**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**ý****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTER ENDED DECEMBER 31, 2002.**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILE NUMBER: 814-00237**

 

**GLADSTONE CAPITALCORPORATION**

(Exact name of registrant as specified inits charter)

 

| **MARYLAND**                                                    |   | **54-2040781**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **1616 ANDERSON ROAD,  SUITE 208**                              |
| **MCLEAN, VIRGINIA 22102**                                      |
| (Address of principal executive office)                         |
|                                                            |   |                                 |
| **(703) 286-7000**                                              |
| (Registrant’s telephone number,  including area code)      |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý No o.

 

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

Yes ý No o.

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.  The number of shares of the issuer’s CommonStock, $0.001 par value, outstanding as of February 7, 2003 was 10,071,844.

 

 

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**GLADSTONE CAPITAL CORPORATION**

**TABLE OF CONTENTS**

 
| PART I.        | FINANCIAL INFORMATION                                                                                                     |
|----------------|---------------------------------------------------------------------------------------------------------------------------|
|           |                                                                                                                      |
| Item 1.        | Financial Statements  (Unaudited)                                                                                         |
|           |                                                                                                                      |
|           | Consolidated Balance Sheets  as of December 31, 2002 and September 30, 2002                                               |
|           | Schedule of Investments as of  December 31, 2002 and September 30, 2002                                                   |
|           | Consolidated  Statements of Operations for the three months ended December 31, 2002 and  December 31, 2001                |
|           | Consolidated  Statements of Stockholders’ Equity for the three months ended December 31,  2002 and December 31, 2001 |
|           | Consolidated  Statements of Cash Flows for the three months ended December 31, 2002 and  December 31, 2001                |
|           | Financial Highlights for the three  months ended December 31, 2002 and December 31, 2001                                  |
|           | Notes to Consolidated  Financial Statements                                                                               |
|           |                                                                                                                      |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               |
|           |                                                                                                                      |
|           | Overview                                                                                                                  |
|           | Results of Operations                                                                                                     |
|           | Liquidity and Capital  Resources                                                                                          |
|           |                                                                                                                      |
| Item  3.       | Quantitative  and Qualitative Disclosure About Market Risk                                                                |
|           |                                                                                                                      |
| Item 4.        | Controls and  Procedures                                                                                                  |
|           |                                                                                                                      |
| PART II.       | OTHER INFORMATION                                                                                                         |
|           |                                                                                                                      |
| Item 1.        | Legal Proceedings                                                                                                         |
|           |                                                                                                                      |
| Item  2.       | Changes  in 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 and  Reports on Form 8-K                                                                                         |
|           |                                                                                                                      |
| SIGNATURES     |
|           |                                                                                                                      |
| CERTIFICATIONS |

 

2

----

 

**PART I—FINANCIALINFORMATION**

 

**Gladstone Capital Corporation**

 

**Consolidated FinancialStatements**

 

**(Unaudited)**

 

**December 31, 2002**

 

 

**CONTENTS**

 
| Consolidated Balance Sheets                           |
|-------------------------------------------------------|
|                                                  |
| Schedule of Investments                               |
|                                                  |
| Consolidated  Statements of Operations                |
|                                                  |
| Consolidated  Statements of Stockholders’ Equity |
|                                                  |
| Consolidated  Statements of Cash Flows                |
|                                                  |
| Financial Highlights                                  |
|                                                  |
| Notes to Consolidated  Financial Statements           |

 

3

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED BALANCESHEETS**

 

**(UNAUDITED)**

 
|                                                                                                       |   | **December 31,  2002** |        | **September 30,  2002** |       |
|------------------------------------------------------------------------------------------------------------|--------|------------------------|-------------|-------------------------|------------|
| **ASSETS**                                                                                                 |   |                   | ** **  |                    | ** ** |
| Investments at fair value (Cost  12/31/2002: $83,826,434; 9/30/2002: $79,718,354)                          |   | $                      | 83,826,434  |                    | $          | 79,718,354 |   |
| Cash and cash equivalents                                                                                  |   | 48,130,938             |        | 51,930,529              |       |
| Cash and cash equivalents pledged to  creditors                                                            |   | 40,005,996             |        | 39,998,799              |       |
| Interest receivable – investments in  debt securities                                                 |   | 854,458                |        | 685,274                 |       |
| Interest receivable – cash and cash  equivalents                                                      |   | 1,464                  |        | 4,389                   |       |
| Interest receivable – officers                                                                        |   | 22,763                 |        | 109,874                 |       |
| Prepaid assets                                                                                             |   | 355,823                |        | 357,955                 |       |
| Other assets                                                                                               |   | 212,945                |        | 116,865                 |       |
|                                                                                                       |   |                   |        |                    |       |
| **TOTAL ASSETS**                                                                                           |   | $                      | 173,410,821 |                    | $          | 172,922,039 |   |
|                                                                                                       |   |                   |        |                    |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                             |   |                   |        |                    |       |
|                                                                                                       |   |                   |        |                    |       |
| **LIABILITIES**                                                                                            |   |                   |        |                    |       |
| Dividends Payable                                                                                          |   | $                      | 2,316,523   |                    | $          | 2,115,087 |   |
| Accrued expenses and deferred  liabilities                                                                 |   | 1,129,697              |        | 944,960                 |       |
| Repurchase agreement                                                                                       |   | 39,205,697             |        | 39,198,719              |       |
|                                                                                                       |   |                   |        |                    |       |
| **Total Liabilities**                                                                                      |   | $                      | 42,651,917  |                    | $          | 42,258,766 |   |
|                                                                                                       |   |                   |        |                    |       |
| **STOCKHOLDERS’ EQUITY**                                                                              |   |                   |        |                    |       |
| Common stock, $0.001 par value,  50,000,000 shares authorized and 10,071,844 shares issued and outstanding |   | $                      | 10,072      |                    | $          | 10,072 |   |
| Capital in excess of par value                                                                             |   | 140,266,684            |        | 140,266,684             |       |
| Notes receivable – officers                                                                           |   | (8,983,796             | )           | (8,983,796              | )          |
| Declared distributions in excess of  undistributed earnings                                                |   | (534,056               | )           | (629,687                | )          |
|                                                                                                       |   |                   |        |                    |       |
| **Total Stockholders’  Equity**                                                                       |   | $                      | 130,758,904 |                    | $          | 130,663,273 |   |
|                                                                                                       |   |                   |        |                    |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                        |   | $                      | 173,410,821 |                    | $          | 172,922,039 |   |

 

SEE ACCOMPANYING NOTES.

 

4

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**GLADSTONE CAPITAL CORPORATION**

 

**SCHEDULE OF INVESTMENTS**

 

**AS OF DECEMBER 31, 2002**

 

**(UNAUDITED)**

 
| **COMPANY(1)**                        |   | **INDUSTRY**                             |   | **INVESTMENT**                          |   | **COST**         |       | **FAIR VALUE**   |   |
|---------------------------------------|--------|------------------------------------------|--------|-----------------------------------------|--------|------------------|------------|------------------|--------|
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| ARI Holdings, Inc.                    |   | Manufacturing auto parts                 |   | Junior Subordinated Term Debt(3)        |   | $                | 8,354,368  |             | $      | 8,354,368 |   |
| Coyne International Enterprises Corp. |   | Uniform cleaning and rental              |   | Senior Term Debt(2)(3)                  |   | 20,135,569       |       | 20,135,569       |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Finn Corporation                      |   | Manufacturing  landscape equipment       |   | Senior Subordinated  Term Debt          |   | 10,500,000  |       | 10,500,000  |   |
|                                  |   |                                     |   | Common Stock  Warrants for 2% ownership |   | $                | 37,000     |             | $      | 37,000 |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Home Care Supply, Inc.                |   | Medical equipment rental                 |   | Senior Term Debt(2)                     |   | 18,000,000       |       | 18,000,000       |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Inca Metal Products Corporation       |   | Manufacturing material handling products |   | Senior Term Debt(2)                     |   | 6,000,000        |       | 6,000,000        |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Kozy Shack Enterprises, Inc.          |   | Food production and sales                |   | Senior Term Debt(2)                     |   | 4,200,000        |       | 4,200,000        |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Marcal Paper Mills, Inc.              |   | Manufacturing paper products             |   | Senior Term Debt(2)                     |   | 7,500,000        |       | 7,500,000        |   |
|                                  |   |                                     |   | First Mortgage Debt(3)                  |   | 9,099,497        |       | 9,099,497        |   |
|                                  |   |                                     |   |                                    |   |             |       |             |   |
| Totals                                |   |                                     |   |                                    |   | $                | 83,826,434 |             | $      | 83,826,434 |   |

 

----

(1) We do not “Control,” and are not an “Affiliate” of, any of ourportfolio companies, each as defined in the Investment Company Act of 1940, asamended (the “1940 Act”). In general, under the 1940 Act, we would “Control” aportfolio company if we owned 25% or more of its voting securities and would bean “Affiliate” of a portfolio company if we owned 5% or more of its votingsecurities.

