**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **ý****QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|--------------------------------------------------------------------------------------------------------------|
|                                                                                                         |
| **FOR THE QUARTER ENDED JUNE 30, 2004**                                                                 |
|                                                                                                         |
| **o****TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**     |

 

**COMMISSION FILE NUMBER: 814-00237**

 

**GLADSTONE CAPITAL CORPORATION**

(Exact name of registrant as specified in its 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 checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months and (2) has been subject to such filing requirements forthe past 90 days. Yes ý No o.

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12 b-2of the Exchange Act).

Yes o No ý.

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.  Thenumber of shares of the issuer’s Common Stock, $0.001 par value, outstanding asof August 10, 2004 was 10,113,444.

 

 

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**GLADSTONE CAPITAL CORPORATION**

**TABLE OF CONTENTS**

 
| PART I.    | FINANCIAL  INFORMATION                                                                                       |   |
|------------|--------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                         |   |
| Item 1.    | Financial  Statements (Unaudited)                                                                            |   |
|       |                                                                                                         |   |
|       | Consolidated Balance Sheets  as of June 30, 2004 and September 30, 2003                            |   |
|       | Schedules  of Investments as of June 30, 2004 and September 30, 2003                               |   |
|       | Consolidated  Statements of Operations for the three months ended June 30, 2004 and  June 30, 2003 |   |
|       | Consolidated  Statements of Operations for the nine months ended June 30, 2004 and  June 30, 2003  |   |
|       | Consolidated  Statement of Stockholders’ Equity for the nine months ended June 30,  2004           |   |
|       | Consolidated  Statements of Cash Flows for the nine months ended June 30, 2004 and  June 30, 2003  |   |
|       | Financial  Highlights for the three and nine months ended June 30, 2004 and  June 30, 2003         |   |
|       | 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, Use of  Proceeds, and Issuer Purchases of Equity Securities                           |   |
|       |                                                                                                         |   |
| 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 |                                                                                                         |

 

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**PART I—FINANCIALINFORMATION**

 

**Gladstone Capital Corporation**

 

**Consolidated Financial Statements**

 

**(Unaudited)**

 

**June 30, 2004**

 

**CONTENTS**

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

 

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED BALANCESHEETS**

**(Unaudited)**

 
| ** **                                                                                                                               | ** ** | **June 30,  2004** | ** **  | **September 30,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|------------------------------|------------|
|                                                                                                                                     |       |                    |        |                         |       |
| ASSETS                                                                                                                                   |       |                    |        |                         |       |
| Investments at fair value (Cost 6/30/2004:  $158,318,500; 9/30/2003: $109,529,893)                                                       |       | $                       | 157,247,029 |                         | $          | 109,307,553 |   |
| Cash and cash equivalents                                                                                                                |       | 4,895,459               |        | 21,143,972                   |       |
| Cash and cash equivalents pledged to creditors                                                                                           |       | 55,006,917              |        | 80,022,249                   |       |
| Interest receivable – investments in debt securities                                                                                |       | 789,623                 |        | 1,041,943                    |       |
| Interest receivable – cash and cash equivalents                                                                                     |       | 170                     |        | 955                          |       |
| Interest receivable – officers                                                                                                      |       | 22,868                  |        | 108,657                      |       |
| Due from custodian                                                                                                                       |       | 627,672                 |        | 1,207,000                    |       |
| Prepaid assets                                                                                                                           |       | 1,512,345               |        | 1,479,815                    |       |
| Other assets                                                                                                                             |       | 431,715                 |        | 254,519                      |       |
|                                                                                                                                     |       |                    |        |                         |       |
| TOTAL ASSETS                                                                                                                             |       | $                       | 220,533,798 |                         | $          | 214,566,663 |   |
|                                                                                                                                     |       |                    |        |                         |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                |       |                    |        |                         |       |
|                                                                                                                                     |       |                    |        |                         |       |
| LIABILITIES                                                                                                                              |       |                    |        |                         |       |
| Accounts payable                                                                                                                         |       | $                       | 146,132     |                         | $          | 23,247 |   |
| Dividends payable                                                                                                                        |       | —                  |        | 3,327,009                    |       |
| Borrowings under lines of credit                                                                                                         |       | 33,520,666              |        | —                       |       |
| Accrued expenses and deferred liabilities                                                                                                |       | 2,289,829               |        | 1,965,025                    |       |
| Repurchase agreement                                                                                                                     |       | 53,908,596              |        | 78,449,000                   |       |
|                                                                                                                                     |       |                    |        |                         |       |
| Total Liabilities                                                                                                                        |       | $                       | 89,865,223  |                         | $          | 83,764,281 |   |
|                                                                                                                                     |       |                    |        |                         |       |
| STOCKHOLDERS’ EQUITY                                                                                                                |       |                    |        |                         |       |
| Common stock, $0.001 par value, 50,000,000 shares  authorized and 10,113,444 and 10,081,844 shares issued and outstanding,  respectively |       | $                       | 10,114      |                         | $          | 10,082 |   |
| Capital in excess of par value                                                                                                           |       | 140,852,913             |        | 140,416,674                  |       |
| Notes receivable – officers                                                                                                         |       | (9,232,698              | )           | (8,985,940                   | )          |
| Net unrealized depreciation on investments                                                                                               |       | (1,071,472              | )           | (222,340                     | )          |
| Undistributed/(overdistributed) net investment  income                                                                                   |       | 109,718                 |        | (416,094                     | )          |
|                                                                                                                                     |       |                    |        |                         |       |
| Total Stockholders’ Equity                                                                                                          |       | $                       | 130,668,575 |                         | $          | 130,802,382 |   |
|                                                                                                                                     |       |                    |        |                         |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                          |       | $                       | 220,533,798 |                         | $          | 214,566,663 |   |

