to purchase commonstock, representing controlling investments that we make in connection withbuyouts and recapitalizations of small and mid-sized companies.  We expect that our target portfolio over timewill include mostly subordinated loans, mezzanine debt, preferred stock, andwarrants to buy common stock. Structurally, subordinated loans and mezzanineloans usually rank lower in priority of payment to senior debt, such as seniorbank debt, and may be unsecured. However, subordinated debt and mezzanine loansrank senior to common and preferred equity in a borrower’s capital structure.Typically, subordinated debt and mezzanine loans have elements of both debt andequity instruments, offering the returns in the form of interest payments associatedwith senior debt, while providing lenders an opportunity to participate in thecapital appreciation of a borrower, if any, through an equity interest. Thisequity interest typically takes the form of warrants. Due to its higher riskprofile and often less restrictive 

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

**Critical Accounting Policies**

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

***InvestmentValuation***

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

*General Valuation Policy:*We value our investment portfolio each quarter. We carry our investments atfair value, as determined in good faith by our Board of Directors.  Securities that are publicly traded, if any,are valued at the closing price of the exchange or securities market on whichthey are listed on the valuation date. Securities which are not traded on apublic exchange or securities market, but for which a limited market exists andthat have been rated by a nationally recognized statistical ratingorganizations (“NRSRO”), such as certain participations in syndicated loans,are valued at the indicative bid price offered by the syndication agent on thevaluation date.

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

We currently engageStandard & Poor’s Loan Evaluation Service (“S&P”) to help evaluate thevalue of 7 of our loan securities (other than those which are publicly tradedor for which a limited market exists, as described above), as well as forevaluations on success fees (conditional interest included in some loansecurities).  We and S&P onlyevaluate the value of a success fee if the probability of receiving the successfee on a given loan is above 6-8%, a threshold of significance.  Upon completing our collection of data withrespect to the investments (including the information described under “CreditInformation,” the risk ratings of the loans described under “Loan Grading andRisk Rating” and the factors described under “Valuation Methods”), thisvaluation data is presented to S&P. S&P makes its independent assessment of the data that we haveassembled and assesses its own data to determine market values for thesecurities.  With regard to its work,S&P has issued the following paragraph:

S&P provides evaluated price opinions which are reflective of whatS&P believes the bid side of the market would be for each loan aftercareful review and analysis of descriptive, market and credit information.  Each price reflects S&P’s best judgmentbased upon careful examination of a variety of market factors.  Because of fluctuation in the market and inother factors beyond its control, S&P cannot guarantee theseevaluations.  The evaluations reflect themarket prices, or 

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estimates thereof, on the date specified.  The prices are based on comparable marketprices for similar securities.  Marketinformation has been obtained from reputable secondary market sources.  Although these sources are considered reliable,S&P cannot guarantee their accuracy.

With our assessment andthe supplemental S&P value estimates, our Board of Directors votes toaccept or not accept the analyses and values recommended by management andS&P.  At the July 11, 2006meeting of the Board of Directors, the Board of Directors elected to accept thevaluations recommended by S&P on the loans in our portfolio as denoted onthe Schedule of Investments as of June 30, 2006 in our consolidated financialstatements.

Because there is a delaybetween when we close an investment and when the investment can be evaluated byS&P, new loans are not valued immediately by S&P; rather, the Board ofDirectors makes its own determination about the value of these investments inaccordance with our valuation policy. Because S&P does not provide values for equity securities our Boardof Directors also independently determines the fair value of these investmentsusing our valuation policy.

*Credit Information:*****We monitor a wide variety of key creditstatistics that provide information regarding our portfolio companies to helpus assess credit quality and portfolio performance.  We require our portfolio companies to provideannual audited and either monthly or quarterly unaudited financialstatements.  Using these statements, wecalculate and evaluate the credit statistics. For purposes of analyzing the financial performance of our portfoliocompanies, we may make certain adjustments to their cash flow statements toreflect the pro forma results of a company consistent with a change of controltransaction, to reflect anticipated cost savings resulting from a merger orrestructuring, costs related to new product development, compensation toprevious owners, and other acquisition or restructuring related items.  For those investments for which S&Pprepares valuation recommendations, we provide this credit information toS&P for its use in preparing its recommendations.  For those investments for which S&P doesnot prepare valuation recommendations, management uses this credit informationin connection with its preparation of valuation recommendations.