(2) Last Out Tranche of senior debt, meaning if the company isliquidated then the holder of the Last Out Tranche is paid after the seniordebt.

(3) Has some paid in kind (PIK) interest. Refer to Note 2 “Summaryof Significant Accounting Policies” of Form 10-K for the fiscal year endedSeptember 30, 2002.

 

SEE ACCOMPANYING NOTES.

 

5

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**SCHEDULE OF INVESTMENTS**

 

**AS OF SEPTEMBER 30, 2002**

 

**(UNAUDITED)**

 
| **COMPANY(1)**                        |   | **INDUSTRY**                             |   | **INVESTMENT**                         |   | **COST**         |       | **FAIR VALUE**   |   |
|---------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|------------------|------------|------------------|--------|
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| ARI Holdings, Inc.                    |   | Manufacturing auto parts                 |   | Junior Subordinated Term Debt(3)       |   | $                | 8,250,803  |             | $      | 8,250,803 |   |
| Coyne International Enterprises Corp. |   | Uniform cleaning and rental              |   | Senior Term Debt(2)(3)                 |   | 16,054,268       |       | 16,054,268       |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Finn Corporation                      |   | Manufacturing landscape equipment        |   | Senior Subordinated Term Debt          |   | 10,500,000  |       | 10,500,000  |   |
|                                  |   |                                     |   | Common Stock Warrants for 2% ownership |   | 37,000           |       | 37,000           |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Home Care Supply, Inc.                |   | Medical equipment rental                 |   | Senior Term Debt(2)                    |   | 18,000,000       |       | 18,000,000       |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Inca Metal Products Corporation       |   | Manufacturing material handling products |   | Senior Term Debt(2)                    |   | 6,000,000        |       | 6,000,000        |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Kozy Shack Enterprises, Inc.          |   | Food production and sales                |   | Senior Term Debt(2)                    |   | 4,300,000        |       | 4,300,000        |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Marcal Paper Mills, Inc.              |   | Manufacturing paper products             |   | Senior Term Debt(2)                    |   | 7,500,000        |       | 7,500,000        |   |
|                                  |   |                                     |   | First Mortgage Debt(3)                 |   | 9,076,283        |       | 9,076,283        |   |
|                                  |   |                                     |   |                                   |   |             |       |             |   |
| Totals                                |   |                                     |   |                                   |   | $                | 79,718,354 |             | $      | 79,718,354 |   |

 

----

(1)  We do not “Control,”and are not an “Affiliate” of, any of our portfolio companies, each as definedin the Investment Company Act of 1940, as amended (the “1940 Act”). In general,under the 1940 Act, we would “Control” a portfolio company if we owned 25% ormore of its voting securities and would be an “Affiliate” of a portfoliocompany if we owned 5% or more of its voting securities.

(2) Last Out Tranche of senior debt, meaning if the company isliquidated then the holder of the Last Out Tranche is paid after the seniordebt.

(3) Has some paid in kind (PIK) interest. Refer to Note 2 “Summaryof Significant Accounting Policies” of Form 10-K for the fiscal year endedSeptember 30, 2002.

 

SEE ACCOMPANYING NOTES.

 

6

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED STATEMENT OF OPERATIONS**

 

**(UNAUDITED)**

 
|                                                                                |   | **Three Months  Ended December  31, 2002** |      | **Three Months  Ended December  31, 2001** |   |
|-------------------------------------------------------------------------------------|--------|--------------------------------------------|-----------|--------------------------------------------|--------|
| **INVESTMENT INCOME**                                                               |   |                                       |      |                                       |   |
| Interest income – investments                                                  |   | $                                          | 2,927,663 |                                       | $      | 329,657 |   |
| Interest income – cash and cash  equivalents                                   |   | 198,166                                    |      | 640,515                                    |   |
| Interest income – notes receivable from  officers                              |   | 109,603                                    |      | 107,418                                    |   |
| Managerial assistance fees                                                          |   | 0                                          |      | 611,809                                    |   |
| Total Investment Income                                                             |   | $                                          | 3,235,432 |                                       | $      | 1,689,399 |   |
|                                                                                |   |                                       |      |                                       |   |
| **EXPENSES**                                                                        |   |                                       |      |                                       |   |
| Salaries and benefits                                                               |   | $                                          | 433,240   |                                       | $      | 277,184 |   |
| Rent                                                                                |   | 54,620                                     |      | 11,053                                     |   |
| Professional fees                                                                   |   | 114,690                                    |      | 101,421                                    |   |
| Directors fees                                                                      |   | 13,500                                     |      | 2,000                                      |   |
| General and administrative                                                          |   | 207,228                                    |      | 100,761                                    |   |
| Total   Expenses                                                               |   | $                                          | 823,278   |                                       | $      | 492,419 |   |
|                                                                                |   |                                       |      |                                       |   |
| **NET INVESTMENT INCOME**                                                           |   | $                                          | 2,412,154 |                                       | $      | 1,196,980 |   |
|                                                                                |   |                                       |      |                                       |   |
| **NET INCREASE (DECREASE) IN STOCKHOLDERS’ EQUITY  RESULTING FROM OPERATIONS** |   | $                                          | 2,412,154 |                                       | $      | 1,196,980 |   |
|                                                                                |   |                                       |      |                                       |   |
| **NET INVESTMENT INCOME PER COMMON SHARE:**                                         |   |                                       |      |                                       |   |
| Basic                                                                               |   | $                                          | 0.24      |                                       | $      | 0.12 |   |
| Diluted                                                                             |   | $                                          | 0.24      |                                       | $      | 0.12 |   |
|                                                                                |   |                                       |      |                                       |   |
| **WEIGHTED AVERAGE SHARES OF COMMON STOCK  OUTSTANDING:**                           |   |                                       |      |                                       |   |
| Basic                                                                               |   | 10,071,844                                 |      | 10,060,178                                 |   |
| Diluted                                                                             |   | 10,124,197                                 |      | 10,146,030                                 |   |

 

SEE ACCOMPANYING NOTES.

