** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

** **
| **x**                                         | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                          |       |                                                                                          |
| **FOR THE  QUARTER ENDED SEPTEMBER 30, 2006** |
| ** **                                    | ** ** | ** **                                                                                    |
| **o**                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**COMMISSION FILE NUMBER:000-51233**

** **

**GLADSTONE INVESTMENT CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**1521 WESTBRANCH DRIVE,SUITE 200**

**MCLEAN, VIRGINIA 22102**

(Address 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 x   No o.

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

Large acceleratedfiler o  Accelerated filer o  Non-accelerated filer x

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes oNo x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date. The number of shares of the issuer’sCommon Stock, $0.001 par value, outstanding as of November 1, 2006 was16,560,100.

 

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**GLADSTONE INVESTMENT CORPORATION**

**TABLE OF CONTENTS**
| PART I.       |   | FINANCIAL INFORMATION                                                                                                                                             |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                                              |
| Item 1.       |   | Financial Statements (Unaudited)                                                                                                                                  |
|          |   |                                                                                                                                                              |
|          |   | Statements of Assets and Liabilities as of September  30, 2006 and March 31, 2006                                                                                 |
|          |   | Schedule of Investments as of September 30, 2006                                                                                                                  |
|          |   | Schedule of Investments as of March 31, 2006                                                                                                                      |
|          |   | Statements  of Operations for the three months ended September 30, 2006 and 2005                                                                                  |
|          |   | Statements of  Operations for the six months ended September 30, 2006 and for the period  June 22, 2005 (Commencement of Operations) to September 30, 2005        |
|          |   | Statements of  Changes in Net Assets for six months ended September 30, 2006 and for the  period June 22, 2005 (Commencement of Operations) to September 30, 2005 |
|          |   | Statements  of Cash Flows for the six months ended September 30, 2006 and for the period  June 22, 2005 (Commencement of Operations) to September 30, 2005        |
|          |   | Financial  Highlights for the three months ended September 30, 2006 and 2005                                                                                      |
|          |   | Financial  Highlights for the six months ended September 30, 2006 and for the period  June 22, 2005 (Commencement of Operations) to September 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 Disclosures About Market Risk                                                                                                       |
|          |   |                                                                                                                                                              |
| Item 4.       |   | Controls and  Procedures                                                                                                                                          |
|          |   |                                                                                                                                                              |
| PART II. |   | OTHER INFORMATION                                                                                                                                                 |
|          |   |                                                                                                                                                              |
| Item 1.       |   | Legal Proceedings                                                                                                                                                 |
|          |   |                                                                                                                                                              |
| Item 1A. |   | Risk  Factors                                                                                                                                                     |
|          |   |                                                                                                                                                              |
| Item 2.       |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                      |
|          |   |                                                                                                                                                              |
| Item 3.       |   | Defaults Upon  Senior Securities                                                                                                                                  |
|          |   |                                                                                                                                                              |
| Item 4.       |   | Submission of  Matters to a Vote of Security Holders                                                                                                              |
|          |   |                                                                                                                                                              |
| Item 5.       |   | Other Information                                                                                                                                                 |
|          |   |                                                                                                                                                              |
| Item 6.       |   | Exhibits                                                                                                                                                          |
|          |   |                                                                                                                                                              |
| SIGNATURES    |

 

2

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

** **
| ** **                                                                                                   | ** ** | **September 30,  2006** | ** **  | **March 31,  2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------------------------|-------------|--------------------------|------------|
| ASSETS                                                                                                       |       |                         |        |                     |       |
| Non-Control/Non-Affiliate  investments (Cost 9/30/06: $122,529,078; 3/31/06: $97,423,004)                    |       | $                            | 121,555,262 |                     | $          | 97,585,972 |   |
| Control investments  (Cost 9/30/06: $56,746,318; 3/31/06: $55,846,318)                                       |       | 56,491,805                   |        | 55,796,318               |       |
| Total investments at  fair value (Cost 9/30/06: $179,275,396; 3/31/06: $153,269,322)                         |       | 178,047,067                  |        | 153,382,290              |       |
| Cash and cash  equivalents                                                                                   |       | 48,446,618                   |        | 75,672,605               |       |
| Interest receivable                                                                                          |       | 1,294,355                    |        | 761,388                  |       |
| Prepaid directors fees                                                                                       |       | 72,500                       |        | —                   |       |
| Prepaid insurance                                                                                            |       | 200,875                      |        | 99,874                   |       |
| Due from Adviser                                                                                             |       | —                       |        | 234,551                  |       |
| Other assets                                                                                                 |       | 74,732                       |        | 173,099                  |       |
| TOTAL ASSETS                                                                                                 |       | $                            | 228,136,147 |                     | $          | 230,323,807 |   |
|                                                                                                         |       |                         |        |                     |       |
| LIABILITIES                                                                                                  |       |                         |        |                     |       |
| Administration fee  payable to Gladstone Administration                                                      |       | $                            | 124,861     |                     | $          | 110,002 |   |
| Base management fee  payable to Gladstone Management                                                         |       | 861,893                      |        | —                   |       |
| Accrued expenses                                                                                             |       | 154,285                      |        | 367,031                  |       |
| Other liabilities                                                                                            |       | 16,692                       |        | 5,077                    |       |
| Total Liabilities                                                                                            |       | 1,157,731                    |        | 482,110                  |       |
| NET ASSETS                                                                                                   |       | $                            | 226,978,416 |                     | $          | 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                                                                              |       | 230,196,151                  |        | 230,229,279              |       |
| Net unrealized  (depreciation) appreciation of investment portfolio                                          |       | (1,228,329                   | )           | 112,968                  |       |
| Distributions in excess  of net investment income                                                            |       | (2,005,966                   | )           | (517,110                 | )          |
| Total Net Assets                                                                                             |       | $                            | 226,978,416 |                     | $          | 229,841,697 |   |
| Net assets per share                                                                                         |       | $                            | 13.71       |                     | $          | 13.88 |   |
|                                                                                                         |       |                         |        |                     |       |

 

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

3

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**GLADSTONE INVESTMENTCORPORATIONSCHEDULE OF INVESTMENTSSeptember 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  (7.5%, Due 5/2013) (3)      |       | $ 4,003,707 |       | $   3,940,200 |
| American Safety Razor Company Inc.              |       | Manufacturing -  razors and blades                                                                                 |       | Senior Term Debt  (7.9%, Due 7/2013) (3)      |       | 1,498,843        |       | 1,511,213                    |
| Aspect Software, Inc.                           |       | Service - call  center software                                                                                    |       | Senior Term Debt  (8.4%, Due 7/2011) (3)      |       | 3,004,076        |       | 3,015,000                    |
| Bankruptcy Management Solutions, Inc.           |       | Service -  software and service to bankrupcy trustees                                                              |       | Senior Term Debt  (8.2%, Due 7/2012) (3)      |       | 1,003,597        |       | 1,010,000                    |
| Brock Holdings II, Inc.                         |       | Service -  industrial specialty maintenance                                                                        |       | Senior Term Debt  (7.9%, Due 8/2013) (3)      |       | 3,008,279        |       | 3,015,000                    |
| Compsych                                        |       | Service -  independent employee assistance programs                                                                |       | Senior Term Debt  (8.1%, Due 2/2012) (3) (7)  |       | 3,956,832        |       | 3,949,850                    |
| CRC Health Group, Inc.                          |       | Service -  substance abuse treatment                                                                               |       | Senior Term Debt  (7.6%, Due 2/2016) (3)      |       | 7,850,634        |       | 7,731,896                    |
| CST Industries Acquisition, Inc.                |       | Manufacturing -  metal storage tanks                                                                               |       | Senior Term Debt  (10.0%, Due 8/2013) (3)     |       | 1,002,100        |       | 1,005,000                    |
| Graham Packaging Holdings Co.                   |       | Manufacturing -  custom blow molded                                                                                |       | Senior Term Debt  (7.8%, Due 10/2011) (3)     |       | 10,778,850       |       | 10,672,062                   |
| J. Crew Operating Corp.                         |       | Retail - apparel                                                                                                   |       | Senior Term Debt  (7.2%, Due 5/2013) (3)      |       | 1,757,068        |       | 1,754,386                    |
| Latham Manufacturing Corp.                      |       | Manufacturing -  swimming pool components accessories                                                              |       | Senior Term Debt  (8.9%, Due 6/2012) (3)      |       | 4,438,762        |       | 4,356,524                    |
| Lexicon Marketing USA, Inc.                     |       | Service -  marketing to Hispanic community                                                                         |       | Senior Term Debt  (7.8%, Due 5/2012) (3)      |       | 2,995,063        |       | 3,029,906                    |
| LVI Services, Inc.                              |       | Service -  asbestos and mold remediation                                                                           |       | Senior Term Debt  (8.2%, Due 11/2010) (3)     |       | 6,475,871        |       | 6,193,200                    |
| Madison River Capital LLC                       |       | Service -  communications and information                                                                          |       | Senior Term Debt  (7.7%, Due 7/2012) (3)      |       | 5,785,564        |       | 5,771,563                    |
| Maidenform, Inc.                                |       | Manufacturing -  intimate apparel                                                                                  |       | Senior Term Debt  (7.2%, Due 5/2010) (3)      |       | 2,803,017        |       | 2,789,500                    |
| MedAssets, Inc.                                 |       | Service -  pharmaceuticals and healthcare GPO                                                                      |       | Senior Term Debt  (8.9%, Due 7/2010) (3) (7)  |       | 2,276,561        |       | 2,273,684                    |
| National Mentor Holdings, Inc.                  |       | Service - home  health care                                                                                        |       | Senior Term Debt  (7.9%, Due 6/2013) (3)      |       | 1,996,572        |       | 2,005,251                    |
| NPC International Inc.                          |       | Service - Pizza  Hut franchisee                                                                                    |       | Senior Term Debt  (7.1%, Due 5/2013) (3)      |       | 3,078,749        |       | 3,039,959                    |
| Nutro Products, Inc.                            |       | Manufacturing -  pet food                                                                                          |       | Senior Term Debt  (7.4%, Due 4/2012) (3)      |       | 2,510,732        |       | 2,490,609                    |
| Ozburn-Hessey Holding Co. LLC                   |       | Service - third  party logistics                                                                                   |       | Senior Term Debt  (8.8%, Due 8/2012) (3)      |       | 6,558,933        |       | 6,480,840                    |
| Patriot Media & Communications CNJ, LLC     |       | Service -  telecommunications                                                                                      |       | Senior Term Debt  (7.6%, Due 3/2013) (3)      |       | 4,294,954        |       | 4,259,764                    |
| RPG Holdings, Inc.                              |       | Manufacturing  and design - greeting cards                                                                         |       | Senior Term Debt  (9.0%, Due 12/2011) (3)     |       | 5,001,216        |       | 4,987,500                    |
| SGS International, Inc.                         |       | Service -  digital imaging and graphics                                                                            |       | Senior Term Debt  (8.1%, Due 12/2011) (3)     |       | 1,620,806        |       | 1,614,829                    |
| SunGard Data Systems, Inc.                      |       | Service &  manufacturing - integrated software and processing solutions and information  availability services |       | Senior Term Debt  (8.0%, Due 2/2013) (3)      |       | 9,975,562        |       | 9,961,406                    |
| Survey Sampling, LLC                            |       | Service -  telecommunications-based sampling                                                                       |       | Senior Term Debt  (8.6%, Due 5/2011) (3)      |       | 3,437,427        |       | 3,401,579                    |
| Triad Laboratory Alliance, LLC                  |       | Service -  regional medical laboratories                                                                           |       | Senior Term Debt  (8.6%, Due 12/2011) (3) (7) |       | 4,980,266        |       | 4,962,500                    |
| US Investigative Services, Inc.                 |       | Service -  background investigations                                                                               |       | Senior Term Debt  (7.9%, Due 10/2012) (3)     |       | 10,946,785       |       | 10,900,586                   |
| Wastequip, Inc.                                 |       | Manufacturing -  waste removal equipment                                                                           |       | Senior Term Debt  (7.6%, Due 7/2011) (3)      |       | 5,488,252        |       | 5,431,456                    |
| **Total Non-Control/Non-Affiliate Investments** | ** ** | ** **                                                                                                         | ** ** | ** **                                    | ** ** | **122,529,078**  | ** ** | **121,555,262**              |