*Loan Grading and Risk Rating:*****Aspart of our valuation procedures we risk rate all of our investments in debtsecurities.  Our risk rating systemuses a scale of 0 to 10, with 10 being the lowest probability of default.  This system is used to estimate theprobability of default on our debt securities and the probability of loss ifthere is a default.  These types ofsystems are referred to as risk rating systems and are used by banks and ratingagencies.  The risk rating system covers bothqualitative and quantitative aspects of the business and the securities wehold.  For those investments for which S&P prepares valuationrecommendations, we compile this information and provide it to S&P for itsconsideration in determining its valuation recommendations.  For those investments for which S&P doesnot prepare valuation recommendations, management uses this information todevelop valuation recommendations.

We seek to have our riskrating system mirror the risk rating systems of major risk rating organizationssuch as those provided by a NRSRO as defined in Rule 2a-7 under the 1940 Act.While we seek to mirror the NRSRO systems, we cannot provide any assurance thatour risk rating system provides the same risk rating as a NRSRO. The followingchart is an estimate of the relationship of our risk rating system to thedesignations used by two NRSROs as they risk rate debt securities of majorcompanies.  Because we have establishedour system to rate debt securities of companies that are unrated by any NRSRO,there can be no assurance that the correlation to the NRSRO set out below isaccurate.  We believe our risk ratingwould be significantly higher than a typical NRSRO risk rating because the riskrating of the typical NRSRO is designed for larger businesses that can affordto pay an NRSRO to rate their securities. However, our risk rating has been designed to risk rate the securitiesof smaller businesses that are not rated by a typical NRSRO. Therefore, when weuse our risk rating on larger business securities, the risk rating is higherthan 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 our understanding that most debtsecurities of middle market companies do not exceed the grade of BBB on a NRSROscale, so there would be no debt securities in the middle market that wouldmeet the definition of AAA, AA or A. Therefore, our scale begins with the designation 10 as the best riskrating which may be equivalent to a BBB from a NRSRO, however, no assurance canbe given that a 10 on our scale is equal to a BBB on a NRSRO scale.

 
| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Investment’s Description(a)**                                                       |
|----------------------------|------------|------------------|------------|-------------------|------------|------------------------------------------------------------------------------------------------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of Default (PD during the next ten years  is 4% and the Expected Loss (EL is 1% or less) |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5 and the EL is 1 to 2%                                                                        |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10 and the EL is 2 to 3%                                                                       |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16 and the EL is 3 to 4%                                                                       |

 

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| **7** |   | Ba3  |   | BB-  |   | PD is 17.8 and the EL is 4 to 5%                                       |
|-------|--------|------|--------|------|--------|------------------------------------------------------------------------|
| **6** |   | B1   |   | B+   |   | PD is 22.0 and the EL is 5 to 6.5%                                     |
| **5** |   | B2   |   | B    |   | PD is 25 and the EL is 6.5 to 8%                                       |
| **4** |   | B3   |   | B-   |   | PD is 27 and the EL is 8 to 10%                                        |
| **3** |   | Caa1 |   | CCC+ |   | PD is 30 and the EL is 10.0 to 13.3%                                   |
| **2** |   | Caa2 |   | CCC  |   | PD is 35 and the EL is 13.3 to 16.7%                                   |
| **1** |   | Caa3 |   | CC   |   | PD is 65 and the EL is 16.7 to 20%                                     |
| **0** |   | N/a  |   | D    |   | PD is 85 or there is a Payment Default and the EL is  greater than 20% |

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

The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default.  The followingtable lists the risk ratings for all of the debt securities at June 30, 2006and March 31, 2006:

| Rating           | ** ** | **June 30, 2006** | ** ** | **March 31, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          |       | 7.3                         |       | 7.1                          |       |
| Weighted Average |       | 6.7                         |       | 6.6                          |       |
| Highest          |       | 9                           |       | 9                            |       |
| Lowest           |       | 5                           |       | 5                            |       |

 

The above scale gives an indication of the probabilityof default and the magnitude of the loss if there is a default.  Our policy is to stop accruing interest on aninvestment if we determine that interest is no longer collectible.  At June 30, 2006, no payments were past dueon any of our debt securities. Additionally, we do not risk rate our equity securities.