 

7

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

 

**(UNAUDITED)**

 
|                                                                 |   | **Common Stock** |   | **Capital in  Excess of  Par Value** |   | **Notes  Receivable  From Sale of  Common  Stock** |   | **(Distributions)  in Excess of  Undistributed  Earnings** |   | **Total  Stockholders’  Equity** |       |
|----------------------------------------------------------------------|--------|------------------|--------|--------------------------------------|--------|----------------------------------------------------|--------|------------------------------------------------------------|--------|---------------------------------------|------------|
| **Shares**                                                           |   | **Amount**       |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Balance at September 30, 2001                                        |   | 10,060,178       |   | $                                    | 10,060 |                                               | $      | 140,131,778                                                |   | $                                     | (8,800,050 | ) | $ | (92,644 | ) | $ | 131,249,144 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Issuance of Common Stock Under Stock  Option Plan                    |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Offering Costs                                                       |   |             |   |                                 |   | (50,971                                            | )      |                                                       |   |                                  |       | (50,971 | ) |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Repayment of Principal on Notes  Receivable                          |   |             |   |                                 |   |                                               |   | 931                                                        |   |                                  |       | 931 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Net Increase in Stockholders’ Equity  Resulting from Operations |   |             |   |                                 |   |                                               |   |                                                       |   | 1,196,980                             |       | 1,196,980 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Distributions Declared ($0.18 per common  share)                     |   |             |   |                                 |   |                                               |   |                                                       |   | (1,810,832                            | )          | (1,810,832 | ) |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Balance at December 31, 2001                                         |   | 10,060,178       |   | $                                    | 10,060 |                                               | $      | 140,080,807                                                |   | $                                     | (8,799,119 | ) | $ | (706,496 | ) | $ | 130,585,252 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Balance at September 30, 2002                                        |   | 10,071,844       |   | $                                    | 10,072 |                                               | $      | 140,266,684                                                |   | $                                     | (8,983,796 | ) | $ | (629,687 | ) | $ | 130,663,273 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Issuance of Common Stock Under Stock  Option Plan                    |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       | 0 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Offering Costs                                                       |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       | 0 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Repayment of Principal on Notes  Receivable                          |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Net Increase in Stockholders’ Equity  Resulting from Operations |   |             |   |                                 |   |                                               |   |                                                       |   | 2,412,154                             |       | 2,412,154 |   |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Distributions Declared ($0.23 per common  share)                     |   |             |   |                                 |   |                                               |   |                                                       |   | (2,316,523                            | )          | (2,316,523 | ) |
|                                                                 |   |             |   |                                 |   |                                               |   |                                                       |   |                                  |       |   |   |
| Balance at December 31, 2002                                         |   | 10,071,844       |   | $                                    | 10,072 |                                               | $      | 140,266,684                                                |   | $                                     | (8,983,796 | ) | $ | (534,056 | ) | $ | 130,758,904 |   |

 

SEE ACCOMPANYING NOTES.

 

8

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 

**(UNAUDITED)**

 
|                                                                                                                                                              |   | **Three Months  Ended  December 31, 2002** |       | **Three Months  Ended  December 31, 2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|--------------------------------------------|--------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                                          |   |                                       |       |                                       |   |
| Net increase (decrease) in stockholders’  equity resulting from operations                                                                                   |   | $                                          | 2,412,154  |                                       | $      | 1,196,980 |   |
| Adjustments to reconcile net increase  (decrease) in stockholders’ equity resulting from operations to net cash  provided by (used in) operating activities: |   |                                       |       |                                       |   |
| Depreciation                                                                                                                                                      |   | 6,765                                      |       | 0                                          |   |
| Increase in interest receivable                                                                                                                                   |   | (79,148                                    | )          | (3,245                                     | )      |
| Increase in other assets                                                                                                                                          |   | (64,022                                    | )          | (114,505                                   | )      |
| Increase (decrease) in accrued expenses  and deferred liabilities                                                                                                 |   | 184,737                                    |       | (142,580                                   | )      |
| Decrease (increase) in prepaid assets                                                                                                                             |   | 2,132                                      |       | 25,676                                     |   |
| Increase in accounts payable                                                                                                                                      |   | 0                                          |       | 250,538                                    |   |
| Increase in investment balance due to  payment in kind interest                                                                                                   |   | (208,080                                   | )          | 0                                          |   |
| Net Cash Provided by Operating  Activities                                                                                                                        |   | $                                          | 2,254,538  |                                       | $      | 1,212,864 |   |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                                                                                                          |   |                                       |       |                                       |   |
| Purchase of furniture and equipment                                                                                                                               |   | $                                          | (38,823    | )                                          | $      | 0 |   |
| Purchase of investments                                                                                                                                           |   | (4,000,000                                 | )          | (42,017,863                                | )      |
| Principal repayments on investments                                                                                                                               |   | 100,000                                    |       | 0                                          |   |
| Proceeds from repurchase agreements                                                                                                                               |   | 39,205,697                                 |       | 0                                          |   |
| Repayment of repurchase agreements                                                                                                                                |   | (39,198,719                                | )          | 0                                          |   |
| Receipt of principal on notes receivable  – officers                                                                                                         |   | 0                                          |       | 931                                        |   |
| Net Cash Used in Investing Activities                                                                                                                             |   | $                                          | (3,931,845 | )                                          | $      | (42,016,932 | ) |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                                                                                          |   |                                       |       |                                       |   |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| Offering costs                                                                                                                                                    |   | $                                          | 0          |                                       | $      | (50,971 | ) |
| Increase (decrease) in accrued offering  costs                                                                                                                    |   | 0                                          |       | (590,382                                   | )      |
| Distributions paid                                                                                                                                                |   | (2,115,087                                 | )          |                                       |   |
| Net Cash (Used in) Financing Activities                                                                                                                           |   | $                                          | (2,115,087 | )                                          | $      | (641,353 | ) |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| **NET DECREASE IN CASH AND CASH EQUIVALENTS**                                                                                                                     |   | $                                          | (3,792,394 | )                                          | $      | (41,445,421 | ) |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                                                                |   | $                                          | 91,929,328 |                                       | $      | 131,824,080 |   |
|                                                                                                                                                              |   |                                       |       |                                       |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD (Note  8)**                                                                                                            |   | $                                          | 88,136,934 |                                       | $      | 90,378,659 |   |

 

SEE ACCOMPANYING NOTES.

 

9

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**GLADSTONE CAPITAL CORPORATION**

 

**FINANCIAL HIGHLIGHTS**

 

**(UNAUDITED)**

 
|                                                  |   | **Three Months  Ended December 31, 2002** |        | **Three Months  Ended December 31, 2001** |   |
|-------------------------------------------------------|--------|-------------------------------------------|-------------|-------------------------------------------|--------|
| Per Share  Data(1)                                    |   |                                      |        |                                      |   |
| Net asset value  at beginning of period               |   | $                                         | 12.97       |                                      | $      | 13.05 |   |
| Net investment income                                 |   | 0.24                                      |        | 0.12                                      |   |
| Distributions from net investment income              |   | (0.23                                     | )           | (0.18                                     | )      |
| Offering costs                                        |   | 0                                         |        | (0.01                                     | )      |
| Net asset value at end of period                      |   | $                                         | 12.98       |                                      | $      | 12.98 |   |
|                                                  |   |                                      |        |                                      |   |
| Per share market value at beginning of  period        |   | $                                         | 16.88       |                                      | $      | 16.14 |   |
| Per share market value at end of period               |   | 16.47                                     |        | 18.69                                     |   |
| Total Return(2)(3)                                    |   | -1.07                                     | %           | 16.91                                     | %      |
| Shares outstanding at end of period                   |   | 10,071,844                                |        | 10,060,178                                |   |
|                                                  |   |                                      |        |                                      |   |
| Ratios/Supplemental  Data                             |   |                                      |        |                                      |   |
| Net assets at end of period                           |   | $                                         | 130,758,904 |                                      | $      | 130,585,252 |   |
| Average net  assets                                   |   | 131,563,142                               |        | 131,219,533                               |   |
| Ratio of  operating expenses to average net assets    |   | 0.63                                      | %           | 0.38                                      | %      |
| Ratio of net  investment income to average net assets |   | 1.83                                      | %           | 0.91                                      | %      |

 

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(1)          Basic per share data.

(2)          Amounts were not annualized for the results of the three-monthperiods ended December 31, 2002 and December 31, 2001.

(3)          Total return equals the increase of the ending market value over thebeginning market value plus dividends divided by the beginning market value.