 

4

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**GLADSTONEINVESTMENT CORPORATIONSCHEDULE OF INVESTMENTS (Continued)September 30, 2006(UNAUDITED)**
| **Company  (1)**                             | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                    | ** ** | **Cost**                                       | ** ** | **Fair Value**                                 |
|----------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|
| **CONTROL INVESTMENTS**                      |       |                                                        |       |                                                  |       |                                           |       |                                           |
|                                         |       |                                                        |       |                                                  |       |                                           |       |                                           |
| Chase II Holdings Corp.                      |       | Manufacturing - Traffic doors                               |       | Revolving Credit Facility (5)                         |       | —                                         |       | —                                         |
|                                         |       |                                                        |       | Senior Term Debt (9.8%, Due 3/2011) (7)               |       | 12,900,000                                     |       | 12,883,875                                     |
|                                         |       |                                                        |       | Senior Term Debt (12.0% Due 3/2011) (7)               |       | 8,000,000                                      |       | 7,960,000                                      |
|                                         |       |                                                        |       | Subordinated Term Debt (13% Due 3/2013) (7)           |       | 6,167,810                                      |       | 6,098,422                                      |
|                                         |       |                                                        |       | Redeemable Preferred Stock (4) (8)                    |       | 6,960,806                                      |       | 6,960,806                                      |
|                                         |       |                                                        |       | Common Stock (4) (8)                                  |       | 61,384                                         |       | 61,384                                         |
|                                         |       |                                                        |       |                                                  |       | 34,090,000                                     |       | 33,964,487                                     |
| Hailey Transport  Corporation                |       | Retail and service - school buses and parts                 |       | Senior Subordinated Term Debt (12.0%, Due 1/2012) (7) |       | 4,000,000                                      |       | 3,930,000                                      |
|                                         |       |                                                        |       | Preferred Stock (4) (8)                               |       | 2,500,000                                      |       | 2,500,000                                      |
|                                         |       |                                                        |       |                                                  |       | 6,500,000                                      |       | 6,430,000                                      |
| Quench Holdings Corp.                        |       | Service - sales, installation and service  of water coolers |       | Revolving Credit Facility (9.3%, Due 3/2009) (6) (7)  |       | 900,000                                        |       | 891,000                                        |
|                                         |       |                                                        |       | Senior Term Debt (9.3%, Due 3/2011) (7)               |       | 4,000,000                                      |       | 4,000,000                                      |
|                                         |       |                                                        |       | Subordinated Term Debt (11.5%, Due 3/2011) (7)        |       | 8,000,000                                      |       | 7,950,000                                      |
|                                         |       |                                                        |       | Common Stock (4) (8)                                  |       | 3,256,318                                      |       | 3,256,318                                      |
|                                         |       |                                                        |       |                                                  |       | 16,156,318                                     |       | 16,097,318                                     |
| **Total Control  Investments**               | ** ** | ** **                                                  | ** ** | ** **                                            | ** ** | **56,746,318**                                 | ** ** | **56,491,805**                                 |
| **Total Investments**                        | ** ** | ** **                                                  | ** ** | ** **                                            | ** ** | **$     179,275,396** | ** ** | **$     178,047,067** |
| **Cash equivalents**                         |       |                                                        |       |                                                  |       |                                           |       |                                           |
|                                         |       | Government                                                  |       | US Treasury Bill                                      |       | 4,082,155                                      |       | 4,082,155                                      |
|                                         |       |                                                        |       | (4.7%, 10/5/2006)                                     |       |                                           |       |                                           |
| * *                                     | * *   | * *                                                    | * *   | * *                                              |       |                                           |       |                                           |
|                                         |       | Government                                                  |       | US Treasury Bill                                      |       | 18,043,299                                     |       | 18,043,299                                     |
|                                         |       |                                                        |       | (4.8%, 10/26/2006)                                    |       |                                           |       |                                           |
|                                         |       |                                                        |       |                                                  |       |                                           |       |                                           |
|                                         |       | Government                                                  |       | US Treasury Bill                                      |       | 7,882,236                                      |       | 7,882,236                                      |
|                                         |       |                                                        |       | (4.7%, 11/24/2006)                                    |       |                                           |       |                                           |
|                                         |       |                                                        |       |                                                  |       |                                           |       |                                           |
| **Total cash equivalents:**                  |       |                                                        |       |                                                  | ** ** | **30,007,690**                                 | ** ** | **30,007,690**                                 |
|                                         |       |                                                        |       |                                                  |       |                                           |       |                                           |
| **Total investments and  cash equivalents:** |       |                                                        | ** ** | ** **                                            | ** ** | **$     209,283,086** | ** ** | **$     208,054,757** |

----

(1)    Certain ofthe listed securities are issued by affiliate(s) of the indicated portfoliocompany.

(2)    Percentagerepresents the weighted average interest rates in effect at September 30, 2006and due date represents the contractual maturity date.

(3)    Marketablesecurities are valued based on the indicative bid price, as of September 30,2006, from the respective originating syndication agent’s trading desk.

(4)    Security isnon-income producing.

(5)    Totalavailable under the revolving credit facility is $500,000 which was undrawn asof September 30, 2006.

(6)    Totalavailable under the revolving credit facility is $2,000,000, of which$1,100,000 remains undrawn at September 30, 2006.

(7)    Valuedusing Standards & Poors Securities Evaluations, Inc. estimates at September30, 2006.

(8)    Fair valueis 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

----

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

** **
| **Company (1)**                         | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                     | ** **      | **Cost**       | ** **      | **Fair Value** |
|----------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|-----------------|----------------|-----------------|---------------------|
| **CONTROL INVESTMENTS**                      |       |                                                        |       |                                                        |            |           |            |                |
|                                         |       |                                                        |       |                                                        |            |           |            |                |
| Chase II Holdings Corp.                      |       | 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 Corp.                        |       | 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 ofthe listed securities are issued by affiliate(s) of the indicated portfoliocompany.

(2)    Percentagerepresents the weighted average interest rates in effect at March 31, 2006 anddue date represents the contractual maturity date.

(3)    Marketablesecurities are valued based on the indicative bid price, as of March 31, 2006,from the respective originating syndication agent’s trading desk.

(4)    Security isnon-income producing.

(5)    Totalavailable under the revolving credit facility is $500,000 which was undrawn asof March 31, 2006.

(6)    Totalavailable under the revolving credit facility is $2,000,000 which was undrawnas of March 31, 2006.

(7)    Valuedusing Standard & Poor’s Securities Evaluations, Inc. estimates at March 31,2006.

(8)    Fair valueis equal to cost due to recent acquisition.

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

 

7

----

**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                              | ** ** | **For the three**      | ** ** | **For the three**      | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                              | ** ** | **months ended**            | ** ** | **months ended**            | ** ** |
| ** **                                                              | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|                                                                    |       |                             |       |                             |       |
| INVESTMENT INCOME                                                       |       |                             |       |                             |       |
| Interest income                                                         |       |                             |       |                             |       |
| Non-Control/Non-Affiliate  investments                                  |       | $                                | 2,387,375  |                             | $          | 193,578 |   |
| Control  investments                                                    |       | 1,256,303                        |       | —                           |       |
| Cash and cash  equivalents                                              |       | 569,580                          |       | 1,613,012                        |       |
| Total interest  income                                                  |       | 4,213,258                        |       | 1,806,590                        |       |
| Other income                                                            |       | 670                              |       | —                           |       |
| Total investment  income                                                |       | 4,213,928                        |       | 1,806,590                        |       |
|                                                                    |       |                             |       |                             |       |
| EXPENSES                                                                |       |                             |       |                             |       |
| Administration  fee                                                     |       | 124,861                          |       | 77,962                           |       |
| Base management  fee                                                    |       | 861,893                          |       | 92,108                           |       |
| Directors fees                                                          |       | 56,250                           |       | 52,000                           |       |
| Insurance  expense                                                      |       | 67,626                           |       | 42,478                           |       |
| Professional  fees                                                      |       | 88,040                           |       | 66,302                           |       |
| Stockholder  related costs                                              |       | 65,100                           |       | 42,903                           |       |
| Taxes and  licenses                                                     |       | 41,337                           |       | —                           |       |
| Other expenses                                                          |       | 24,935                           |       | 19,931                           |       |
| Total expenses                                                          |       | 1,330,042                        |       | 393,684                          |       |
| NET INVESTMENT INCOME                                                   |       | 2,883,886                        |       | 1,412,906                        |       |
|                                                                    |       |                             |       |                             |       |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS                     |       |                             |       |                             |       |
| Realized loss on  sale of Non-Control/Non-Affiliate investments         |       | (1,934                           | )          | —                           |       |
| Net unrealized  (depreciation) appreciation of investment portfolio     |       | (33,908                          | )          | 63,826                           |       |
| Net loss on  investments                                                |       | (35,842                          | )          | 63,826                           |       |
|                                                                    |       |                             |       |                             |       |
|                                                                    |       |                             |       |                             |       |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS (Refer to Note 5) |       | $                                | 2,848,044  |                             | $          | 1,476,732 |   |
|                                                                    |       |                             |       |                             |       |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE: |       |                             |       |                             |       |
| Basic and  Diluted                                                      |       | $                                | 0.17       |                             | $          | 0.09 |   |
|                                                                    |       |                             |       |                             |       |
| SHARES OF COMMON STOCK  OUTSTANDING:                                    |       |                             |       |                             |       |
| Basic and  diluted weighted average shares                              |       | 16,560,100                       |       | 16,231,404                       |       |
|                                                                    |       |                             |       |                             |       |

 

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

8

----

 

**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                          | ** ** | ** **                       | ** ** | **For the period**     | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | ** **                       | ** ** | **June 22, 2005**      | ** ** |
| ** **                                                          | ** ** | **For the six**        | ** ** | **(Commencement of**        | ** ** |
| ** **                                                          | ** ** | **months ended**            | ** ** | **Operations) to**          | ** ** |
| ** **                                                          | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| INVESTMENT  INCOME                                                  |       |                             |       |                             |       |
| Interest income                                                     |       |                             |       |                             |       |
| Non-Control/Non-Affiliate investments                               |       | $                                | 4,351,855  |                             | $          | 193,578 |   |
| Control investments                                                 |       | 2,446,605                        |       | —                           |       |
| Cash and cash equivalents                                           |       | 1,277,920                        |       | 1,661,210                        |       |
| Total interest income                                               |       | 8,076,380                        |       | 1,854,788                        |       |
| Other income                                                        |       | 986                              |       | —                           |       |
| Total investment income                                             |       | 8,077,366                        |       | 1,854,788                        |       |
|                                                                |       |                             |       |                             |       |
| EXPENSES                                                            |       |                             |       |                             |       |
| Administration fee                                                  |       | 240,250                          |       | 105,045                          |       |
| Base management fee                                                 |       | 1,663,202                        |       | 92,108                           |       |
| Directors fees                                                      |       | 99,500                           |       | 52,000                           |       |
| Insurance expense                                                   |       | 140,237                          |       | 42,478                           |       |
| Professional fees                                                   |       | 167,788                          |       | 66,302                           |       |
| Stockholder related costs                                           |       | 158,866                          |       | 43,538                           |       |
| Interest expense                                                    |       | —                           |       | 378                              |       |
| Taxes and licenses                                                  |       | 98,444                           |       | —                           |       |
| Other expenses                                                      |       | 44,029                           |       | 20,233                           |       |
| Total expenses                                                      |       | 2,612,316                        |       | 422,082                          |       |
| NET INVESTMENT  INCOME                                              |       | 5,465,050                        |       | 1,432,706                        |       |
|                                                                |       |                             |       |                             |       |
| REALIZED AND  UNREALIZED GAIN (LOSS) ON INVESTMENTS                 |       |                             |       |                             |       |
| Net realized gain on sale of  Non-Control/Non-Affiliate investments |       | 1,339                            |       | —                           |       |
| Net unrealized (depreciation) appreciation of  investment portfolio |       | (1,341,297                       | )          | 63,826                           |       |
| Net gain on investments                                             |       | (1,339,958                       | )          | 63,826                           |       |
|                                                                     |            |                                  |            |                                  |            |  |  |

 
|                                                                    |   |       |      |       |   |
|-------------------------------------------------------------------------|--------|------------|-----------|------------|--------|
|                                                                    |   |       |      |       |   |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS (Refer to Note 5) |   | $          | 4,125,092 |       | $      | 1,496,532 |   |
|                                                                    |   |       |      |       |   |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE: |   |       |      |       |   |
| Basic and Diluted                                                       |   | $          | 0.25      |       | $      | 0.09 |   |
|                                                                    |   |       |      |       |   |
| SHARES OF COMMON  STOCK OUTSTANDING:                                    |   |       |      |       |   |
| Basic and diluted weighted average shares                               |   | 16,560,100 |      | 16,084,900 |   |
|                                                                    |   |       |      |       |   |