*Valuation Methods:*  For debt securities, we first determine ifthe debt security is publicly traded (i.e., if it is listed on an exchange orsecurities market).  If it is publiclytraded, then we determine the value based on the closing price for the securityon the exchange or securities market on which it is listed on the valuationdate.  If the security is not publiclytraded, but a limited market for the security exists, such as for aparticipation in a syndicated loan, then we value it at the indicative bid priceoffered by the syndication agent on the valuation date.  At June 30, 2006, none of the debt securitiesin our portfolio were publicly traded and there was a limited market for 18debt securities in our portfolio.

Fordebt securities that are not publicly traded, for which there is no market, orfor which there is a market but have not been rated by a NRSRO, we begin withthe risk rating designation of the security described above.  Using the risk rating designation above, weseek to determine the value of the security as if we intended to currently sellthe security.  To determine the currentsale price of the security, we consider some or all of the following factors:

·                  financialstanding of the issuer of the security;

·                  comparison ofthe business and financial plan of the issuer with actual results;

·                  the cost of thesecurity;

·                  the size of thesecurity held as it relates to the liquidity of the market for such securities;

·                  contractualrestrictions on the disposition of the security;

·                  pending publicoffering of the issuer of the security;

·                  pendingreorganization activity affecting the issuer such as mergers or debtrestructuring;

·                  reported pricesof similar securities of the issuer or comparable issuers;

·                  ability of theissuer to obtain needed financing;

·                  changes in theeconomy affecting the issuer;

·                  recent purchasesor sale of a security of the issuer;

·                  pricing andsales by other buyers or sellers of similar securities;

·                  financialstatements of the borrower;

·                  reports fromportfolio company senior management and ownership;

·                  the type ofsecurity;

·                  cost at date ofpurchase;

·                  size of holding;

·                  discount frommarket value of unrestricted securities of the same class at the time ofpurchase;

·                  special reportsprepared by analysts;

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·                  informationas to any transactions or offers with respect to the security;

·                  existenceof merger proposals or tender offers affecting the securities;

·                  thecollateral;

·                  theissuer’s ability to make payments;

·                  thecurrent and forecasted earnings of the issuer;

·                  statisticalratios compared to lending standards;

·                  statisticalratios compared to similar securities; and

·                  otherpertinent factors.

For those debt securitiesfor which S&P prepares valuation recommendations, we provide the foregoinginformation to S&P for its use in preparing such recommendations.

For convertible debt,equity, success fees or other equity-like securities, we first determine ifthere is any market for the security.  Ifthere is a market, then we determine the value based on the market prices for thesecurity, even if that market is not robust. At June 30, 2006 there was no market for any of the equity securities weowned.  If there is no market for theequity securities, then we use the same information we would use for a debtsecurity valuation described above, except risk-rating, as well as standardvaluation techniques used by major valuation firms to value the equitysecurities of private companies.  Thesevaluation techniques consist of discounted cash flow of the expected sale pricein the future, valuation of the securities based on recent sales in comparabletransactions, and a review of similar companies that are publicly traded andthe market multiple of their equity securities. For equity securities that havebeen in our portfolio for less than one year, we estimate fair value atcost.  At June 30, 2006 we had $12.8million invested, at cost, in equity securities compared to our debt portfoliowith a cost basis of $157.7  million.

At June 30, 2006 we hadtotal unrealized depreciation of approximately $1.2 million which was primarilycomposed of net unrealized depreciation of our syndicated loan investments.

***Tax Status***

*Federal Income Taxes*

We currently qualify and intend to continue to qualifyfor treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code.As a RIC, we are not subject to federal income tax on the portion of ourtaxable income and gains distributed to stockholders. To qualify as a RIC, weare required to distribute to stockholders at least 90% of investment companytaxable income, as defined by the Code. In an effort to avoid certain excisetaxes imposed on RICs, we currently intend to distribute during each calendaryear, an amount at least equal the sum of (1) 98% of our ordinary income forthe calendar year, (2) 98% of our capital gains in excess of capital losses forthe one-year period ending on October 31 of the calendar year and (3) anyordinary income and net capital gains for preceding years that were notdistributed during such years.