 

SEE ACCOMPANYING NOTES**.**

 

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**GLADSTONE CAPITAL CORPORATION**

 

**NOTES TO FINANCIALSTATEMENTS**

 

**DECEMBER 31, 2002**

 

**(UNAUDITED)**

 

NOTE 1. UNAUDITEDINTERIM FINANCIAL STATEMENTS

 

Interim financialstatements of Gladstone Capital Corporation (the “Company”) are prepared inaccordance with generally accepted accounting principles (“GAAP”) for interimfinancial information and pursuant to the requirements for reporting on Form10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financialstatements prepared in accordance with GAAP are omitted.  In the opinion of management, alladjustments, consisting solely of normal recurring accruals, necessary for thefair statement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-K forthe fiscal year ended September 30, 2002, as filed with the Securities andExchange Commission.

 

NOTE 2. ORGANIZATION

 

The Company wasincorporated under the General Corporation Laws of the State of Maryland on May30, 2001 as a closed-end investment company. The Company has elected to be treated as a business development company,or BDC, under the Investment Company Act of 1940, as amended (the “1940Act”).  In addition, the Company haselected to be treated for tax purposes as a regulated investment company, orRIC, under the Internal Revenue Code of 1986, as amended (the “Code”).  The Company’s investment objectives are toachieve a high level of current income by investing in debt and equitysecurities of established private businesses.

 

Gladstone Advisers,Inc., a wholly-owned subsidiary of the Company, conducts the dailyadministrative operations of the Company. The financial statements of this subsidiary are consolidated with thoseof the Company.

 

NOTE 3. EARNINGS PERSHARE

 

The following table setsforth the computation of basic and diluted earnings per share for the threemonths ended December 31, 2001 and December 31, 2002:

 
|                                                |   | **Three  Months  Ended December 31,  2002** |      | **Three  Months  Ended December 31,  2001** |   |
|-----------------------------------------------------|--------|---------------------------------------------|-----------|---------------------------------------------|--------|
|                                                |   |                                        |      |                                        |   |
| Numerator for basic and diluted earnings  per share |   | $                                           | 2,412,154 |                                        | $      | 1,196,980 |   |
|                                                |   |                                        |      |                                        |   |
| Denominator for basic weighted average  shares      |   | 10,071,844                                  |      | 10,060,178                                  |   |
|                                                |   |                                        |      |                                        |   |
| Dilutive potential shares                           |   | 52,353                                      |      | 85,852                                      |   |
|                                                |   |                                        |      |                                        |   |
| Denominator for diluted weighted average  shares    |   | 10,124,197                                  |      | 10,146,030                                  |   |
|                                                |   |                                        |      |                                        |   |
| Employee stock options                              |   | 811,664                                     |      | 811,664                                     |   |
|                                                |   |                                        |      |                                        |   |
| Basic earnings per common share                     |   | 0.24                                        |      | 0.12                                        |   |
| Diluted earnings per common share                   |   | 0.24                                        |      | 0.12                                        |   |
|                                                     |        |                                             |           |                                             |        |  |  |

 

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NOTE 4. DIVIDENDS

 

The Company is requiredto pay out as a dividend 90% of its ordinary income and short-term capitalgains for each taxable year in order to maintain its status as a RIC underSubtitle A, Chapter 1 of Subchapter M of the Code.  It is the policy of the Company to pay out as a dividend up to100% of those amounts.  The amount to bepaid out as a dividend is determined by the Board of Directors each quarter andis based on the annual earnings estimated by the management of theCompany.  Based on that estimate, adividend is declared each quarter.  Atyear-end the Company may pay a bonus dividend, in addition to the quarterlydividends, to ensure that it has paid out at least 90% of its ordinary incomeand short-term capital gains for the year. The Company has a policy of retaining long-term capital gains, if any,and not paying them out as dividends.

 

On January 15, 2002, theCompany paid a dividend of $0.18 per share on its common stock to itsstockholders of record as of December 31, 2001.  On April 8, 2002, the Company paid a dividend of $0.21 per shareon its common stock to its stockholders of record as of March 28, 2002.  On July 8, 2002, the Company paid a dividendof $0.21 per share on its common stock to its stockholders of record as of June28, 2002. On October 7, 2002, the Company paid a dividend of $0.21 per share onits common stock to its stockholders of record as of September 30, 2002.  On January 7, 2003, the Company paid adividend of $0.23 per share on its common stock to its stockholders of recordas of December 31, 2002.

 

NOTE 5. INVESTMENTVALUATION

 

The Company carries itsinvestments at fair value, as determined by its Board of Directors.  Securities that are publicly traded arevalued at the closing price on the valuation date.  Debt and equity securities that are not publicly traded arevalued at fair value as determined in good faith by the Board of Directors. Inmaking such determination, the Board of Directors values non-convertible debtsecurities at cost plus amortized original issue discount plus PIK interest, ifany, unless adverse factors lead to a determination of a lesser valuation.  In valuing convertible debt, equity, successfees or other equity like securities, the Board of Directors determines thefair value based on the collateral, the issuer’s ability to make payments, theearnings 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.

 

NOTE 6. LOAN ANDMANAGERIAL ASSISTANCE FEES

 

The 1940 Act requiresthat a business development company make available managerial assistance to itsportfolio companies.  The Companyprovides managerial assistance to its portfolio companies through itswholly-owned subsidiary, Gladstone Advisers, Inc.  The Company receives fee income for managerial assistance itrenders to portfolio companies in connection with its investments.  Such fees are normally paid at the closingof the Company’s investments and are generally non-recurring.  These managerial assistance services vary byinvestment, but generally consist of reviewing existing credit facilities,arranging bank financing, arranging equity financing, structuring financingfrom multiple lenders, structuring financing from equity investors,restructuring existing loans, raising equity and debt capital, and providinggeneral financial advice.  For the threemonths ended December 31, 2002 and December 31, 2001, these fees totaled $0 and$611,809 respectively.

 

From time to time, theCompany will be invited to participate as a co-lender in a transaction.  Where the Company does not providesignificant managerial assistance services in connection with its investment,loan fees paid to the Company in such situations will be deferred and amortizedover the life of the loan.

 

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NOTE7. PAYMENT IN KIND INTEREST

 

The Company has loans inits portfolio, which contain a payment in kind (“PIK”) provision. The PIKinterest is added to the principal balance of the loan and recorded asincome.  To maintain the Company’sstatus as a RIC (as discussed in Note 5, above), this non-cash source of incomemust be paid out to stockholders in the form of dividends, even though theCompany has not yet collected the cash. For the three months ended December 31,2002 and December 31, 2001, the Company recorded PIK income of $211,321 and $0respectively.  At December 31, 2002 andSeptember 30, 2002 the Company had accrued on its balance sheet, a total in PIKincome of $608,571 and $400,490 respectively. The Company does not have any original issue discount income.

 

NOTE 8. REPURCHASEAGREEMENT

 

A repurchase agreementinvolves the purchase by an investor, such as the Company, of a specifiedsecurity and the simultaneous agreement by the seller to repurchase it at anagreed upon future date and at a price which is greater than the purchase priceby an amount that reflects an agreed-upon interest date. Such interest rate iseffective for the period of time during which the investor’s money is investedin the arrangement and is related to current market interest rates rather thanthe coupon rate on the purchased security. The Company requires the continualmaintenance by its custodian or the correspondent in its account with theFederal Reserve/Treasury Book Entry System of underlying securities in anamount at least equal to the repurchase price. If the seller were to default onits repurchase obligation, the Company might suffer a loss to the extent thatthe proceeds from the sale of the underlying securities were less than therepurchase price. A seller’s bankruptcy could delay or prevent a sale of the underlyingsecurities.

 

On December 31, 2002,the Company entered into a Repurchase Agreement with UBS Paine Webber for$39,205,697, which agreement was settled on January 2, 2003.  The Repurchase Agreement was recorded atcost and was fully collateralized by a United States Treasury Bill with a fairvalue of $40,015,000 and a carrying value of $40,005,996 that matured onJanuary 9, 2003.  The interest rate onthe Repurchase Agreement was 1.18%.  OnSeptember 30, 2002, the Company entered into a Repurchase Agreement with UBSPaine Webber for $39,198,719, which agreement was settled on October 1,2002.  The Repurchase Agreement wasrecorded at cost and was fully collateralized by a United States Treasury Billwith a fair value of $40,004,000 and a carrying value of $39,998,799 thatmatured on October 1, 2002.  Theinterest rate on the Repurchase Agreement was 1.85%.      In the future the Company plans to use a similar form ofrepurchase agreements as an investment option or in order to satisfy certainasset diversification requirements and maintain the Company’s status as a RIC.