 

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

9

----

**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**
| ** **                                           | ** ** | ** **                       | ** **  | **For the period**     | ** ** |
|------------------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                           | ** ** | ** **                       | ** **  | **June 22, 2005**      | ** ** |
| ** **                                           | ** ** | **For the six**        | ** **  | **(Commencement of**        | ** ** |
| ** **                                           | ** ** | **months ended**            | ** **  | **Operations) to**          | ** ** |
| ** **                                           | ** ** | **September 30, 2006** | ** **  | **September 30, 2005** | ** ** |
| *Operations:*                                        |       |                             |        |                             |       |
| Net investment income                                |       | $                                | 5,465,050   |                             | $          | 1,432,706 |   |
| Realized gain on sale of investments                 |       | 1,339                            |        | —                           |       |
| Unrealized (depreciation) appreciation of portfolio  |       | (1,341,297                       | )           | 63,826                           |       |
| Increase in net  assets from operations              |       | 4,125,092                        |        | 1,496,532                        |       |
|                                                 |       |                             |        |                             |       |
| *Capital  transactions:*                             |       |                             |        |                             |       |
| Issuance of common stock                             |       | —                           |        | 230,248,986                      |       |
| Shelf registration offering costs                    |       | (33,128                          | )           | —                           |       |
| Dividends from net investment income                 |       | (6,955,245                       | )           | (993,606                         | )          |
| Total change in net assets from capital transactions |       | (6,988,373                       | )           | 229,255,380                      |       |
|                                                 |       |                             |        |                             |       |
| Total change in  net assets                          |       | (2,863,281                       | )           | 230,751,912                      |       |
|                                                 |       |                             |        |                             |       |
| Net Assets                                           |       |                             |        |                             |       |
| Beginning of period                                  |       | 229,841,697                      |        | 1,500                            |       |
| End of period                                        |       | $                                | 226,978,416 |                             | $          | 230,753,412 |   |

 

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

10

----

 

**GLADSTONEINVESTMENT CORPORATIONSTATEMENTS OF CASH FLOWS(UNAUDITED)**
| ** **                                                                                                               | ** ** | ** **                       | ** ** | **For the period**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                               | ** ** | ** **                       | ** ** | **June 22, 2005**      | ** ** |
| ** **                                                                                                               | ** ** | **For the six**        | ** ** | **(Commencement of**        | ** ** |
| ** **                                                                                                               | ** ** | **months ended**            | ** ** | **Operations) to**          | ** ** |
| ** **                                                                                                               | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|                                                                                                                     |       |                             |       |                             |       |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                |       |                             |       |                             |       |
| ** **                                                                                                               |       |                             |       |                             |       |
| Net increase in net assets resulting from operations                                                                     |       | $                                | 4,125,092  |                             | $          | 1,496,532 |   |
| Adjustments to reconcile net increase in net assets resulting  from operations to net cash used in operating activities: |       |                             |       |                             |       |
| Purchase of investments                                                                                                  |       | (49,477,779                      | )          | (40,844,381                      | )          |
| Principal repayments of investments                                                                                      |       | 6,838,467                        |       | 333,363                          |       |
| Proceeds from the sale of debt investments                                                                               |       | 16,549,229                       |       | —                           |       |
| Net unrealized depreciation (appreciation) of  investment portfolio                                                      |       | 1,341,297                        |       | (63,826                          | )          |
| Net realized gains on sales of investments                                                                               |       | (1,339                           | )          | —                           |       |
| Net amortization of premiums and discounts                                                                               |       | 85,348                           |       | 3,134                            |       |
| Increase in interest receivable                                                                                          |       | (532,967                         | )          | (106,434                         | )          |
| Increase in prepaid assets                                                                                               |       | (176,467                         | )          | (295,450                         | )          |
| Decrease (increase) in other assets                                                                                      |       | 101,333                          |       | (13,606                          | )          |
| Decrease in other liabilities                                                                                            |       | 11,615                           |       | —                           |       |
| Increase in administration fee payable to Gladstone  Administration                                                      |       | 14,859                           |       | 77,962                           |       |
| Increase in base management fee payable to Gladstone  Management                                                         |       | 1,096,444                        |       | 67,434                           |       |
| Increase in accounts payable                                                                                             |       | —                           |       | 32,071                           |       |
| (Decrease) increase in accrued expenses                                                                                  |       | (212,746                         | )          | 30,343                           |       |
| Net cash used in operating activities                                                                                    |       | (20,237,614                      | )          | (39,282,858                      | )          |
|                                                                                                                     |       |                             |       |                             |       |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                               |       |                             |       |                             |       |
| ** **                                                                                                               |       |                             |       |                             |       |
| Net proceeds from the issuance of common stock                                                                           |       | —                           |       | 230,296,850                      |       |
| Shelf offering registration costs                                                                                        |       | (33,128                          | )          | —                           |       |
| Distributions paid                                                                                                       |       | (6,955,245                       | )          | (993,606                         | )          |
| Decrease in loan payable to affiliate                                                                                    |       | —                           |       | (50,000                          | )          |
| Net cash (used in) provided by financing activities                                                                      |       | (6,988,373                       | )          | 229,253,244                      |       |
|                                                                                                                     |       |                             |       |                             |       |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1)**                                                            |       | (27,225,987                      | )          | 189,970,386                      |       |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                      |       | 75,672,605                       |       | 3,636                            |       |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                                                            |       | $                                | 48,446,618 |                             | $          | 189,974,022 |   |
|                                                                                                                     |       |                             |       |                             |       |
| **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.*

11

----

**GLADSTONEINVESTMENT CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                         | ** ** | **For the three**      | ** **  | **For the three**      | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                                         | ** ** | **months ended**            | ** **  | **months ended**            | ** ** |
| ** **                                                         | ** ** | **September 30, 2006** | ** **  | **September 30, 2005** | ** ** |
| Per Share Data (1)                                                 |       |                             |        |                             |       |
| Balance at beginning of period                                     |       | $                                | 13.75       |                             | $          | 13.90 |   |
|                                                               |       |                             |        |                             |       |
| *Income from investment operations:*                               |       |                             |        |                             |       |
| Net investment income (2)                                          |       | 0.17                             |        | 0.09                             |       |
| Realized gain on sale of investments (2)                           |       | —                           |        | —                           |       |
| Net unrealized appreciation of investments (2)                     |       | —                           |        | —                           |       |
| Total from investment operations                                   |       | 0.17                             |        | 0.09                             |       |
| Distributions                                                      |       | (0.21                            | )           | (0.06                            | )          |
| Net asset value at end of period                                   |       | $                                | 13.71       |                             | $          | 13.93 |   |
|                                                               |       |                             |        |                             |       |
| Per share market value at beginning of period                      |       | $                                | 14.82       |                             | $          | 15.05 |   |
| Per share market value at end of period                            |       | 14.60                            |        | 14.68                            |       |
| Total return (3)                                                   |       | -0.04                            | %           | -2.07                            | %          |
| Shares outstanding at end of period                                |       | 16,560,100                       |        | 16,560,100                       |       |
|                                                               |       |                             |        |                             |       |
| Ratios/Supplemental  Data                                          |       |                             |        |                             |       |
| Net assets at  end of period                                       |       | $                                | 226,978,416 |                             | $          | 230,753,412 |   |
| Average net  assets (4)                                            |       | $                                | 226,140,557 |                             | $          | 230,242,643 |   |
| Ratio of  expenses to average net assets (annualized)              |       | 2.35                             | %           | 0.68                             | %          |
| Ratio of net  investment income to average net assets (annualized) |       | 5.10                             | %           | 2.45                             | %          |
|                                                               |       |                             |        |                             |       |

----

(1)    Basedon actual shares outstanding.

(2)    Basedon weighted average basic per share data.

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

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

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

12

----

**GLADSTONEINVESTMENT CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                         | ** ** | ** **                       | ** **  | **For the period**     | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                                         | ** ** | ** **                       | ** **  | **June 22, 2005**      | ** ** |
| ** **                                                         | ** ** | **For the six**        | ** **  | **(Commencement of**        | ** ** |
| ** **                                                         | ** ** | **months ended**            | ** **  | **Operations) to**          | ** ** |
| ** **                                                         | ** ** | **September 30, 2006** | ** **  | **September 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)                                          |       | 0.33                             |        | 0.09                             |       |
| Realized gain on sale of investments (3)                           |       | —                           |        | —                           |       |
| Net unrealized appreciation of investments (3)                     |       | (0.08                            | )           | —                           |       |
| Total from investment operations                                   |       | 0.25                             |        | 0.09                             |       |
| Distributions                                                      |       | (0.42                            | )           | (0.06                            | )          |
| Net asset value at end of period                                   |       | $                                | 13.71       |                             | $          | 13.93 |   |
|                                                               |       |                             |        |                             |       |
| Per share market value at beginning of period                      |       | $                                | 14.90       |                             | $          | 15.00 |   |
| Per share market value at end of period                            |       | 14.60                            |        | 14.68                            |       |
| Total return (4)                                                   |       | 0.87                             | %           | -1.74                            | %          |
| Shares outstanding at end of period                                |       | 16,560,100                       |        | 16,560,100                       |       |
|                                                               |       |                             |        |                             |       |
| Ratios/Supplemental  Data                                          |       |                             |        |                             |       |
| Net assets at  end of period                                       |       | $                                | 226,978,416 |                             | $          | 230,753,412 |   |
| Average net  assets (5)                                            |       | $                                | 226,929,612 |                             | $          | 222,716,478 |   |
| Ratio of  expenses to average net assets (annualized)              |       | 2.30                             | %           | -0.57                            | %          |
| Ratio of net investment  income to average net assets (annualized) |       | 4.82                             | %           | 1.93                             | %          |

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(1)    Basedon actual shares outstanding.

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

(3)    Basedon weighted average basic per share data.

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

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

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

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**GLADSTONEINVESTMENT CORPORATION**

**NOTESTO FINANCIAL STATEMENTSSEPTEMBER 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.

Gladstone BusinessInvestment LLC, a wholly-owned subsidiary of the Company, was established onAugust 11, 2006 for the sole purpose of owning the Company’s portfolio ofinvestments in connection with the establishment of its line of credit facilitywith Deutsche Bank AG, which recently closed on October 19, 2006.  The financial statements of the subsidiaryare consolidated with those of the Company.

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 statements andnotes thereto should be read in conjunction with the financial statements andnotes 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 or hasone 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.