***Revenue Recognition***

*Interest Income Recognition*

Interest income is recorded on the accrual basis tothe extent that such amounts are expected to be collected. We will stopaccruing interest on investments when it is determined that interest is nolonger collectible. Conditional interest, or a success fee, is recorded whenearned upon full repayment of a loan investment.

*Fee Income*

The 1940 Actrequires that a business development company make available managerial assistanceto its portfolio companies by providing significant guidance and counselconcerning the management, operations, or business objectives and policies ofthe respective portfolio company. We provide these and other services throughour adviser, GMC. Currently, neither we nor GMC receive fees in connection withmanagerial assistance. GMC provides managerial assistance to our portfoliocompanies and currently does not charge for those services. If GMC does chargemanagerial assistance fees in the future, any such fees will be credited to thebase management fee otherwise due to GMC from us under the advisory agreement.However, GMC also receives fees for the other services it provides, and 50% ofthose fees for other services are credited to the investment advisory fees dueto GMC These other fees are generally non-recurring, are recognized as revenuewhen earned and are paid directly to GMC by the borrower or potential borrowerupon the closing of the investment. The services GMC provides vary by investment,but generally include a wide variety of services to the portfolio companiessuch as investment banking services, arranging bank financing, arranging equityfinancing, 

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structuringfinancing from multiple lenders and investors, reviewing existing creditfacilities, restructuring existing loans, raising equity and debt capital,turnaround management, merger and acquisition services and recruiting newmanagement personnel.  Any services ofthis nature subsequent to the closing would generally generate a separate feeat the time of completion which is payable either to us or GMC. From time totime, we are invited to participate as a co-lender in a transaction. In theevent that we do not provide significant services in connection with ourinvestment, loan fees paid directly to GMC in such situations are deferred andamortized over the life of the loan.

**RESULTS OFOPERATIONS**

*Three months ended June 30, 2006compared to the period June 22, 2005 (Commencement of operations) to June 30,2005*

**Investment Income**

Investment income for the three months ended June 30,2006 was $3,863,438 and consisted of interest income of $3,154,782 on ourportfolio of investments and interest income of $708,340 from cash and cashequivalents, representing income earned on the investment of the remainingproceeds of our initial public offering.

Investment income for the period June 22, 2005(commencement of operations) to June 30, 2005 was $48,198 and consisted solelyof interest earned on our cash and cash equivalents that we received from theproceeds of our initial public offering.

The weighted average yield on our portfolio ofinvestments, excluding cash and cash equivalents, was 8.77% for the threemonths ended June 30, 2006.

**Operating Expenses**

Operating expenses for the three months ended June 30,2006 were $1,282,274.

The administration fee payable to GladstoneAdministration was $115,389 for the three months ended June 30, 2006 comparedto $27,083 for the period June 22,2005 (commencement of operations) to June 30, 2005. This fee consists ofour allocable portion of Gladstone Administration’s rent and other overheadexpenses, and our allocable portion of the salaries and benefits of our chieffinancial officer, chief compliance officer, controller and their respectivestaffs. Our allocable portion of expenses is derived by multiplying thepercentage of our average assets (the assets at the beginning and ending ofeach quarter) in comparison to the average assets of all companies managed byGMC.

The base management fee to GMC was $801,309 for thethree months ended June 30, 2006. The base management fee is currently computedquarterly as described under “Investment Advisory and Management Agreement.”  There was no base management fee for the period June 22, 2005 (commencement of operations)to June 30, 2005 as none of the proceeds from our initial public offering wereinvested during that period.

Directors’ fees for the three months ended June 30,2006 were $43,250 and consisted of the amortization of the directors’ annualstipend and individual meeting fees.  Thedirectors’ fees for the prior year period were not declared until July 2005and, therefore, no expense was recorded for the period June 22, 2005 (commencement of operations) to June 30, 2005.

Insurance expense for the three months ended June 30,2006 was $72,611 and consisted of the amortization of the directors andofficers insurance policy and professional liability policy. There was noinsurance expense for the prior year period as the premiums were not in effectuntil July 2005.

Professional fees for the three months ended June 30,2006 were $79,748 and primarily consisted of legal fees and audit andaccounting fees.  There were noprofessional fees expensed in the prior period as the legal and accounting feesincurred related to our initial public offering and were capitalized.