 

SEE ACCOMPANYINGNOTES.

 

1

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**GLADSTONE CAPITAL CORPORATION**

**SCHEDULE OFINVESTMENTS**

**AS OF JUNE 30, 2004**

**(UNAUDITED)**

 
| **Company  (1)**                                  | ** ** | **Industry**                                                          | ** ** | **Investment**                                                                | ** ** | **Cost**                         | ** **      | **Fair Value**                  | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------|-----------------|---------------------------------|------------|
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| A and G, Inc.  (d/b/a Alstyle)                    |       | Activewear products                                                   |       | Senior Term Debt (2)                                                          |       | $                                | 12,250,000      |                            | $          | 12,250,000 |   |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| America’s Water Heater Rentals               |       | Household appliances  rental                                          |       | Senior Term Debt (3)  (5) (7)                                                 |       | 12,000,000                       |            | 12,720,000                      |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| ARI Holdings, Inc.                                |       | Manufacturing-auto  parts                                             |       | Senior Term Debt (5)  Second Lien Term Debt (5)                               |       | 1,283,891  3,620,033             |            | 1,277,472  3,570,257            |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Bear Creek Corporation                            |       | Premium horticultural  and food products                              |       | Second Lien Term Debt  (6)                                                    |       | 6,000,000                        |            | 6,090,000                       |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Benetech, Inc.                                    |       | Dust management systems  for the coal and electric utility industries |       | Senior Term Debt  Senior Term Debt (2)                                        |       | 3,250,000

3,250,000             |            | 3,250,000

3,250,000            |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Burt’s Bees, Inc.                            |       | Personal &  household products                                    |       | Senior Term Debt (6)                                                          |       | 983,333                          |            | 995,625                         |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Coyne International Enterprises                   |       | Industrial services                                                   |       | Senior Term Debt (2)  (4) (5)                                                 |       | 15,658,088                       |            | 15,501,507                      |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Finn Corporation                                  |       | Manufacturing-landscape  equipment                                    |       | Senior Subordinated  Term Debt (5)                                            |       | 10,500,000                       |            | 9,240,000                       |       |
|                                              |       |                                                                  |       | Common Stock Warrants                                                         |       | 37,000                           |            | 492,284                         |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Fugate and Associates,  Inc.  (d/b/a ERS Imaging) |       | Aggregator &  Reseller - Printer Cartridges, etc.                 |       | Senior Term Debt (5)  Senior Term Debt (2) (5)                                |       | 1,333,332  3,150,000             |            | 1,329,999  3,134,250            |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Gammill, Inc.                                     |       | Designer and assembler  of quilting machines and accessories          |       | Senior Term Debt (5)  Senior Term Debt (2) (5)                                |       | 4,835,256