 

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*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 Securities Evaluations, Inc. (“SPSE”) to perform independent valuationsof some of its investments.  The Board ofDirectors uses opinions of value submitted by SPSE as a component of thefoundation for the final fair value determination of such investments.  In making fair value determinations, theBoard of Directors values non-convertible debt securities at cost plusamortized original issue discount plus payment in kind (“PIK”) interest, ifany, unless adverse factors lead to a determination of a lesser valuation.  In valuing convertible debt, equity, successor exit fees or other equity-like securities, the Board of Directors determinesthe fair value based on the collateral, the issuer’s ability to make payments,the earnings of the issuer, sales to third parties of similar securities, thecomparison to publicly traded securities, discounted cash flow and otherpertinent factors.  Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have resulted had a readymarket for the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains ultimately realized onthese investments to be different than the valuation currently assigned.  Because there is a delay between when theCompany closes a loan and when the loan can be evaluated by SPSE, new loans arenot evaluated immediately by SPSE; rather, the Board of Directors makes its ownindependent determination about the value of the loan in accordance with theCompany’s valuation policy without the input of SPSE.  Because SPSE does not perform independent valuationsof the Company’s equity securities, the Board of Directors also determines thefair value of these investments without the input of SPSE.  The Board of Directors considers a number ofqualitative and quantitative factors in current market conditions whenperforming valuations and is ultimately responsible for the fair value anddisclosure of investments in the financial statements.

*InterestIncome Recognition*

Interest income,adjusted for amortization of premiums and acquisition costs and for the accretionof discounts, is recorded on the accrual basis to the extent that such amountsare expected to be collected. The Company stops accruing interest on itsinvestments when it is determined that interest is no longer collectible.  Conditional interest or a success fee isrecorded 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. However, GMC receives fees for the other services itprovides, and 50% of those fees for other services are credited to theinvestment 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. From time to time, the Company isinvited to participate as a co-lender in a transaction. In the event that theCompany does 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.

*Cash and Cash Equivalents*

The Company considers all short-term, highly liquidinvestments that are both readily convertible to cash and have a maturity ofthree months or less at the time of purchase to be cash equivalents. Itemsclassified as cash equivalents include temporary investments in U.S. Treasurybills and can also include commercial paper and money-market funds. All of theCompany’s cash at September 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 depreciation reflectsthe difference between the fair market value of the investment and the costbasis of such investment.

*Income Taxes*

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

*New Accounting Pronouncements*

 In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, *Fair Value Measurments*(“SFAS 157”).  SFAS 157 defines fairvalue, establishes a framework for measuring fair value in GAAP and expandsdisclosures about fair value measurements.  SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years.  The Company is required toadopt the provisions of SFAS 157 beginning with the fiscal year ended March 31,2009.  The Company does not expect this pronouncement to have a materialimpact on the Company’s financial position or net increase to net assetsresulting from operations.

NOTE 3. RELATED PARTY TRANSACTIONS

**Investment Advisory and ManagementAgreement**

We have entered into an investmentadvisory and management agreement with GMC (the “Advisory Agreement”), which iscontrolled by our chairman and chief executive officer. In accordance with theAdvisory Agreement, 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 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 September 30, 2006,the base management fee was computed and payable quarterly.  Beginning in periods subsequent to December31, 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 and July11, 2006, the Company’s Board of Directors accepted a voluntary waiver from GMCthat allowed the current calculation of the base management fee to be effectivethrough June 30, 2006 and September 30, 2006, respectively.  Further, on October 10, 2006, the Company’sBoard of Directors accepted another voluntary waiver from GMC that will allowthe current calculation of the base management fee to be effective through December31, 2006.

When GMC receives fees fromthe Company’s portfolio companies, such as investment banking fees, structuringfees or executive recruiting services fees, one half of these fees will becredited against the base management fee that the Company would otherwise berequired to pay to GMC.  For the three andsix months ended September 30, 2006, the Company recognized a base managementfee of $861,893 and $1,663,202, respectively, of which $861,893 remained unpaidat September 30, 2006 and is reflected in the accompanying statements of assetsand liabilities as a base management fee payable to GMC.  The Company recognized a base management feeof $92,108 for the three months ended September 30, 2005 and for the periodJune 22, 2005 (commencement of operations) to September 30, 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 the Company’s pre-incentive fee net investmentincome for the immediately preceding calendar quarter. The capital gainsincentive fee is determined and payable annually in arrears as of the end ofeach fiscal year (or upon termination of the Advisory Agreement, as of thetermination date) and equals 20.0% of the realized capital gains sinceinception through the end of the current fiscal year, if any, computed net ofall realized capital losses, and net unrealized capital 

16

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depreciation sinceinception at the end of each fiscal year. Refer to the Company’s Form 10-K forthe fiscal year ended March 31, 2006 for more information regarding thecalculation of the incentive fee.

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 or six months ended September30, 2006, the three months ended September 30, 2005 or the period June 22, 2005(Commencement of operations) to September 30, 2005.

**Administration Agreement**

The Company has entered into an administrationagreement (the “Administration Agreement”) with Gladstone Administration, LLC(“Gladstone Administration”), a wholly owned subsidiary of GMC, which iscontrolled by the Company’s chairman and chief executive officer. Pursuant tothe Administration Agreement, Gladstone Administration furnishes the Companywith office facilities, equipment and clerical, bookkeeping and record keepingservices at such facilities and performs, or oversees the performance of theCompany’s required administrative services. Such required administrativeservices include, among other things, being responsible for the financialrecords which we are required to maintain and preparing reports to ourstockholders and reports filed with the Securities and Exchange Commission (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, treasurer and theirrespective staff. The Company recorded fees to Gladstone Administration on thestatement of operations of $124,861 and $77,962 for the three months ended September30, 2006 and 2005, respectively.   TheCompany recorded fees to Gladstone Administration on the statement ofoperations of $240,250 and $105,045 for the six months ended September 30, 2006and the period June 22, 2005 (Commencement of operations) to September 30, 2005,respectively. As of September 30, 2006, $124,861 was unpaid and included in theadministration fee payable to Gladstone Administration in the accompanyingstatements of assets and 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 repaid withaccrued interest of $378 using a portion of the net proceeds from the Company’sinitial public offering.

NOTE 4. COMMON STOCK

As of September 30, 2006 and March 31, 2006,100,000,000 shares of $0.001 par value common stock were authorized and16,560,100 shares were outstanding.

NOTE 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 period**     | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                       | ** ** | ** **                       | ** ** | ** **                       | ** ** | ** **                       | ** ** | **June 22, 2005**      | ** ** |
| ** **                                                                                       | ** ** | **For the three**      | ** ** | **For the three**      | ** ** | **For the six**        | ** ** | **(Commencement of**        | ** ** |
| ** **                                                                                       | ** ** | **months ended**            | ** ** | **months ended**            | ** ** | **months ended**            | ** ** | **Operations) to**          | ** ** |
| ** **                                                                                       | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|                                                                                             |       |                             |       |                             |       |                             |       |                             |       |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                | 2,848,044  |                             | $          | 1,476,732                        |       | $                                | 4,125,092  |   | $ | 1,496,532 |   |
|                                                                                             |       |                             |       |                             |       |                             |       |                             |       |
| Denominator for  basic and diluted shares                                                        |       | 16,560,100                       |       | 16,231,404                       |       | 16,560,100                       |       | 16,084,900                       |       |
|                                                                                             |       |                             |       |                             |       |                             |       |                             |       |
| Basic and diluted net  increase in net assets per share resulting from operations                |       | $                                | 0.17       |                             | $          | 0.09                             |       | $                                | 0.25       |   | $ | 0.09 |   |

 

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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% ofthose amounts. The amount to be paid out monthly as a dividend is determined bythe 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 for the six months ended September 30, 2006 and theperiod June 22, 2005 (Commencement of operations) to September 30, 2005:

**FY 2007**
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| July 11, 2006             |       | September  21, 2006  |       | September  29, 2006   |       | $                                | 0.07       |   |
| July 11, 2006             |       | August  21, 2006     |       | August  31, 2006      |       | $                                | 0.07       |   |
| July 11, 2006             |       | July  19, 2006       |       | July  31, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | June  22, 2006       |       | June  30, 2006        |       | $                                | 0.07       |   |
| April 11, 2006            |       | May  22, 2006        |       | May  31, 2006         |       | $                                | 0.07       |   |
| April 11, 2006            |       | April 20, 2006       |       | April 28, 2006        |       | $                                | 0.07       |   |

 

**FY 2006**
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| July 7, 2005              |       | September  22, 2005  |       | September  30, 2005   |       | $                                | 0.02       |   |
| July 7, 2005              |       | August  23, 2005     |       | August  31, 2005      |       | $                                | 0.02       |   |
| July 7, 2005              |       | July 21, 2005        |       | July 29, 2005         |       | $                                | 0.02       |   |

 

**NOTE 7.SUBSEQUENT EVENTS**

*Line of Credit*

Through theCompany’s wholly-owned subsidiary Gladstone Business Investment, LLC (“BusinessInvestment”), the Company has obtained a $100 million revolving credit facility(the “Credit Facility”).  On October 19,2006, the Company executed a Purchase and Sale Agreement pursuant to which itagreed to sell certain loans to Business Investment in consideration of amembership interest therein. Simultaneously, Business Investment executed a Credit Agreement (the“Credit Agreement”) with Deutsche Bank AG, New York Branch (“Deutsche Bank”),as administrative agent, pursuant to which Business Investment pledged theloans purchased from the Company to secure future advances by certaininstitutional lenders. Availability under the Credit Facility will terminate onOctober 18, 2007, unless extended in the discretion of the lenders, at therequest of Business Investment. Interest will be payable monthly during theterm of the Credit Facility and principal will be payable out of collections onloans purchased from the Company during the period following the date of whichavailability for advances has terminated through maturity.  The Credit Facility will mature two yearsfollowing the date on which availability for advances has terminated and onsuch date, all principal, interest and other amounts owing under the CreditFacility will be due and payable. Interest rates charged on the advances under the facility are based onthe rate paid by the lenders on commercial paper notes issued by such lendersto fund some or all of the advances, the London Interbank OfferedRate (“LIBOR”), the Prime Rate or the FederalFunds Rate, depending on market conditions, and adjusts periodically.  As of October 31, 2006, there was nooutstanding principal balance under the Credit Facility.  Available borrowings are subject to variousconstraints imposed under the Credit Agreement, based on the aggregate loanbalance pledged by Business Investment, which varies as loans or added andrepaid, regardless of whether such repayments are early prepayment or are madeas contractually required.  At October 31,2006, the remaining borrowing capacity available under the Credit Facility wasapproximately $100 million.  

The CreditFacility contains covenants that require Business Investment to maintain itsstatus as a separate entity; prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions);and restrict material changes to the Company’s credit and collection policies.  The facility also restricts some of the termsand provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofOctober 31, 2006, Business Investment was in compliance with all of thefacility covenants.  The Companycurrently intends to securitize some or all of the loans held by BusinessInvestment and if it is able to do so, it will use the proceeds from thesecuritization to pay down any amounts then outstanding under the revolvingcredit facility.

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The administrative agent also requires that anyinterest or principal payments on pledged loans be remitted directly by theborrower into lockbox accounts controlled by Deutsche Bank. Once a month,Deutsche Bank remits the collected funds to the Company after payment of anyinterest and expenses provided for under the Credit Agreement. 

 

GMC, the Company’s affiliated external adviser,services the loans pledged under the Credit Facility.  As a condition to this servicing arrangement,the Company executed a performance guaranty pursuant to which it guaranteedthat GMC would comply fully with all of its obligations under the CreditFacility. The performance guaranty requires the Company to maintain a minimumnet worth of $100 million and to maintain “asset coverage” with respect to“senior securities representing indebtedness” of at least 200%, in accordancewith Section 18 of the 1940 Act. As of October 31, 2006, the Company was incompliance with its covenants under the performance guaranty.

* *

*Loan Participations*

In October 2006, the Company purchased additional loanparticipations of  three new portfoliocompanies of approximately $4.0 million and received principal repayments ofapproximately $2.4 million on its loan participations. In addition, the Companysold two of its loan participations realizing a net loss of $8,491 on the transactions.