Stockholder related costs for the three months endedJune 30, 2006 were $93,766 and consisted of the amortization of annual Nasdaqlisting fees, transfer agent fees, annual report printing fees, Securities andExchange Commission filing fees and press release costs.  The $635 of stockholder related costs for theperiod June 22, 2005 (commencement of operations) to June 30, 2005 consistedsolely of press release costs for the respective period.

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Interest expense for theperiod June 22, 2005 (commencement of operations) to June 30, 2005 was $378 andconsisted of interest due on a loan payable to affiliate, which was repaid inJune 2005.

Taxes and licensesexpense for the three months ended June 30, 2006 was $57,107 was primarilycomprised of franchise taxes due to the state of Delaware and other feessurrounding state and regulatory licensing, registration and other corporatefiling fees.

Other expenses for the three months ended June 30,2006 were $19,094 and consisted of conferences, travel, bank fees, documentcustody charges and miscellaneous expenses. Other expenses for the period June 22, 2005 (commencement of operations)to June 30, 2005 were $302 and consisted primarily of bank fees and miscellaneousexpenses.

**Realized and Unrealized Gain (Loss)on Investments**

For the three months ended June 30, 2006, werecognized gains on the sale of four loan participations in the aggregateamount of $3,273 and we recorded net unrealized depreciation of investments inthe aggregate amount of $1,307,389.

At March 31, 2006, the fair value of our investmentportfolio exceeded the cost basis of our portfolio by approximately$113,000.  At June 30, 2006, the fairvalue of our investment portfolio was less than the cost basis of our portfolioby approximately $1.2 million, representing an overall decrease ofapproximately $1.3 million.  Thisdecrease is primarily the result of the decline in market value of oursyndicated loan investments.

**Net Increase in Net Assets fromOperations**

Overall, we realized a net increase in net assetsresulting from operations of $1,277,048 for the three months ended June 30,2006 as a result of the factors discussed above. Based on basic and dilutedweighted average common shares of 16,560,100 outstanding, our net increase innet assets from operations per basic and diluted weighted average common sharefor the three months ended June 30, 2006 was $0.08.  Net increase in net assets resulting from operationsfor the period June 22, 2005 (commencement of operations) to June 30, 2005 was$19,800 and was comprised solely of net investment income for that period.

**LIQUIDITY ANDCAPITAL RESOURCES**

Net cash used in operating activities for the threemonths ended June 30, 2006 was approximately $13.9 million and consisted  primarily of the purchase of syndicated loaninvestments, an increase in interest receivable on our portfolio investmentsand a decrease in accrued expenses from the prior year end, offset by sales ofexisting portfolio investments, increases in base management fee andadministrative fees payable and unrealized depreciation of our portfolioinvestments.

A summary of our investment activity for the threemonths ended June 30, 2006 is as follows:

 
| ** **                        | ** ** | **New   Investments** | ** ** | **Principal   Repayments** | ** ** | **Investments   Sold** | ** ** | **Gain on   Disposal** | ** ** |
|-----------------------------------|------------|----------------------------|------------|---------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| Three months  ended June 30, 2006 |       | $                          | 33,665,549 |                            | $          | 874,222                     |       | $                                | 15,548,454 |   | $ | 3,273 |   |
|                                   |            |                            |            |                                 |            |                             |            |                                  |            |  |  |  |  |

 

During the three months ended June 30, 2006, wepurchased new investments using a portion of the remaining proceeds from our initialpublic offering.  We will continue to usethe proceeds from our initial public offering to make investments in syndicatedloans, subordinated debt, mezzanine debt, preferred stock and other higheryielding investments.  We also expect toestablish a line of credit facility to enable us to continue our investmentactivities once the proceeds from our initial public offering have been fullyinvested.