 

NOTE 9. DEFERREDCOMPENSATION PLAN

 

The company has adopteda deferred compensation plan (the “Plan”) effective January 1, 2002.  The Plan permits an employee to defer thelesser of  75% of his or her totalcompensation or the applicable Internal Revenue Service (“IRS”) limit.  The employees are eligible to participate inthe Plan upon completion of 1,000 hours of service within the first six monthsof employment or after one year of service. The service requirement is waived for those employees who were employedas of January 1, 2002.    The Companyhas funded $23,569 in contributions to the Plan that were recorded for thefiscal year ended September 30,2002. The Company has received a determination letter from the IRS concurringthat the deferred compensation plan satisfies the qualification requirements ofthe Code.

 

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

 

**All statements containedherein, other than historical facts, may constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended.These statements may relate to, among other things, future events or our futureperformance or financial condition. In some cases, you can identifyforward-looking statements by terminology such as “may,” “might,” “believe,”“will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,”“intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential” orthe negative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by such forward-lookingstatements. Such factors include, among others: (1) adverse changes in interestrates; (2) our failure or inability to establish or maintain referralarrangements with leveraged buyout funds and venture capital funds to generateloan opportunities; (3) the loss of one or more of our executive officers, inparticular David Gladstone or Terry Lee Brubaker; (4) our inability toestablish or maintain a credit facility on terms reasonably acceptable to us,if at all; (5) our inability to successfully securitize our loan portfolio onterms reasonably acceptable to us, if at all; (6) the decision of ourcompetitors to aggressively seek to make senior and subordinated loans to smalland medium-sized businesses on terms more favorable than we intend to provide;and (7) those factors listed under the caption “Risk Factors” of the AnnualReport on Form 10-K as filed with the Securities and Exchange Commission onDecember 11, 2002. We caution readers not to place undue reliance on any suchforward-looking statements, which are made pursuant to the Private SecuritiesLitigation Reform Act of 1995 and, as such, speak only as of the date made. Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise,after the date of this Form 10-Q**.

 

*The following analysisof our financial condition and results of operations should be read inconjunction with our financial statements and the notes thereto containedelsewhere in this report.*

 

**OVERVIEW**

 

We wereincorporated under the General Corporation Laws of the State of Maryland on May30, 2001. Our investment objectives are to achieve a high level of currentincome by investing in debt securities, consisting primarily of senior termdebts, senior subordinated term debts and junior subordinated term debts, ofestablished private businesses that are backed by leveraged buyout funds,venture capital funds or others. In some instances some of the senior termdebts may be “last out tranches” meaning our debt is part of the senior termdebt but is paid last from those payments coming to the senior term debtholders if the borrower is liquidated. We also provide first and secondmortgage debt secured by business real estate. We normally do not providerevolving lines of credit. In addition, we may acquire existing loans made byothers if those loans meet our profile. We also seek to provide ourstockholders with long-term capital growth through the appreciation in thevalue of warrants, success fees or other equity-type instruments that we mayreceive when we provide debt. We operate as a closed-end, non-diversifiedmanagement investment company, and have elected to be treated as a businessdevelopment company under the 1940 Act.

 

We seek out smalland medium-sized businesses that meet certain criteria, including (1) thepotential for growth in cash flow, (2) adequate assets for loan collateral, (3)experienced management teams with a significant ownership interest in theborrower, (4) profitable operations based on the borrower’s cash flow, (5)reasonable capitalization of the borrower (usually by leveraged buyout funds orventure capital funds) and (6) the potential to realize appreciation and gainliquidity in our equity position, if any. We anticipate that liquidity in ourequity position will be achieved through a merger or acquisition of theborrower, a public offering by the borrower or by exercise of our right torequire the borrower to buy back its warrants. We lend to borrowers that needfunds to finance growth, restructure their balance sheets or effect a change ofcontrol.

 

Our loanstypically range from $5 million to $15 million, mature in no more than sevenyears and accrue interest at a fixed or variable rate that exceeds the primerate. A number of our loans have a provision that calls for

 

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some portion of theinterest payments to be deferred and added to the principal balance so that theinterest is paid, together with the principal, at maturity. This form ofdeferred interest is often called “paid-in-kind” or “PIK” interest, and, whenearned, we record PIK interest as interest income and add the PIK interest tothe principal balance of the loans. The amount of PIK interest accrued and onour books as of December 31, 2002 was approximately $608,000.

 

Because our loanswill generally be subordinated debt of private companies who typically cannotor will not expend the resources to have their debt securities rated by acredit rating agency, we expect that most, if not all, of the debt securitieswe acquire will be unrated. We cannot accurately predict what ratings theseloans might receive if they were in fact rated, and therefore we cannotdetermine whether or not they could be considered to be “investment grade”quality.

 

To the extentpossible, our loans generally are collateralized by a security interest in theborrower’s assets. Interest payments are generally made monthly or quarterly(except to the extent of any PIK interest) with amortization of principalgenerally being deferred for several years. The principal amount of the loansand any accrued but unpaid interest generally become due at maturity at five toseven years. When we receive a warrant to purchase stock in a borrower inconnection with a loan, the warrant will typically have an exercise price equalto the fair value of the portfolio company’s common stock at the time of theloan and entitle us to purchase a modest percentage of the borrower’s stock.

 

In addition, as abusiness development company under the 1940 Act, we are required to makeavailable significant managerial assistance to our portfolio companies. Weprovide these services, for which we receive fees, through our wholly ownedsubsidiary, Gladstone Advisers, Inc. Such fees are typically paid in part atthe time a prospective portfolio company signs a non-binding term sheet withus, with the remainder paid at the closing of the investments. These fees aregenerally non-recurring, however in some instances they may have a recurringcomponent. The specific services we provide vary by portfolio company, butgenerally consist of reviewing existing credit facilities, arranging bankfinancing, arranging equity financing, structuring financing from multiplelenders, structuring financing from equity investors, restructuring existingloans, raising equity and debt capital and providing general financial advice.We record these fees as managerial assistance fee revenue in the period inwhich the fees are earned.

 

Our business plancalls for managerial assistance fee revenue to equal or exceed our operatingexpenses (excluding interest expense). However, during the quarter endedDecember 31, 2002, operating expenses (excluding interest expense) exceededmanagerial assistance fee revenue by approximately $820,000. Because wetypically generate managerial assistance fee revenue only when we make newloans, our relatively slow pace of loans during the quarter ending December 31,2002 led to this shortfall. In the future, we will need to make loans at afaster pace in order to meet this objective. However, we believe that, as theeconomic environment improves, we will be able to make sufficient newinvestments so that over time our managerial assistance fee revenue will equal orexceed our operating expenses (excluding interest expense), although there canbe no guarantee that we will be able to do so.

 

Prior to making aninvestment, we ordinarily enter into a non-binding term sheet with thepotential borrower. These non-binding term sheets are generally subject to anumber of conditions, including but not limited to the satisfactory completionof our due diligence investigations of the potential borrower’s business andreaching agreement on the legal documentation for the loan. Typically, uponexecution of the non-binding term sheet, the potential borrower pays us anon-refundable fee for our services rendered through the date of thenon-binding term sheet. Where the fee paid is non-refundable, we recognize thisfee as revenue upon execution of the non-binding term sheet.

 

In the event thatwe expend significant effort in considering and negotiating a potentialinvestment 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 arerecognized as “other income” in the quarter in which such reimbursement isreceived. Also, in the event that we have incurred significant legal fees inconnection with the transaction, we will typically also seek reimbursement forthese expenses from the proposed borrower. However, there can be no guaranteethat we will be successful in collecting any such reimbursements.