*Dividends*

On October 10, 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** | ** ** |
|---------------------------|------------|--------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|------------|
| October 10, 2006          |       | October  23, 2006  |       | October  31, 2006    |       | $                     | 0.07       |                             |
| October 10, 2006          |       | November  21, 2006 |       | November  30, 2006   |       | $                     | 0.07       |                             |
| October 10, 2006          |       | December 20, 2006  |       | December 29, 2006    |       | $                     | 0.07       |                             |

 

**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 ability ofthese 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, and in the Company’s registration statement on Form N-2 as filed with theSecurities and Exchange Commission on October 13, 2006. We caution readers not****to place undue reliance on any suchforward-looking statements, which are made****pursuant to the Private Securities Litigation ReformAct 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.*

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**OVERVIEW**

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

Our 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 these investmentstypically may be originated more quickly than investments in companiesundergoing a buyout or recapitalization. We employed this strategy in order tomore quickly invest our initial capital to generate current income. Seniorsecured syndicated loans typically involve a number of banks or other financialinstitutions and are generally more marketable than loans that are notsyndicated. We believe we will be able to sell our interests in senior securedsyndicated loans and reinvest the proceeds in subordinated debt, mezzaninedebt, 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 28 such syndicatedloans in the aggregate principal amount, net of any repayments, ofapproximately $121.7 million.  We expectto continue purchasing syndicated loans using the proceeds from our initialpublic offering and borrowings from our credit facility.

Through our wholly-owned subsidiary, GladstoneBusiness Investment, LLC, we recently entered into a $100 millionline of credit with Deutsche Bank AG, New York Branch asadministrative agent.  We intend to usethis line of credit to borrow funds to facilitatefinancing of future investments.  The line of credit is at a variable interest rate below the average variableinterest rate of our senior syndicated loans. 

*** ***

At September 30, 2006, wehave investments of approximately $44.0 million in revolving credit facilities,senior and subordinated debt of three portfolio companies, including borrowingsunder revolving credit facilities.  Inaddition, at September 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“paid in kind” interest or “PIK.” We will generally seek investments that donot generate PIK interest as we have to pay out this accrued interest asdividends to our stockholders and we may have to borrow money or raiseadditional capital in order to meet the tax test for a regulated investmentcompany (“RIC”) by having to pay out at least 90% of our income.  As of September 30, 2006, none of ourinvestments bear PIK interest.

We may also encounter“original issue discount” income, or “OID” income, which arises when aninvestor simultaneously purchases a warrant and a note from a company. Thistransaction requires an allocation of a portion of the purchase price to thewarrant and reduces the note by the same amount. This would cause us to have torecord the note as if we paid less than the face amount of the note and,therefore, we would have to amortize the OID over the life of the loan. Thiswould create income that would be required to be paid out as dividends to ourstockholders in 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 marketvalue in order to avoid OID income.

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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.  If a portfoliocompany is charged for managerial assistance then GMC will credit all suchnon-managerial assistance fees against the base management fee.  In addition, GMC provides additional servicesto our portfolio companies, for which it receives fees, in connection with ourinvestments.  These fees are generallynon-recurring, however in some instances they may have a recurring componentthat is also paid to GMC.  One half ofany such non-recurring fees received by GMC are credited against the basemanagement advisory fee payable to GMC pursuant to the terms of our advisoryagreement, which has the effect of reducing our expenses to the extent of anysuch fees received by GMC.  The specificservices GMC provides vary by portfolio company, but generally include a widevariety of services such as investment banking, arranging bank financing andequity financing, structuring financing from multiple lenders and investors,reviewing existing credit facilities, restructuring existing loans, raisingequity and debt capital, turnaround management, merger and acquisition servicesand recruiting new management 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 whichhas 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, secretary and director, is a member of theBoard of Directors of GMC and is its vice chairman and chief operatingofficer.  George Stelljes III, ourpresident, chief investment officer and director, is a member of the Board ofDirectors of GMC and 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 development company;and Gladstone Land Corporation, an agricultural real estate company owned byMr. Gladstone.  All of our directors andexecutive officers serve as either directors or executive officers, or both, ofGladstone Commercial Corporation and Gladstone Capital Corporation.  In the future, GMC may provide investmentadvisory and administrative services to other funds, both public and private,of which it is the sponsor.

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 September 30, 2006, the basemanagement fee was computed and payable quarterly.  Beginning in periods subsequent to December31, 2006, the base management fee will be assessed at an annual rate of 2%computed on the basis of the average value of our gross assets at the end ofthe two most recently completed quarters, which are total assets, includinginvestments made with proceeds of borrowings, less any uninvested cash or cashequivalents resulting from borrowings.  This calculation was originally scheduledto begin in periods after March 31, 2006; however, on April 11, 2006 and July11, 2006, our board of directors accepted voluntary waivers from GMC thatallowed the current calculation of the base management fee to be effectivethrough June 30, 2006 and September 30, 2006, respectively.  Further, on October10, 2006, our board of directors accepted another voluntary waiver from GMC thatwill allow the current calculation of the base management fee to be effectivethrough December 31, 2006. When GMC

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also receives fees fromour portfolio companies, such as investment banking fees, structuring fees orexecutive recruiting services fees, one half of these fees will be creditedagainst the base management fee that we would otherwise be required to pay to GMC.Theincentive fee consists of two parts: an income-based incentive fee and acapital gains incentive fee. 

The income-basedincentive fee will reward GMC if our quarterly net investment income (beforegiving effect to the incentive fee) exceeds 1.75% of our net assets.  GMC will receive a capital gains incentivefee of 20% of our realized capital gains (net of realized capital losses andunrealized 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, treasurer and theirrespective staffs. Our allocable portion of expenses is derived by multiplyingGladstone Administration’s total expenses by the percentage of our averagetotal assets (the total assets at the beginning and end of each quarter) incomparison to the 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 and equityinstruments, 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 covenants as compared to senior debt,mezzanine debt generally earns a higher return than senior secured debt. Thewarrants associated with mezzanine loans are typically detachable, which allowslenders to receive repayment of their principal on an agreed amortizationschedule while retaining their equity interest in the borrower. Mezzanine debtalso may include a “put” feature, which permits the holder to sell its equityinterest back to the borrower at a price determined through an agreed formula.We believe that mezzanine loans offer an alternative investment opportunitybased upon their historic returns and resilience during economic downturns.

**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.

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*General Valuation Policy:* Usingprocedures established by our board of directors, we value our investmentportfolio each quarter. We carry our investments at fair value, as determinedin good faith by or under the direction of our board of directors. Securitiesthat are publicly traded, if any, are valued at the closing price of theexchange or securities market on which they are listed on the valuation date.Securities that are not traded on a public exchange or securities market, butfor which a limited market exists and that have been rated by a nationallyrecognized statistical rating organizations, which we refer to as a NRSRO,(such as certain participations in syndicated loans) are valued at theindicative bid price offered by the syndication agent on the valuation date.

 

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

 

At September 30, 2006, we engaged SPSE to submit opinions of value for sixof our loan securities.  We request thatSPSE also evaluate and assign values to success fees (conditional interestincluded in some loan securities) when we determine that the probability ofreceiving a success fee on a given loan is above 6-8%, a threshold ofsignificance.  Upon completing ourcollection of data with respect to the investments (including the informationdescribed under “Credit Information,” the risk ratings of the loans describedunder “Loan Grading and Risk Rating” and the factors described under “ValuationMethods”), this valuation data is presented to SPSE.  SPSE makes its independent assessment of thedata that we have assembled and assesses its own data to form an opinion as towhat they consider to be the market values for the securities.  With regard to its work, SPSE has issued thefollowing paragraph:

 

SPSE provides evaluatedprice opinions which are reflective of what SPSE believes the bid side of themarket would be for each loan after careful review and analysis of descriptive,market and credit information.  Eachprice reflects SPSE’s best judgment based upon careful examination of a varietyof market factors.  Because offluctuation in the market and in other factors beyond its control, SPSE cannotguarantee these evaluations.  Theevaluations reflect the market prices, or estimates thereof, on the datespecified.  The prices are based oncomparable market prices for similar securities.  Market information has been obtained fromreputable secondary market sources. Although these sources are considered reliable, SPSE cannot guaranteetheir accuracy.

 

SPSE opinions of value are submitted to our board of directors alongwith GMC’s supplemental assessment and recommendation regarding valuation ofeach of these investments. GMC generally accepts the opinion of value given bySPSE, however in certain limited circumstances, such as when GMC  may learn new information regarding aninvestment between the time of submission to SPSE and the date of the boardassessment, GMC conclusions as to value may differ from the opinion of valuegiven by SPSE.  Our board of directorsthen reviews whether GMC has followed its established procedures fordeterminations of fair value, and votes to accept or not accept the recommendedvaluation of our investment portfolio. At the October 11, 2006 meeting of the board of directors, GMC and ourmanagement recommended, and the board of directors elected to accept, theopinions of value given by SPSE on the seven loans in our portfolio as denotedon the Schedule of Investments as of September 30, 2006 in our consolidatedfinancial statements.

 

Because there is a delay between when we close an investment and whenthe investment can be evaluated by SPSE, new loans are not valued immediatelyby SPSE; rather, management  makes itsown determination about the value of these investments in accordance with ourvaluation policy.  Because SPSE does notprovide values for equity securities, GMC determines the fair value of theseinvestments using valuation policies approved by our board of directors.

 

*Credit Information:*****GMC monitors a wide variety of key creditstatistics that provide information regarding our portfolio companies to helpus assess credit quality and portfolio performance.  We and GMC participate in the periodic boardmeetings of our portfolio

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companies in which withhold control investments and also require them to provide annual audited andmonthly unaudited financial statements. Using these statements and board discussions, GMC calculates andevaluates the credit statistics.  

*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 coversboth qualitative and quantitative aspects of the business and the securities wehold.  

We seek to haveour risk rating system mirror the risk rating systems of major risk ratingorganizations such as those provided by a NRSRO as defined in Rule 2a-7 underthe 1940 Act. While we seek to mirror the NRSRO systems, we cannot provide anyassurance that our risk rating system provides the same risk rating as a NRSRO.The following chart is an estimate of the relationship of our risk ratingsystem to the designations used by two NRSROs as they risk rate debt securitiesof major companies.  Because we haveestablished our system to rate debt securities of companies that are unrated byany NRSRO, there can be no assurance that the correlation to the NRSRO set outbelow is accurate.  We believe our riskrating would be significantly higher than a typical NRSRO risk rating becausethe risk rating of the typical NRSRO is designed for larger businesses.  However, our risk rating has been designed torisk rate the securities of smaller businesses that are not rated by a typicalNRSRO. Therefore, when we use our risk rating on larger business securities,the risk rating is higher than a typical NRSRO rating.  The primary difference between our riskrating and the rating of a typical NRSRO is that our risk rating uses morequantitative determinants and includes qualitative determinants that we believeare not used in the NRSRO rating.  It isour understanding that most debt securities of middle market companies do notexceed the grade of BBB on a NRSRO scale, so there would be no debt securitiesin the middle market that would meet the definition of AAA, AA or A.  Therefore, our scale begins with thedesignation 10 as the best risk rating which may be equivalent to a BBB from aNRSRO, however, no assurance can be given that a 10 on our scale is equal to aBBB on a NRSRO scale.

| Company’s  System | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Investment’s Description(a)**                                               | ** ** |
|------------------------|------------|------------------|------------|-------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **>10**             |       | Baa2             |       | BBB               |       | Probability  of Default (PD) during the next ten years is 4% and the Expected Loss  (EL) is 1% or less |       |
| **10**                 |       | Baa3             |       | BBB-              |       | PD  is 5 and the EL is 1 to 2%                                                                         |       |
| **9**                  |       | Ba1              |       | BB+               |       | PD  is 10 and the EL is 2 to 3%                                                                        |       |
| **8**                  |       | Ba2              |       | BB                |       | PD  is 16 and the EL is 3 to 4%                                                                        |       |
| **7**                  |       | Ba3              |       | BB-               |       | PD  is 17.8 and the EL is 4 to 5%                                                                      |       |
| **6**                  |       | B1               |       | B+                |       | PD  is 22.0 and the EL is 5 to 6.5%                                                                    |       |
| **5**                  |       | B2               |       | B                 |       | PD  is 25 and the EL is 6.5 to 8%                                                                      |       |
| **4**                  |       | B3               |       | B-                |       | PD  is 27 and the EL is 8 to 10%                                                                       |       |
| **3**                  |       | Caa1             |       | CCC+              |       | PD  is 30 and the EL is 10.0 to 13.3%                                                                  |       |
| **2**                  |       | Caa2             |       | CCC               |       | PD  is 35 and the EL is 13.3 to 16.7%                                                                  |       |
| **1**                  |       | Caa3             |       | CC                |       | PD  is 65 and the EL is 16.7 to 20%                                                                    |       |
| **0**                  |       | N/a              |       | D                 |       | PD is 85 or there is a  Payment Default and the EL is greater than 20%                                 |       |

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

The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default.  Our policy is to stopaccruing interest on an investment if we determine that interest is no longercollectible.  At September 30, 2006, nopayments were past due on any of our debt securities.  Additionally, we do not risk rate our equitysecurities.  