The following table summarizes the contractualprincipal amortization and maturity of our investment portfolio by fiscal year:

| Fiscal Year Ended March 31, | ** ** | **Amount**  | ** **  |
|-------------------------------------------------|------------|-------------|-------------|
| 2007                                            |       | $           | 2,041,291   |   |
| 2008                                            |       | 4,409,693   |        |
| 2009                                            |       | 5,044,633   |        |
| 2010                                            |       | 6,476,665   |        |
| 2011                                            |       | 33,138,630  |        |
| Thereafter                                      |       | 105,699,984 |        |
|                                            |       |        |        |
| **Total  contractual repayments**               |       | 156,810,896 |        |
|                                            |       |        |        |
| Investments in  equity securities               |       | 12,778,508  |        |
| Unamortized premiums on  debt securities:       |       | 885,136     |        |
| **Total**                                       |       | $           | 170,474,540 |   |

 

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For the period June 22, 2005 (commencement ofoperations) to June 30, 2005, we recorded net cash proceeds resulting from ourinitial public offering of $200,164,544, which were primarily invested in cashand short-term investments at June 30, 2005.

For the three months ended June 30, 2006, ourdividends paid of $3,477,621 exceeded our net investment income (including realizedgains) by $893,184.  We declared thesedividends based on net investment income for the quarter.  Our investment pace continues to be slowerthan expected entering our second year of operations and, consequently, our netinvestment income was lower than our original estimates.

In order to qualify as a RIC and to avoid corporatelevel tax on the income we distribute to our stockholders, we are required,under Subchapter M of the Code, to distribute at least 90% of our ordinaryincome and realized net short-term capital gains to our stockholders on anannual basis. In accordance with these requirements, we have declared thefollowing dividends since our inception:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| April 11, 2006            |       | June  22, 2006       |       | June  30, 2006        |       | $0.07                            |       |
| April 11, 2006            |       | May  22, 2006        |       | May  31, 2006         |       | $0.07                            |       |
| April 11, 2006            |       | April  20, 2006      |       | April  28, 2006       |       | $0.07                            |       |
| January 10, 2006          |       | March  17, 2006      |       | March  31, 2006       |       | $0.07                            |       |
| January 10, 2006          |       | February  16, 2006   |       | February  28, 2006    |       | $0.07                            |       |
| January 10, 2006          |       | January  23, 2006    |       | January  31, 2006     |       | $0.07                            |       |
| October 7, 2005           |       | December  21, 2005   |       | December  31, 2005    |       | $0.04                            |       |
| October 7, 2005           |       | November  21, 2005   |       | November  30, 2005    |       | $0.04                            |       |
| October 7, 2005           |       | October  21, 2005    |       | October  30, 2005     |       | $0.04                            |       |
| July 7, 2005              |       | September  22, 2005  |       | September  30, 2005   |       | $0.02                            |       |
| July 7, 2005              |       | August  23, 2005     |       | August  31, 2005      |       | $0.02                            |       |
| July 7, 2005              |       | July 21, 2005        |       | July 29, 2005         |       | $0.02                            |       |

 

**Contractual Obligations andOff-Balance Sheet Arrangements**

As of June 30, 2006,we were a party to signed and non-binding term sheets for three allocations ofsyndicate loan participations.  Thefuture scheduled contractual payments at June 30, 2006 are as follows:

 
| ** **                       | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                | ** ** | **Less than 1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Investments                      |       | 7,000,000                                |       | 7,000,000 |   |   |   |   |   |   |   |
| Total                            |       | $                                        | 7,000,000  |   | $ | 7,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of the date of this report, $5 million of theinvestment purchase obligations summarized above has been funded. See Note 7 “SubsequentEvents” in our Consolidated Financial Statements for further information.

We do not have any significant off-balance sheetarrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K as of June30, 2006.

**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

We are subject to financial market risks, includingchanges in interest rates. General interest rate fluctuations may have asubstantial negative impact on our investments and investment opportunities and,accordingly have a material adverse effect on our investment objectives and ourrate of return on invested capital. Currently our entire investment portfoliois at variable rates. In addition, an increase in interest rates would make itmore expensive to use debt for our financing needs, if any.

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We expect to borrow funds to finance future lendingactivities after we have substantially fully invested the proceeds of ourinitial public offering. These future borrowings may be at fixed or variablerates. To date, we have not borrowed any funds nor do we currently foresee theshort-term necessity to borrow funds.