 

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The onlysignificant continuing revenue associated with the investments we have alreadyclosed is interest paid and, potentially, capital gains received in connectionwith the liquidation of any associated equity interest (e.g., warrants). Whilein some instances we may also receive on-going managerial assistance feerevenue in connection with a consummated investment, any such amounts havebeen, and in the future are expected to be, insignificant.

 

The generaleconomic climate during the fiscal year ended September 30, 2002 and the threemonths ended December 31, 2002****wasunfavorable. Many businesses saw their sales and business prospects declineduring this time. Consequently, many of these companies were forced to lay offemployees and engage in other cost cutting measures. As a result of thedifficult business climate, we determined it prudent to proceed cautiously inmaking loans during the 2002 fiscal year and in the three months ended December31, 2002. Since our initial public offering in August 2001, we have made 11****different loans to, or investments in, 8****companies for a total of approximately $93****million (including the maximum aggregateamount outstanding under an $8 million line of credit in favor of one of ourportfolio companies, that has subsequently been retired). This was below ourobjective set at the beginning of the 2002 fiscal year. In the fourth quarterof the 2002 fiscal year, one of our investments, including all amountsoutstanding under a $7 million senior term loan and an $8 million senior lineof credit, was repaid in full.

 

In spite of theeconomic environment, we are earnestly working toward the consummation of moreinvestments. These prospective loans are subject to, among other things, thesatisfactory completion of our due diligence investigation of each borrower,acceptance of terms and structure and necessary consents. With respect to eachprospective loan, we will only agree to provide the loan if, among otherthings, the results of our due diligence investigations are satisfactory, theterms and conditions of the loan are acceptable and all necessary consents arereceived. Our management has initiated its due diligence investigations of thepotential borrowers, however we can not assure you that we will not discoverfacts in the course of completing our due diligence that would render aparticular investment imprudent or that any of these loans will actually bemade.

 

**CriticalAccounting Policies**

 

Our accountingpolicies are more fully described in the footnotes to our consolidatedfinancial statements contained elsewhere in this report. As disclosed in thefootnotes to our consolidated financial statements, the preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities at the date of the financialstatements, and revenues and expenses during the period reported. Actualresults could differ from those estimates. Refer to note 2 “Summary ofSignificant Accounting Policies” in the “Notes to Financial Statements” of ourform 10-K for the fiscal year ended September 30, 2002.

 

In December 2002,the Financial Accounting Standards Board approved the issuance of FASBStatement No. 148 “Accounting for Stock-Based Compensation – Transition andDisclosure.” The statement amends FASB Statement No. 123 “Accounting forStock-Based Compensation” to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock basedemployee compensation. In addition Statement No. 148 amends the disclosurerequirements of Statement No. 123 to require more prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. This statement is effective for financial statements for fiscal yearsending and for interim periods beginning after December 15, 2002. The companyis analyzing the additional requirements of this Statement and will include therequired disclosures in its Form 10-Q for the quarter ending March 31, 2003.

 

**InvestmentValuation**

 

The mostsignificant estimate inherent in the preparation of our consolidated financialstatements is the valuation of investments and the related amounts ofunrealized appreciation and depreciation of investments recorded.

 

We value ourinvestment portfolio each quarter. Members of our portfolio management teamprepare the portfolio company valuations using the most recent portfoliocompany financial statements and forecasts. These individuals consult with themanagement of the portfolio company to obtain further updates on the portfolio

 

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company’s performance,including information such as industry trends, new product development, andother operational issues. The valuations are presented to our board of directors,which reviews and approves the portfolio valuations in accordance with ourGeneral Valuation Policy, Credit Information, Loan Grading and Risk Rating andValuation Methodology.

 

General Valuation Policy: We carry our investments atfair value, as determined by our board of directors. Securities that arepublicly traded, if any, are valued at the closing price on the valuation date.Debt and equity securities that are not publicly traded or for which we havevarious degrees of trading restrictions, are valued at fair value as determinedin good faith by our board of directors. In making the good faith determinationof the securities, we start with the cost basis of the security, which includesthe amortized original issue discount and PIK interest, if any. We then applythe methods set out below in Valuation Methods. Due to the uncertainty inherentin the valuation process, such estimates of fair value may differ significantlyfrom the values that would have been obtained had a ready market for the securitiesexisted, and the differences could be material. Additionally, changes in themarket environment and other events that may occur over the life of theinvestments may cause the gains or losses ultimately realized on theseinvestments to be different than the valuations currently assigned.  No single standard for determining fairvalue in good faith exists since fair value depends upon circumstances of eachindividual case. In general, fair value is the amount that the company mightreasonably expect to receive upon the current sale of the security.

 

Credit Information:****We monitor a wide variety of key creditstatistics that provide information regarding our portfolio companies to helpus assess credit quality and portfolio performance. We require our portfoliocompanies to provide annual audited and monthly, unaudited financialstatements. Using these statements, we calculate and evaluate the creditstatistics. For purposes of analyzing the financial performance of ourportfolio companies, we may make certain adjustments to their cash flowstatements (EBITDA) to reflect the pro forma results of a company consistentwith a change of control transaction, to reflect anticipated cost savingsresulting from a merger or restructuring, costs related to new productdevelopment, compensation to previous owners, and other acquisition orrestructuring related items.

 

Loan Grading and RiskRating:****As of December 31, 2002 weincreased the scale of our loan grading system from one that had a scale of 1to 4, to a scale that uses 0 to 10.  This system is used to estimate the probability of default on our debtsecurities and the probability of loss if there is a default.  These types of systems are referred to asrisk rating systems and are used by banks and rating agencies. We risk rateeach of our debt securities. The risk rating system covers both qualitative andquantitative aspects of the business and the securities we hold.

 

We seek to have our riskrating system mirror the risk rating systems of major risk rating organizationssuch as those provided by nationally recognized statistical ratingorganizations (“NRSRO”) as defined in Rule 2a-7 under the 1940 Act. While weseek to mirror the NRSRO systems, we cannot provide any assurance that our riskrating system provides the same risk rating as a NRSRO. The following chart isan estimate of the relationship of our risk rating system to the designationsused by two NRSROs as they risk rate debt securities of major companies.  Because we have established our system torate debt securities of companies that are unrated by any NRSRO there can be noassurance that the correlation to the NRSRO set out below is accurate. 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 BBB as the best risk rating.

 
| **Company’s System** |   | **First  NRSRO** |   | **Second  NRSRO** |   | **Gladstone  Capital’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**                    |   | Ba3              |   | 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)the default rates set here are for a ten year term debt, if the company’s debtsecurity is less than ten years then the probability of default is adjusted toa lower percentage for the shorter period which may move the security higher onthe company’s risk rating scale.*

 

At September 30, 2002,all debt investments were grade 3 under the 1-to-4 loan grading system. Therating of 3 on the 1-4 system means that the portfolio companies wereperforming as agreed and they have paid on time.  Using the expanded scale, at December 31, 2002 the average debtsecurity was risk rated 7.5 for all debt securities and the weighted averagerisk rating was 7.5 for the all debt securities. The highest rated loan was 9.0and the lowest was 6.0. The above scale gives an indication of the probabilityof default and the magnitude of the loss if there is a default using theexpanded risk rating scale.

 

Our policy is to stopaccruing interest on an investment if we determine that interest is no longercollectible. To date we have not placed any investments on non-accrual. AtSeptember 30, 2002 and December 31, 2002, no payments were past due on any ofour debt securities. We do not risk rate our equity securities.