Thefollowing table lists the risk ratings for all of the debt securities in ourportfolio at September 30, 2006 and March 31, 2006:

| Rating           | ** ** | **September 30, 2006** | ** ** | **March 31, 2006** | ** ** |
|------------------|------------|----------------------------------|------------|------------------------------|------------|
| Highest          |       | 9                                |       | 9                            |       |
| Average          |       | 7.2                              |       | 7.1                          |       |
| Weighted Average |       | 6.7                              |       | 6.6                          |       |
| Lowest           |       | 6                                |       | 5                            |       |

 

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*Valuation Methods:*  We determine the value of publicly-tradeddebt securities based on the closing price for the security on the exchange orsecurities market on which it is listed on the valuation date.  We value debt securities that are notpublicly traded, but for which a limited market for the security exists, suchas participations in syndicated loans, at the indicative bid price offered bythe syndication agent on the valuation date. At September 30, 2006, none of the debt securities in our portfolio werepublicly traded and there was a limited market for 28 debt securities in ourportfolio.

 

Debt securities that are not publicly traded, for which there is nomarket, or for which there is a market but the securities have not been ratedby a NRSRO, we begin with the risk rating designation of the security asdescribed above.  Using this risk ratingdesignation, we seek to determine the value of the security as if we intendedcurrently to sell the security.  Todetermine the current sale price of the security, we consider some or all ofthe following factors:

 

·      financial standing of the issuer of thesecurity;

·      comparison of the business and financialplan of the issuer with actual results;

·      the cost of the security;

·      the size of the security held as itrelates to the liquidity of the market for such securities;

·      contractual restrictions on thedisposition of the security;

·      pending public offering of the issuer ofthe security;

·      pending reorganization activity affectingthe issuer such as mergers or debt restructuring;

·      reported prices of similar securities ofthe issuer or comparable issuers;

·      ability of the issuer to obtain neededfinancing;

·      changes in the economy affecting theissuer;

·      recent purchases or sale of a security ofthe issuer;

·      pricing and sales by other buyers orsellers of similar securities;

·      financial statements of the borrower;

·      reports from portfolio company seniormanagement and ownership;

·      minutes of portfolio company boardmeetings;

·      the type of security;

·      cost at date of purchase;

·      size of holding;

·      discount from market value of unrestrictedsecurities of the same class at the time of purchase;

·      special reports prepared by analysts;

·      information as to any transactions oroffers with respect to the security;

·      existence of merger proposals or tenderoffers affecting the securities;

·      the collateral;

·      the issuer’s ability to make payments;

·      the current and forecasted earnings of theissuer;

·      statistical ratios compared to lendingstandards;

·      statistical ratios compared to similarsecurities; and

·      other pertinent factors.

 

For those debt securities for which SPSE prepares opinions of value, weprovide some or all of the foregoing information to SPSE for its use inpreparing such recommendations.

 

We value convertible debt, equity, success fees or other equity-likesecurities for which there is a market based on the market prices for suchsecurities, even if that market is not robust. At March 31, 2006 and September 30, 2006 there was no market for any ofthe equity securities we owned.  To valueequity securities for which no market exists, we use the same information wewould use for a debt security valuation described above, except risk-rating, aswell as standard valuation techniques used by major valuation firms to valuethe equity securities of private companies. These valuation techniques consist of discounted cash flow of theexpected sale price in the future, valuation of the securities based on recentsales in comparable transactions, and a review of similar companies that arepublicly traded and the market multiple of their equity securities.  At September 30, 2006 we had $12.8 millioninvested, at cost, in equity securities compared to our debt portfolio with acost basis of $166.5 million.  At March31, 2006 we had $12.8 million invested, at cost, in equity securities comparedto our debt portfolio with a cost basis of $140.5 million.  

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At September 30, 2006 wehad total unrealized depreciation of approximately $1.2 million, which wasprimarily composed of net unrealized depreciation of our syndicated loaninvestments.  At March 31, 2006 we hadtotal unrealized appreciation of approximately $113,000, which was mainlycomposed of net unrealized appreciation of our syndicated loan investments.

***Tax Status***

*Federal Income Taxes*

We currently qualify and intend to continue to qualifyfor treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M of the InternalRevenue Code of 1986, as amended, which we refer to as the Code. As a RIC, weare not subject to federal income tax on the portion of our taxable income andgains distributed to stockholders. To qualify as a RIC, we are required todistribute to stockholders at least 90% of investment company taxable income,as defined by the Code. In an effort to avoid certain excise taxes imposed onRICs, we currently intend to distribute during each calendar year, an amount atleast equal the sum of (1) 98% of our ordinary income for the calendar year,(2) 98% of our capital gains in excess of capital losses for the one-yearperiod ending on October 31 of the calendar year and (3) any ordinary incomeand net capital gains for preceding years that were not distributed during suchyears.

***Revenue Recognition***

*Interest 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*

The1940 Act requires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objectives andpolicies of the respective portfolio company. We provide these and otherservices through our adviser, GMC. Currently, neither we nor GMC receive feesin connection with managerial assistance. However, GMC receives fees for theother services it provides, and 50% of those fees for other services arecredited to the investment advisory fees due to GMC These other fees aregenerally non-recurring, are recognized as revenue when earned and are paiddirectly to GMC by the borrower or potential borrower upon the closing of theinvestment. The services GMC provides vary by investment, but generally includea wide variety of services to the portfolio companies such as investmentbanking services, arranging bank financing, arranging equity financing,structuring financing from multiple lenders and investors, reviewing existingcredit facilities, restructuring existing loans, raising equity and debtcapital, turnaround management, merger and acquisition services and recruitingnew management personnel.  Any servicesof this nature subsequent to the closing would generally generate a separatefee at the time of completion. From time to time, we are invited to participateas a co-lender in a transaction. In the event that we do not providesignificant services in connection with our investment, loan fees paid directlyto GMC in such situations are deferred and amortized over the life of the loan.

**RESULTS OF OPERATIONS**

*Three months ended September 30,2006 compared to the three months ended September 30, 2005*

**Investment Income**

Investment income for the three months ended September30, 2006 increased $2,407,338 to $4,213,928 from $1,806,590 for the threemonths ended September 30, 2005. 

Interest income from Non-Control/Non-Affiliateinvestments increased $2,193,797 to $2,387,375 for the three months endedSeptember 30, 2006 compared to $193,578 for the three months ended September30, 2005.  This increase was mainly theresult of approximately $82 million of additional Non-Control/Non-Affiliateinvestments at September 30, 2006 compared to the prior year period in which wewere beginning to invest the proceeds from our initial public offering insyndicate loans.  

Interest income from Control investments was$1,256,303 for the three months ended September 30, 2006 representing intereston our non-syndicated loan investments. At September 30, 2005, we had not yetinvested in any Control investments.

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Interest income from cash and equivalents decreased$1,043,432 to $569,580 for the three months ended September 30, 2006 from$1,613,012 for the three months ended September 30, 2005.  This decrease is the result of our continuedinvestment of the proceeds of our initial public offering in Control andNon-Control/Non-Affiliate investments. At September 30, 2005 we had approximately $190 million of cashequivalents compared to approximately $48 million at September 30, 2006representing a decrease of approximately $142 million.  

The weighted average yield on our portfolio ofinvestments, excluding cash and cash equivalents, was 8.72% for the threemonths ended September 30, 2006 and 6.38% for the three months ended September30, 2005.

**Operating Expenses**

Operating expenses for the three months ended September30, 2006 were $1,330,042 compared to $393,684 for the three months endedSeptember 30, 2005 representing an overall increase of $936,358.

The administration fee payable to GladstoneAdministration was $124,861 for the three months ended September 30, 2006compared to $77,962 for the threemonths ended September 30, 2005. This fee consists of our allocableportion of Gladstone Administration’s rent and other overhead expenses, and ourallocable portion of the salaries and benefits of our chief financial officer,chief compliance officer, treasurer, controller and their respective staffs.Our allocable portion of expenses is derived by multiplying the percentage ofour average assets (the assets at the beginning and ending of each quarter) incomparison to the average assets of all companies managed by GMC.  The increase was mainly attributable to thepersonnel growth of Gladstone Administration. 

The base management fee payable to GMC was $861,893for the three months ended September 30, 2006 compared to $92,108 for the threemonths ended September 30, 2005. The base management fee is currently computedquarterly as described under “Investment Advisory and Management Agreement.”  The increase in the base management fee inthe current quarter is attributable to the contined investment of the proceedsfrom our initial public offering. 

Directors’ fees for the three months ended September30, 2006 and 2005 were $56,250 and  $52,000,respectively.  Directors’ fees consist ofthe amortization of the directors’ annual stipend and individual meetingfees.  

Insurance expense for the three months ended September30, 2006 was $67,626 compared to $42,478 for the three months ended September30, 2005.  Insurance expense consists ofthe amortization of the directors and officers insurance policy andprofessional liability policy. The increase of $25,148 is mainly due to ourpolicies not beginning until August 2005 thereby resulting in the amortizationof only two months of insurance premiums in the prior year period. 

Professional fees for the three months ended September30, 2006 were $88,040, an increase of $21,738 over the professional fees forthe three months ended September 30, 2005 of $66,302.  Professional fees primarily consist of legalfees and audit and accounting fees.  Theincrease is mainly due to an increase in audit fees related to our compliancewith Sarbanes-Oxley regulations and recurring legal fees resulting fromincreased operations.  

Stockholder related costs increased $22,197 for thethree months ended September 30, 2006 to $65,100 from $42,903 in the threemonths ended September 30, 2005. Stockholder related costs consist of the amortization of annual Nasdaqlisting fees, transfer agent fees, annual report printing fees, Securities andExchange Commission filing fees and press release costs.  The increase in stockholder related costs ismainly due to the fees incurred in connection with our inaugural annual meetingof stockholders on August 10, 2006.

Taxes and licensesexpense for the three months ended September 30, 2006 was $41,337 and wasprimarily comprised of franchise taxes due to the state of Delaware and otherfees surrounding state and regulatory licensing, registration and othercorporate filing fees.

Other expenses for the three months ended September30, 2006 were $24,935 compared to $19,931 for the three months ended September30, 2005.  Other expenses consist ofconferences, travel, bank fees, document custody charges and miscellaneousexpenses.  

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

For the three months ended September 30, 2006, werecognized a loss on the sale of one loan participation in the amount of $1,934and we recorded net unrealized depreciation of investments in the aggregateamount of $33,908.  The net unrealizeddepreciation of our investments for the three months ended September 30, 2006was primarily related to the decline in market value of our Control

27

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investments over the three month period. 