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant. Under this analysis, a hypothetical increase in the one monthLondon Interbank Offered Rate (“LIBOR”) by 1% would increase our net increasein net assets resulting from operations by approximately $1.3 million or 18%,over the next twelve months, compared to the net increase in net assetsresulting from operations for the period July 1, 2005 to June 30, 2006. Ahypothetical decrease in the one month LIBOR by 1% would decrease our netincrease in net assets resulting from operations by approximately $1.3 millionor 18%, over the next twelve months, compared to the net increase in net assetsfrom operations for the period July 1, 2005 to June 30, 2006. Althoughmanagement believes that this analysis is indicative of our existing interestrate sensitivity, it does not adjust for potential changes in credit quality,size and composition of our investment portfolio and other businessdevelopments that could affect net increase in net assets resulting fromoperations. Accordingly, no assurances can be given that actual results wouldnot differ materially from the results under this hypothetical analysis.

We expect to hedge against interest rate fluctuationsin the future by using standard hedging instruments such as forward contracts,futures, currency options, interest rate swaps, caps, collars and floors. Whilehedging activities may insulate us against adverse fluctuations in interestrates, they may also limit our ability to participate in the benefits of lowerinterest rates with respect to our portfolio of investments. We currently arenot engaged in any hedging activities.

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

 

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**ITEM 4. CONTROLSAND PROCEDURES.**

As of June 30, 2006, we, including our Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of our disclosure controls and procedures. Based on thatevaluation, our management, including the Chief Executive Officer and ChiefFinancial Officer, concluded that our disclosure controls and procedures wereeffective in timely alerting management, including the Chief Executive Officerand Chief Financial Officer, of material information about us required to beincluded in periodic Securities and Exchange Commission filings. However, inevaluating the disclosure controls and procedures, management recognized thatany controls and procedures, no matter how well designed and operated canprovide only reasonable assurance of achieving the desired control objectives,and management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

There have been no changes in our internal controlover financial reporting that occurred during the quarter ended June 30, 2006that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

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**PART II—OTHER INFORMATION**

**ITEM 1. LEGALPROCEEDINGS.**

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

**ITEM 1A. RISKFACTORS.**

There have been no material changes to the riskfactors as disclosed in the Company’s Annual Report on Form 10-K for the fiscalyear ended March 31, 2006 filed with the Securities and Exchange Commission onJune 14, 2006.

**ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

Not applicable.

**ITEM 3. DEFAULTSUPON SENIOR SECURITIES.**

Not applicable.

**ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

Not applicable.

**ITEM 5. OTHERINFORMATION.**

Not applicable

**ITEM 6. EXHIBITS**

See the exhibit index.

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**SIGNATURE**

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

 

**Date: August 2, 2006**

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**EXHIBITINDEX**
| Exhibit | ** ** | **Description**                                                                                                                                                                                                                                                           |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1     |       | Articles of Amendment and Restatement of the  Articles 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 March 31, 2005.                               |
|    |       |                                                                                                                                                                                                                                                                      |
| 3.2     |       | By-laws, incorporated by reference to Exhibit b to  the Registration Statement on Form N-2 (File No. 333-123699), filed March 31,  2005.                                                                                                                                  |
|    |       |                                                                                                                                                                                                                                                                      |
| 4.1     |       | Specimen Stock Certificate, incorporated by  reference to Exhibit 99.E on Form N-2/A (File No. 333-123699), filed June 21,  2005.                                                                                                                                         |
|    |       |                                                                                                                                                                                                                                                                      |
| 10.1*   |       | Joint Directors Nonqualified Excess Plan of  Gladstone Commercial Corporation, Gladstone Capital Corporation and Gladstone  Investment Corporation incorporated by reference to the Company’s Current  Report on Form 8-K (File No. 0-51233) filed on July 11, 2006. |
|    |       |                                                                                                                                                                                                                                                                      |
| 11      |       | Computation of Per Share Earnings (included in the  notes to the unaudited financial statements contained in this report).                                                                                                                                                |
|    |       |                                                                                                                                                                                                                                                                      |
| 31.1    |       | Certification of Chief Executive Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
|    |       |                                                                                                                                                                                                                                                                      |
| 31.2    |       | Certification of Chief Financial Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
|    |       |                                                                                                                                                                                                                                                                      |
| 32.1    |       | Certification of Chief Executive Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
|    |       |                                                                                                                                                                                                                                                                      |
| 32.2    |       | Certification of Chief Financial Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |

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*                    Denotesmanagement contract or compensatory plan or arrangement.

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

 

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