 

Valuation Methods:**** For debt securities, we first determine ifthere is a market for the debt security. If there is a market, then we willdetermine the value based on the market prices for the security, even if thatmarket is not robust. At December 31, 2002 and September 30, 2002 there was nomarket for any of the debt securities we hold. If there is no market for thedebt securities, then we begin with the risk rating designation of the securitydescribed above.  Using the risk ratingdesignation above, we seek to determine the value of the security as if weintended to sell the security in a current sale. To determine the current saleprice of the security, we may use some or all of the following items: financialstanding of the issuer of the security, comparison of the business andfinancial plan of the issuer with actual results, the cost of the security, thesize of the security held as it relates to the liquidity of the market for suchsecurities, contractual restrictions on the disposition of the security,pending public offering of the issuer of the security, pending reorganizationactivity affecting the issuer such as mergers or debt restructuring, reportedprices of similar securities of the issuer or comparable issuers, ability ofthe issuer to obtain needed financing, changes in the economy affecting theissuer, recent purchases or sale of a security of the issuer, pricing by otherbuyers or sellers of similar securities, financial statements of the borrower,the type of security, cost at date of purchase, size of holding, discount frommarket value of unrestricted securities of the same class at the time ofpurchase, special reports prepared by analysts, information as to anytransactions or offers with respect to the security, existence of mergerproposals or tender offers affecting the securities, the collateral, theissuer’s ability to make payments, the current and forecasted earnings of theissuer, sales to third parties of similar securities, statistical ratioscompared to lending standards, statistical ratios compared to other similarsecurities and other pertinent factors.

 

For equity securities, we first determine if there is any market forthe equity security. If there is a market, then we determine the value based onthe market prices for the security, even if that market is not robust. AtDecember 31, 2002 and September 30, 2002 there was no market for any of theequity securities we owned. If there is no market for the equity securities,then we use the same information we would use for a debt security valuationdescribed above, as well as standard valuation techniques used by majorvaluation firms to value the equity securities of private companies. Thesevaluation techniques consist of: discounted cash flow of the expected salesprice in the future, the value of the securities based on the recent sale ofcomparable transactions and a review of similar companies that are publiclytraded and the market multiple of their equity securities. At December 31, 2002we had $37,000 invested in equity securities compared to our debt portfolio of$83,789,434.

 

Our new risk ratingsystem is more detailed than our prior system. Due to the more detailed natureof the risk rating system there is the likelihood that future valuations willchange more frequently.

 

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**ManagerialAssistance Fees**

 

The 1940 Actrequires that a business development company make available managerialassistance to its portfolio companies. We provide managerial assistance to ourportfolio companies in connection with our investments through our wholly ownedsubsidiary, Gladstone Advisers, Inc. and receive fees for our managerialassistance services. These fees are normally paid at the closing of ourinvestments in our portfolio companies, are generally non-recurring and arerecognized as revenue when earned. The managerial assistance services weprovide vary by investment, but generally consist of reviewing existing creditfacilities, arranging bank financing, arranging equity financing, structuring financingfrom multiple lenders, structuring financing from equity investors,restructuring existing loans, raising equity and debt capital, and providinggeneral financial advice. From time to time, we are invited to participate as aco-lender in a transaction. In the event that we do not provide significantmanagerial assistance services in connection with our investment, loan feespaid to us in such situations are deferred and amortized over the life of theloan.

 

**RESULTS OF OPERATIONS**

 

*Comparison of the threemonths ended December 31, 2002 to the three months ended December 31, 2001*

 

**Investment Income**

 

Investment incomefor the three months ended December 31, 2002 was approximately $3.2 million ascompared to $1.7 million for the three months ended December 31, 2001. Thisincrease was primarily a result of increased interest income from investments.

 

Interest incomefrom our investments in debt securities of private companies was approximately$2.9 million for the three months ended December 31, 2002 as compared to$329,000 for the three months ended December 31, 2001. This increase****wasprimarily a result of the increase in new investments of $41.8 million.

 

The weightedaverage yield on our portfolio for the three months ended December 31, 2002 was13.36% (without giving effect to PIK interest) and 14.30% (after giving effectto PIK interest). The weighted average yield for the three months endedDecember 31, 2001 was 12.51%. There was no PIK interest recorded for the threemonths ended December 31, 2001. The weighted average portfolio outstandingincluding PIK for the fourth quarter was $81,863,584.

 

Interest incomefrom invested cash and cash equivalents for the three months ended December 31,2002 was approximately $198,000, as compared to $640,000 for the three monthsended December 31, 2001. This decrease****wasprimarily a result of the $41.8 million of new investments made betweenDecember 31, 2001 and December 31, 2002.

 

For the threemonths ended December 31, 2002, we recorded approximately $109,000 in interestincome from loans to our employees in connection with the exercise of employeestock options, as compared to approximately $107,000 in interest income fromsuch loans for the three months ended December 31, 2001. This increase****was primarily a result of $186,000 in newemployee loans.

 

Managerialassistance fees were $0 for the three months ended December 31, 2002, ascompared to $611,809 for the three months ended December 31, 2001. This decrease****wasthe result of no new investment closings during the quarter with related fees.

 

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**Operating Expenses**

 

Operating expensesfor the three months ended December 31, 2002 were approximately $823,000, ascompared to approximately $492,000 for the three months ended December 31,2001. This increase****was primarilya result of six new employees, new office space and operating expenses relatedto the increase in staff and overall operations.

 

Salaries andbenefits for the three months ended December 31, 2002 were approximately$433,000, as compared to approximately $277,000 for the three months endedDecember 31, 2001. This increase****wasa result of the hiring of six new employees.

 

General andadministrative expenses, consisting primarily of insurance, office operations,travel and stockholder related expenses for the three months ended December 31,2002 were approximately $183,000, as compared to approximately $101,000 for thethree months ended December 31, 2001. This increase****was primarily a result of the related expenses to newemployees and increased operations.

 

Professional fees,consisting primarily of legal and audit fees, for the three months endedDecember 31, 2002 were approximately $115,000, as compared to approximately$101,000 for the three months ended December 31, 2001. This increase****wasprimarily a result of an increase in audit fees associated with moreinvestments.

 

Rent expense forthe three months ended December 31, 2002 was approximately $55,000, as comparedto approximately $11,000 for the three months ended December 31, 2001. Thisincrease****was primarily a result ofnew office space acquired in September 2002.

 

Directors’ feesfor the three months ended December 31, 2002 were approximately $13,500, ascompared to approximately $2,000 for the three months ended December 31, 2001.This increase****was primarily aresult of the accounting for the annual directors fee pro rated over the 2003fiscal year.

 

We believe thatour current level of operating expenses is not necessarily indicative of ourfuture operating expenses. We estimate that over time, as we continue to morefully deploy the proceeds of our initial public offering, our operatingexpenses will be approximately two percent of our net assets.

 

**Net Investment Income**

 

As a result of theinvestment income and operating expenses described above, we had net investmentincome of approximately $2.4 million for the three months ended December 31,2002.  Based on a weighted-average of10,071,844 (basic) and 10,124,197 (diluted) shares outstanding, our netinvestment income per common share for the three months ended December 31, 2002was $0.24 (basic) and $0.24 (diluted).

 

For the three months ended December 31, 2001, we had net investment income ofapproximately $1.2 million.  Based on aweighted-average of 10,060,178 (basic) and 10,146,030 (diluted) sharesoutstanding, our net investment income per common share for the three monthsended December 31, 2001 was $0.12 (basic) and $0.12 (diluted).

 

Unrealizedappreciation and depreciation did not occur for the quarters ending December31, 2001 and 2002. However, we expect that for the quarter ending March 31,2003 there will be changes in the unrealized appreciation and depreciation aswe become better at using our more detailed risk rating system. There were norealized gains or losses for the quarters ending December 31, 2001 or 2002.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

At December 31, 2002, we had investments in debtsecurities of, or loans to, 7 private companies, totaling approximately $83.8million of total investment assets. This number includes approximately $608,000in accrued PIK interest, which as described in “Overview,” is added to thecarrying value of our investments.

 

In January 2003,we closed a $5.5 million investment in Wing Stop Restaurants International,Inc., a franchiser of fast food chicken restaurants. The investment consistedof a loan with added income from a success fee

 

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if the business is successful. In February 2003 we closed in escrow,a loan for $12 million and believe the escrow will be released and the loanwill be funded in March 2003.