**Net Increase in Net Assets fromOperations**

Overall, we realized a net increase in net assetsresulting from operations of $2,848,044 for the three months ended September30, 2006 as a result of the factors discussed above. Our net increase in netassets from operations per basic and diluted weighted average common share forthe three months ended September 30, 2006 was $0.17 compared to $0.09 for thethree months ended September 30, 2005.   

*Six months ended September 30, 2006compared to the period June 22, 2005 (Commencement of operations) to September30, 2005*

**Investment Income**

Investment income for the six months ended September30, 2006 increased $6,222,578 to $8,077,366 from $1,854,788 for the periodended June 22, 2005 (commencement of operations) to September 30, 2005. 

Interest income from Non-Control/Non-Affiliateinvestments increased $4,158,277 to $4,351,855 for the six months endedSeptember 30, 2006 compared to $193,578 for the the period ended June 22, 2005(commencement of operations) to September 30, 2005. This increase was mainlythe result of approximately $82 million of new Non-Control/Non-Affiliateinvestments compared to the prior year period in which we were beginning toinvest the proceeds from our initial public offering in syndicate loans.  

Interest income from Control investments was$2,446,605 for the six months ended September 30, 2006 representing interest onour non-syndicated loan investments. At September 30, 2005, we had not yetinvested in any Control investments. 

Interest income from cash and equivalents decreased$383,290 to $1,277,920 for the six months ended September 30, 2006 from$1,661,210 for the period ended June 22, 2005 (commencement of operations) toSeptember 30, 2005.  This decrease ismainly the result of our continued investment of the proceeds of our initialpublic offering in Control and Non-Control/Non-Affiliate investments but isoffset by the prior year period only consisting of only 100 days compared to182 days in the current year period. 

The weighted average yield on our portfolio ofinvestments, excluding cash and cash equivalents, was 8.44% for the six monthsended September 30, 2006 and 6.38% for the period ended June 22, 2005(commencement of operations) to September 30, 2005.

**Operating Expenses**

Operating expenses for the six months ended September30, 2006 were $2,612,316 compared to $422,082 for the period ended June 22,2005 (commencement of operations) to September 30, 2005 representing an overallincrease of $2,190,234.

The administration fee payable to GladstoneAdministration was $240,250 for the six months ended September 30, 2006compared to $105,045 for the periodended June 22, 2005 (commencement of operations) to September 30, 2005.This fee consists of our allocable portion of Gladstone Administration’s rentand other overhead expenses, and our allocable portion of the salaries andbenefits of our chief financial officer, chief compliance officer, treasurer, controllerand their respective staffs. Our allocable portion of expenses is derived bymultiplying the percentage of our average assets (the assets at the beginningand ending of each quarter) in comparison to the average assets of allcompanies managed by GMC.  The increasewas mainly attributable to the personnel growth of GladstoneAdministration.  

The base management fee payable to GMC was $1,663,202for the six months ended September 30, 2006 compared to $92,108 for the periodended June 22, 2005 (commencement of operations) to September 30, 2005. Thebase management fee is currently computed quarterly as described under“Investment Advisory and Management Agreement.” The increase in the base management fee in the current period isattributable to the continued investment of our initial public offeringproceeds. In addition, we did not incur a base management fee for the periodJune 22, 2005 (commencement of operations) to June 30, 2005 as we did not haveany investments at that date.

Directors’ fees for the six months ended September 30,2006 and 2005 were $99,500 and $52,000, respectively.  Directors’ fees consist of the amortizationof the directors’ annual stipend and individual meeting fees.  The directors’ fees for the prior year periodwere not declared until July 2005 and therefore, only three months of expensewas recognized.

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Insurance expense for the six months ended September30, 2006 was $140,237 compared to $42,478 for the period ended June 22, 2005(commencement of operations) to September 30, 2005.  Insurance expense consists of theamortization of the directors and officers insurance policy and professionalliability policy. The increase of $97,759 is mainly due to our policies notbeginning until August 2005 thereby resulting in the amortization of only twomonths of insurance premiums in the prior year period. 

Professional fees for the six months ended September30, 2006 were $167,788 , an increase of $101,486 over the professional fees forthe period ended June 22, 2005 (commencement of operations) to September 30,2005 of $66,302.  Professional feesprimarily consist of legal fees and audit and accounting fees.  The increase is mainly due to the shortenedprior year period and an increase in audit fees related to our compliance withSarbanes-Oxley regulations.  

Stockholder related costs increased $115,328 for the sixmonths ended September 30, 2006 to $158,866 from $43,538 in the period endedJune 22, 2005 (commencement of operations) to September 30, 2005.  Stockholder related costs consist of theamortization of annual Nasdaq listing fees, transfer agent fees, annual reportprinting fees, Securities and Exchange Commission filing fees and press releasecosts.  The increase in stockholderrelated costs is mainly due to the shortened prior year period and feesincurred in connection with our inaugural annual meeting of stockholders onAugust 10, 2006.

Interest expense for the period ended June 22, 2005(commencement of operations) to September 30, 2005 was $378 and consisted ofinterest due on a loan payable to an affiliate, which was repaid in June 2005.

Taxes and licensesexpense for the six months ended September 30, 2006 was $98,444 and wasprimarily comprised of franchise taxes due to the state of Delaware and otherfees surrounding state and regulatory licensing, registration and othercorporate filing fees.  

Other expenses for the six months ended September 30,2006 were $44,029 compared to $20,233 for the period ended June 22, 2005(commencement of operations) to September 30, 2005.  Other expenses consist of conferences,travel, bank fees, document custody charges and miscellaneous expenses.  The decrease in other expenses is mainlyattributable to the shorter prior year period.

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

For the six months ended September 30, 2006, werecognized gains on the sale of five loan participations in the aggregateamount of $1,339 and we recorded net unrealized depreciation of investments inthe aggregate amount of $1,341,297.

At March 31, 2006, the fair value of our investmentportfolio exceeded the cost basis of our portfolio by approximately$113,000.  At September 30, 2006, thefair value of our investment portfolio was less than the cost basis of ourportfolio by approximately $1.2 million, representing an unrealized loss ofapproximately $1.3 million.  Thisdecrease is primarily the result of the decline in market value of oursyndicated loan investments. Approximately $254,000 of this unrealized loss is attributable to thedecline in market value of our investments in the senior debt of our ControlInvestments.   

**Net Increase in Net Assets fromOperations**

Overall, we realized a net increase in net assetsresulting from operations of $4,125,092 for the six months ended September 30,2006 as a result of the factors discussed above. Our net increase in net assetsfrom operations per basic and diluted weighted average common share for the sixmonths ended September 30, 2006 was $0.25 and our net increase in net assetsfrom operations per basic and diluted weighted average common share for theperiod ended June 22, 2005 (commencement of operations) to September 30, 2005was $0.09.  

**LIQUIDITY ANDCAPITAL RESOURCES**

**Operations**

Net cash used in operating activities for the sixmonths ended September 30, 2006 was approximately $20.2 million and consistedprimarily of the purchase of syndicated loan investments, an increase in ourinvestment interest receivable and a decrease in accrued expenses from theprior year end, offset by sales of existing portfolio investments, increases inbase management fee and administrative fees payable and unrealized depreciationof our portfolio investments.

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A summary of our investment activity for the sixmonths ended September 30, 2006 and the period June 22, 2005 (Commencement ofoperations) to September 30, 2005 is as follows:

| Quarter Ended  | ** ** | **New   Investments** | ** ** | **Principal   Repayments** | ** ** | **Investments   Sold** | ** ** | **Gain on   Disposal** | ** ** |
|---------------------|------------|----------------------------|------------|---------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| June 30, 2006       |       | $                          | 33,665,549 |                            | $          | 874,222                     |       | $                                | 15,548,454 |   | $ | 3,273 |   |
| September 30,  2006 |       | 15,812,230                 |       | 5,964,245                       |       | 999,437                     |       | (1,934                           | )          |
| **Total**           |       | $                          | 49,477,779 |                            | $          | 6,838,467                   |       | $                                | 16,547,890 |   | $ | 1,339 |   |

 

| Quarter Ended  | ** ** | **New   Investments** | ** ** | **Principal   Repayments** | ** ** | **Investments   Sold** | ** ** | **Gain on   Disposal** | ** ** |
|---------------------|------------|----------------------------|------------|---------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| June 30, 2005       |       | $                          | —     |                            | $          | —                      |       | $                                | —     |   | $ | — |   |
| September 30,  2005 |       | 40,844,381                 |       | 333,363                         |       | —                      |       | —                           |       |
| **Total**           |       | $                          | 40,844,381 |                            | $          | 333,363                     |       | $                                | —     |   | $ | — |   |

 

During the six monthsended September 30, 2006, we purchased new investments using a portion of theremaining proceeds from our initial public offering.  We will continue to use the proceeds from ourinitial public offering to make investments in syndicated loans, subordinateddebt, mezzanine debt, preferred stock and other higher yieldinginvestments.  We anticipate issuingadditional equity securities to obtain additional capital in the future. The terms of the future equity issuancescannot be determined and there can be no assurances that the equity marketswill be available to us on terms we deem favorable.  On October 13, 2006 we filed a registrationstatement with the Securities and Exchange Commission that, when declaredeffective, would permit us to issue, through one or more transactions, up to anaggregate of $100 million in securities, consisting of common stock, preferredstock and/or debt securities.  To date wehave incurred approximately $54,000 of costs in connection with thisregistration statement.  

 

The following tablesummarizes the contractual principal amortization and maturity of ourinvestment portfolio by fiscal year:

| Fiscal Year Ended March 31, | ** ** | **Amount**   | ** ** |
|-------------------------------------------------|------------|--------------|------------|
| 2007                                            |       | $924,697     |       |
| 2008                                            |       | 4,520,475    |       |
| 2009                                            |       | 5,635,859    |       |
| 2010                                            |       | 6,391,319    |       |
| 2011                                            |       | 33,681,941   |       |
| Thereafter                                      |       | 114,476,186  |       |
| **Total  contractual repayments**               |       | 165,630,477  |       |
| Investments in  equity securities               |       | 12,778,508   |       |
| Unamortized premiums on  debt securities:       |       | 866,411      |       |
| **Total**                                       |       | $179,275,396 |       |

 

For the period June 22, 2005 (commencement ofoperations) to September 30, 2005, we recorded net cash proceeds resulting fromour initial public offering of $230,296,850, of which approximately $40 millionwas invested in portfolio companies and the remainder was invested in cash andshort-term investments at September 30, 2005.

For the six months ended September 30, 2006, ourdividends paid of $6,955,245 exceeded our net investment income (includingrealized gains) by $1,488,856.  Wedeclared these dividends based on our estimates of net investment income forthe fiscal year.  Our investment pacecontinues to be slower than expected in our second year of operations and,consequently, our net investment income was lower than our original estimates.