 

The followingtable summarizes the contractual principal amortization and maturity of ourinvestment portfolio by fiscal year:

 
| **Year**   |   | **Amount** |       |
|------------|--------|------------|------------|
| 2003       |   | $          | 1,475,000  |   |
| 2004       |   | $          | 10,494,368 |   |
| 2005       |   | $          | 11,539,497 |   |
| 2006       |   | $          | 15,957,000 |   |
| 2007       |   | $          | 27,260,569 |   |
| Thereafter |   | $          | 17,100,000 |   |
| Total      |   | $          | 83,826,434 |   |

 

Cash provided byoperating activities for the three months ended December 31, 2002, consisting primarilyof the items described in “Results of Operations,” was approximately $2.2million. Net cash used in investing activities was approximately $3.9 millionduring the three months ended December 31, 2002. The net cash used consisted ofinvestments in our portfolio companies of $4,000,000, partially offset therepayment, by our portfolio companies, of investments in principal amount of$100,000.****Net cash used infinancing activities was approximately $2.1 million for the three months endedDecember 31, 2002 and consisted of the payment of dividends.

 

During the threemonths ended December 31, 2002, cash and cash equivalents decreased fromapproximately $91.9 million at the beginning of the period to approximately$88.1 million at the end of the period. This decrease of approximately $3.8million was largely the result of our new $4.0 million investment.

 

On December 31,2002, we entered into a repurchase agreement with UBS Paine Webber forapproximately $40.0 million. The repurchase agreement was fully collateralizedby a United States treasury bill with a fair value of approximately $40.0million that matured on January 9, 2003. The interest rate on the repurchaseagreement was 1.18%. This repurchase agreement was reflected on our balancesheet as of December 31, 2002 as an increase in cash and cash equivalentspledged to creditors of $40.0 million, along with a corresponding liability forapproximately the same amount. The repurchase agreement was settled on January2, 2003. In the future, we plan to use a similar form of repurchase agreementas an investment option or in order to satisfy certain asset diversificationrequirements and maintain our status as a RIC.

 

In order toqualify as a regulated investment company and to avoid corporate level tax onthe income we distribute to our stockholders, we are required, under SubchapterM of the Code, to distribute at least 90% of our ordinary income and short-termcapital gains to our stockholders on an annual basis. In accordance with theserequirements, we declared and paid quarterly cash dividends of $0.23 for thequarter ended December 31, 2002.

 

We anticipateborrowing funds and issuing additional equity securities to obtain additionalcapital once the proceeds of our initial public offering have been fullyinvested. To this end, we have filed with the Securities and ExchangeCommission (“SEC”) a registration statement that would permit us to issue,through one or more transactions, up to an aggregate of $75 million in oursecurities, which may consist of shares of our common stock, preferred stock,or debt securities. We may not issue any such securities until the SEC hasdeclared the registration statement effective, and we currently have noimmediate plans to issue any securities under the registration statement.

 

In addition toborrowing funds and issuing additional securities, we also intend to pursue astrategy of securitizing our loan portfolio in approximately one to two years.We may use the cash we receive upon the sale of

 

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interests in our loans torepay bank borrowings and make additional loans. We can not assure you thatthis securitization strategy will be successful.

 

**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

We are subject tofinancial market risks, including changes in interest rates.  We expect that ultimately approximately 50%of the loans in our portfolio will be made at fixed rates, with approximately50% made at variable rates; however, to date all of our loans have been made atfixed rates.

 

We expect toborrow funds to finance future lending activities after we have substantiallyfully invested the proceeds of our initial public offering.  These future borrowings may be at fixedrates or variable rates. To date, we have not borrowed any funds.

 

We expect to hedgeagainst interest rate fluctuations in the future by using standard hedginginstruments such as futures, options and forward contracts.  While hedging activities may insulate usagainst adverse fluctuations in interest rates, they may also limit our abilityto participate in the benefits of lower interest rates with respect to ourportfolio of investments.

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

(a)          Evaluationof disclosure controls and procedures.

 

Within the 90 daysprior to the filing date of this quarterly report on Form 10-Q, we carried outan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures. This evaluation was carried out under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer. Based upon that evaluation,our Chief Executive Officer and our Chief Financial Officer have concluded thatour disclosure controls and procedures are adequate and effective.

 

Disclosurecontrols and procedures are controls and other procedures that are designed toensure that information required to be disclosed in our reports filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC’s rules and forms.Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed in ourreports filed under the Exchange Act is accumulated and communicated tomanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

 

(b)         Changes ininternal controls.

 

There have been nosignificant changes, including corrective actions with regard to significantdeficiencies or material weaknesses, in our internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate we carried out the evaluation discussed in paragraph (a) above.

 

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**PART II–OTHER INFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS.**

 

Neither the Company nor its subsidiary iscurrently subject to any material legal proceeding, nor, to the Company’sknowledge, is any material legal proceeding threatened against the Company orits subsidiary.

 

**ITEM 2. CHANGES IN SECURITIES AND USE OFPROCEEDS.**

 

Not applicable.

 

**ITEM 3. DEFAULTS UPONSENIOR SECURITIES.**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM 5. OTHER INFORMATION.**

 

On January 3, 2003, Paul Adelgren wasappointed director, to serve until the 2004 annual meeting of stockholders ofthe Company.

 

**ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

**(a)****                                 ****EXHIBITS**

 

See the exhibit index on page 27.

 

**(b)****                                 ****REPORTS ON FORM 8-K**

 

On December 20, 2002, the Company filed anItem 4 Form 8-K in connection with its change of independent auditors.

 

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**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|   | **GLADSTONE CAPITAL  CORPORATION**    |
|--------|---------------------------------------|
|   |                                  |
|   | By:                                   | /s/ HARRY BRILL |   |
|   |                                  |
|   | Harry Brill                           |
|   | Chief Financial Officer and Treasurer |

 

Date: February 10, 2003

 

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**CERTIFICATIONS**

 

I, DavidGladstone, certify that:

 

1.  I have reviewed this quarterly report onForm 10-Q of Gladstone Capital Corporation;

 

2.  Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.  The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented inthis quarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officerand I have indicated in this quarterly report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies and materialweaknesses.

 

Date: February 10, 2003

 
| /s/  DAVID GLADSTONE           |   |
|-------------------------------------|--------|
|  David Gladstone               |   |
| Chief Executive Officer  and        |   |
| Chairman of the Board  of Directors |   |

 

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I, Harry Brill,certify that:

 

1.  I have reviewed this quarterly report onForm 10-Q of Gladstone Capital Corporation;

 

2.  Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this annual report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.  The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented inthis quarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officerand I have indicated in this quarterly report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Date: February 10, 2003

 
| /s/  HARRY BRILL                  |   |
|----------------------------------------|--------|
| Harry Brill                            |   |
| Chief Financial  Officer and Treasurer |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit** |   | **Description**                                                                                                                                                                                                                           |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                      |
| 3.1         |   | Articles of Amendment and Restatement of the Articles of  Incorporation, incorporated by reference to Exhibit a.2 to Pre-Effective  Amendment No. 1 to the Registration Statement on Form N-2 (File No.  333-63700), filed July 27, 2001. |
|        |   |                                                                                                                                                                                                                                      |
| 3.2         |   | By-laws, incorporated by reference to Exhibit b to Pre-Effective  Amendment No. 1 to the Registration Statement on Form N-2 (File No.  333-63700), filed July 27, 2001.                                                                   |
|        |   |                                                                                                                                                                                                                                      |
| 11          |   | Computation of Per Share Earnings (included in the notes to the  unaudited financial statements contained in this report).                                                                                                                |
|        |   |                                                                                                                                                                                                                                      |
| 99.1        |   | Certification.                                                                                                                                                                                                                            |

 

All other exhibits for which provision ismade in the applicable regulations of the Securities and Exchange Commissionare not required under the related instruction or are inapplicable andtherefore have been omitted.

 

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