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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** |
|-----------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------|
| October 10, 2006      |       | December 20, 2006    |       | December 29, 2006     |       | $                                | 0.07 |
| October 10, 2006      |       | November 21, 2006    |       | November 30, 2006     |       | $                                | 0.07 |
| October 10, 2006      |       | October 23, 2006     |       | October 31, 2006      |       | $                                | 0.07 |
| July 11, 2006         |       | September 21, 2006   |       | September 29, 2006    |       | $                                | 0.07 |
| July 11, 2006         |       | August 21, 2006      |       | August 31, 2006       |       | $                                | 0.07 |
| July 11, 2006         |       | July 19, 2006        |       | July 31, 2006         |       | $                                | 0.07 |
| April 11, 2006        |       | June 22, 2006        |       | June 30, 2006         |       | $                                | 0.07 |
| April 11, 2006        |       | May 22, 2006         |       | May 31, 2006          |       | $                                | 0.07 |
| April 11, 2006        |       | April 20, 2006       |       | April 28, 2006        |       | $                                | 0.07 |
| January 10, 2006      |       | March 17, 2006       |       | March 31, 2006        |       | $                                | 0.07 |
| January 10, 2006      |       | February 16, 2006    |       | February 28, 2006     |       | $                                | 0.07 |
| January 10, 2006      |       | January 23, 2006     |       | January 31, 2006      |       | $                                | 0.07 |
| October 7, 2005       |       | December 21, 2005    |       | December 31, 2005     |       | $                                | 0.04 |
| October 7, 2005       |       | November 21, 2005    |       | November 30, 2005     |       | $                                | 0.04 |
| October 7, 2005       |       | October 21, 2005     |       | October 30, 2005      |       | $                                | 0.04 |
| July 7, 2005          |       | September 22, 2005   |       | September 30, 2005    |       | $                                | 0.02 |
| July 7, 2005          |       | August 23, 2005      |       | August 31, 2005       |       | $                                | 0.02 |
| July 7, 2005          |       | July 21, 2005        |       | July 29, 2005         |       | $                                | 0.02 |

 

**Revolving Credit Facility**

On October 19, 2006 through our wholly-ownedsubsidiary Gladstone Business Investment, LLC (“Business Investment”), theCompany has obtained a $100 million revolving credit facility (the “CreditFacility”).  On October 19, 2006, the Company executed a Purchase and SaleAgreement pursuant to which it agreed to sell certain loans to BusinessInvestment in consideration of a membership interest therein. Simultaneously, Business Investment executed a Credit Agreement (the “CreditAgreement”) with Deutsche Bank AG, New York Branch (“Deutsche Bank”), asadministrative agent, and others, pursuant to which Business Investment pledgedthe loans purchased from the Company to secure future advances by certaininstitutional lenders. Availability under the Credit Facility willterminate on October 18, 2007, unless extended in the discretion of thelenders, at the request of Business Investment. Interest will be payablemonthly during the term of the Credit Facility and principal will be payableout of collections on loans purchased from the Company during the periodfollowing the date of which availability for advances has terminated throughmaturity.  The Credit Facility willmature two years following the date on which availability for advances hasterminated and on such date, all principal, interest and other amounts owingunder the Credit Facility will be due and payable.  Interest rates charged on the advances underthe facility are based on the rate paid by the lenders on commercial papernotes issued by such lenders to fund some or all of the advances, the LondonInterbank Offered Rate (“LIBOR”), the Prime Rate or the Federal Funds Rate,depending on market conditions, and adjusts periodically.  As of October31, 2006, there was no outstanding principal balance under the Credit Facility.Available borrowings are subject to various constraints imposed under theCredit Agreement, based on the aggregate loan balance pledged by BusinessInvestment, which varies as loans or added and repaid, regardless of whethersuch repayments are early prepayment or are made as contractuallyrequired.  At October 31, 2006, the remaining borrowing capacity availableunder the Credit Facility was approximately $100 million.  If we request arenewal of the Credit Facility, any such renewal will be granted in thediscretion of the lenders and there can be no guarantee that we will be able torenew the Credit Facility on terms that are favorable to us, if at all. In the event that we are not able to renew or refinance the Credit Facilitythis could have a material adverse impact on our liquidity and ability to fundnew investments.  

The Credit Facility contains covenants that requireBusiness Investment to maintain its status as a separate entity; prohibitcertain significant corporate transactions (such as mergers, consolidations,liquidations or dissolutions); and restrict material changes to the Company’scredit and collection policies.  The facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As of October 31, 2006, BusinessInvestment was in compliance with all of the facility covenants.  Wecurrently intend to securitize some or all of the loans held by BusinessInvestment and if we are able to do so, we will use the proceeds from thesecuritization to pay down any amounts then outstanding under the revolvingcredit facility.  

The administrative agent also requires that any interest or principalpayments on pledged loans be remitted directly by the borrower into lockboxaccounts controlled by Deutsche Bank. Once a month, Deutsche Bank remits thecollected funds to the Company after payment of any interest and expensesprovided for under the Credit Agreement.

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GMC, our affiliatedexternal adviser, services the loans pledged under the Credit Facility. As a condition to this servicing arrangement, we executed a performance guarantypursuant to which we guaranteed that GMC would comply fully with all of itsobligations under the Credit Facility. The performance guaranty requires us tomaintain a minimum net worth of [$100] million and to maintain “asset coverage”with respect to “senior securities representing indebtedness” of at least 200%,in accordance with Section 18 of the 1940 Act. As of October 31, 2006, wewere in compliance with our covenants under the performance guaranty.

 

**Contractual Obligations andOff-Balance Sheet Arrangements**

As of September30, 2006, we were a party to signed and non-binding term sheets for twoallocations of syndicate loan participations for approximately $0.5 million andone buyout investment approximating $29.5 million.  The future scheduled contractual payments at September30, 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                      |       | 30,024,000 |       | 30,024,000                               |       | — |   | — |   | — |   |
| Total                            |       | $          | 30,024,000 |                                     | $          | 30,024,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

As of the date of this report, $524,000 of theinvestment purchase obligations summarized above has been funded. See Note 7“Subsequent Events” in our Consolidated Financial Statements for furtherinformation.

We do not have any significant off-balance sheetarrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K as of September30, 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 opportunitiesand, accordingly have a material adverse effect on our investment objectivesand our rate of return on invested capital. Currently our entire investmentportfolio is at variable rates. In addition, an increase in interest rateswould make it more expensive to use debt for our financing needs, if any.

We expect to borrow fundsto finance future lending activities after we have substantially fully investedthe proceeds of our initial public offering. These future borrowings may be atfixed or variable rates. For example, interest rates chargedon the advances under our credit facility are based on the rate paid by thelenders on commercial paper notes issued by such lenders to fund some or all ofthe advances, LIBOR, the Prime Rate or the Federal Funds Rate, depending onmarket conditions, and adjusts periodically. As of October 31, 2006, there was no outstanding principal balance underthe credit facility.

 

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant. Under this analysis, a hypothetical increase in the one monthLIBOR by 1% would increase our net increase in net assets resulting fromoperations by approximately $1.4 million or 16.0%, over the next twelve months,compared to the net increase in net assets resulting from operations for theperiod October 1, 2005 to September 30, 2006. A hypothetical decrease in theone month LIBOR by 1% would decrease our net increase in net assets resultingfrom operations by approximately $1.4 million or 16.0%, over the next twelvemonths, compared to the net increase in net assets from operations for theperiod October 1, 2005 to September 30, 2006. Although management believes thatthis analysis is indicative of our existing interest rate sensitivity, it doesnot adjust for potential changes in credit quality, size and composition of ourinvestment portfolio and other business developments that could affect netincrease in net assets resulting from operations. Accordingly, no assurancescan be given that actual results would not differ materially from the resultsunder this hypothetical analysis.

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

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fluctuations in interest rates, they may also limitour ability to participate in the benefits of lower interest rates with respectto our portfolio of investments. We currently are not engaged in any hedgingactivities.

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.

 

**ITEM 4.   CONTROLSAND PROCEDURES.**

As of September 30, 2006, we, including our ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of our disclosure controls and procedures. Based onthat evaluation, our management, including the Chief Executive Officer andChief Financial Officer, concluded that our disclosure controls and procedureswere effective in timely alerting management, including the Chief ExecutiveOfficer and Chief Financial Officer, of material information about us requiredto be included in periodic Securities and Exchange Commission filings. However,in evaluating the disclosure controls and procedures, management recognizedthat any controls and procedures, no matter how well designed and operated canprovide only reasonable assurance of achieving the desired control objectives,and management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

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

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**PART II—OTHERINFORMATION**

**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.**

Our business is subject to certain risks and eventsthat, if they occur, could adversely affect our financial condition and resultsof operations and the trading price of our common stock. For a discussion ofthese risks, please refer to the “Risk Factors” section of our Annual Report onForm 10-K for the fiscal year ended March 31, 2006, filed by us with theSecurities and Exchange Commission on June 14, 2006 as well as the Company’sRegistration Statement on Form N-2, filed on October 13, 2006 (the“Registration Statement”). In connection with our preparation of this quarterlyreport, management has reviewed and considered these risk factors and hasdetermined that the following risk factors should be read in connection withthe existing risk factors disclosed in our Annual Report on Form 10-K for thefiscal year ended March 31, 2006 and the Registration Statement.

***Our credit facility imposescertain limitations on us. ***

The administrative agentand lenders under our credit facility have fixed dollar claims on our assetsthat are senior to the claims of our stockholders and, thus, have a preferenceover our stockholders with respect to our assets. Our credit facility alsocontains customary default provisions and financial covenants for loans of thisnature, such as a minimum portfolio yield, maximum charge-off ratios anddefault ratios with respect to the loans purchased from us, a restriction onchanging our business and loan quality standards. An event of default under ourcredit facility would likely result, among other things, in termination offurther funds available under that facility and an accelerated maturity datefor all amounts outstanding under the facility. This would likely disrupt theportfolio companies whose loans we financed through the facility, could reduceour revenues and, by delaying any cash payment allowed to us under our facilityuntil the lenders have been paid in full, could reduce our liquidity and cashflow.

 

**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.**

The 2006 Annual Meeting of Stockholders was held on August 10,2006.  The stockholders voted and approvedthe following matter:

 

·      The election of three directors to hold office until the 2009Annual Meeting of Stockholders and one director to hold office until the 2008Annual Meeting of Stockholders.

 

| Nominee                   | ** ** | **Shares Voted For** | ** ** | **Authority Withheld** | ** ** |
|---------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| Terry Lee Brubaker (2009) |       |                           | 16,294,021 |                        |       |   | 59,909 |   |   |
| Maurice W. Coulon (2009)  |       |                           | 16,284,517 |                        |       |   | 69,413 |   |   |
| David A.R. Dullum (2009)  |       |                           | 16,293,507 |                        |       |   | 60,423 |   |   |
| Gerard Mead (2008)        |       |                           | 16,285,946 |                        |       |   | 67,984 |   |   |

 

**ITEM 5. OTHERINFORMATION.**

Not applicable

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**ITEM 6. EXHIBITS**

See the exhibit index.

35

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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: November 1, 2006**

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**EXHIBIT INDEX**
| Exhibit | ** ** | **Description**                                                                                                                                                                                                                                                                            |
|---------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1     |       | Amended and Restated Certificate of Incorporation,  incorporated by reference to Exhibit a.2 to Pre-Effective Amendment No. 1 to  the Registration Statement on Form N-2 (File No. 333-123699), filed May 13,  2005.                                                                       |
|    |       |                                                                                                                                                                                                                                                                                       |
| 3.2     |       | Amended and Restated Bylaws, incorporated by  reference to Exhibit b.2 to Pre-Effective Amendment No. 3 to the Registration  Statement on Form N-2 (File No. 333-123699), filed June 21, 2005.                                                                                             |
|    |       |                                                                                                                                                                                                                                                                                       |
| 4.1     |       | Specimen Stock Certificate, incorporated by  reference to Exhibit 99.d to Pre-Effective Amendment No. 3 to the  Registration Statementon Form N-2 (File No. 333-123699), filed June 21, 2005.                                                                                              |
|    |       |                                                                                                                                                                                                                                                                                       |
| 10.1*   |       | 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 12, 2006.                  |
|    |       |                                                                                                                                                                                                                                                                                       |
| 10.2    |       | Credit Agreement by and among Gladstone Business  Investment LLC, Deutsche Bank AG, and certain other parties, dated as of  October 19, 2006, incorporated by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K (File No. 814-00704), filed on October 23, 2006. |
|    |       |                                                                                                                                                                                                                                                                                       |
| 11      |       | Computation of Per Share Earnings (included in the  notes to the unaudited financial statements contained in this report).                                                                                                                                                                 |
|    |       |                                                                                                                                                                                                                                                                                       |
| 31.1    |       | Certification of Chief Executive Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                       |
|    |       |                                                                                                                                                                                                                                                                                       |
| 31.2    |       | Certification of Chief Financial Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                       |
|    |       |                                                                                                                                                                                                                                                                                       |
| 32.1    |       | Certification of Chief Executive Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                       |
|    |       |                                                                                                                                                                                                                                                                                       |
| 32.2    |       | Certification of Chief Financial Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                       |

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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.

37

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