4,750,000             |            | 4,853,388

4,767,813            |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Inca Metal Products Corporation                   |       | Material handling and  storage products                               |       | Senior Term Debt (2)  (5)                                                     |       | 2,446,733                        |            | 2,189,826                       |       |
| Kingway Acquistion, Inc.                          |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Clymer Acquistion, Inc.                           |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Maidenform, Inc.                                  |       | Intimate apparel                                                      |       | Second Lien Term Debt  (6)                                                    |       | 10,003,705                       |            | 10,012,500                      |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Marcal Paper Mills, Inc.                          |       | Manufacturing-paper  products                                         |       | Senior Subordinated  Term Debt (5)                                            |       | 6,800,000                        |            | 6,205,000                       |       |
|                                              |       |                                                                  |       | First Mortgage Loan                                                           |       | 9,231,598                        |            | 9,231,598                       |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| MD Beauty, Inc.                                   |       | Cosmetic and skin care  products                                      |       | Second Lien Term Debt                                                         |       | 8,000,000                        |            | 8,000,000                       |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| MedAssets, Inc.                                   |       | Pharmaceuticals and  healthcare GPO                                   |       | Senior Term Debt (6)                                                          |       | 1,938,015                        |            | 1,933,392                       |       |
|                                              |       |                                                                  |       | Second Lien Term Debt  (6)                                                    |       | 6,503,516                        |            | 6,565,000                       |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Mistras Holdings Corp.                            |       | Nondestructive testing  instruments, systems and services             |       | Senior Term Debt (2)  (5)  Senior Term Debt (2) (5)  Senior Term Debt (2) (5) |       | 10,000,000  5,000,000  1,000,000 |            | 9,925,000  4,950,000  1,000,000 |       |
|                                              |       |                                                                  |       |                                                                          |       |                             |            |                            |       |
| Woven Electronics Corporation                     |       | Custom electrical cable  assemblies                                   |       | Senior Term Debt (2)  (5)                                                     |       | 2,494,000                        |            | 2,497,118                       |       |
|                                              |       |                                                                  |       | Senior Term Debt (3)  (5)                                                     |       | 12,000,000                       |            | 12,015,000                      |       |
| **Total:**                                        | ** ** | ** **                                                            | ** ** | ** **                                                                    | ** ** | **$**                            | **158,318,500** | ** **                      | **$**      | **157,247,029** | ** ** |

 

2

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----

(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 is liquidatedthen the holder of the Last Out Tranche is paid after the senior debt.

(3) Last Out Tranche of senior debt, meaning if the company isliquidated then the holder of the Last Out Tranche is paid after the seniordebt, however the debt is junior to another Last Out Tranche.

(4) Has some paid in kind (PIK) interest.  Refer to Note 2 “Summary of SignificantAccounting Policies” of Form 10-K for the fiscal year ended September 30,2003.

(5) Fair value was based on valuation prepared and provided byStandard & Poor’s Loan Evaluation Services.

(6) Marketable securities are valued based on the bid price, as ofJune 30, 2004, from the respective originating syndication agent’s tradingdesk.

(7) Includes a success fee with a fair value of $600,000 and nocost basis.

 

SEE ACCOMPANYINGNOTES.

 

3

----

 

**GLADSTONE CAPITAL CORPORATION**

**SCHEDULE OF INVESTMENTS**

**AS OF SEPTEMBER 30, 2003**

 
| **Company  (1)**                                  | ** ** | **Industry**                                              | ** ** | **Investment**                                       | ** ** | **Cost**              | ** **      | **Fair Value**        | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------|-----------------|-----------------------|------------|
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| America’s Water Heater Rentals               |       | Household appliances  rental                              |       | Senior Term Debt (2)  (4)                            |       | 12,000,000            |            | 12,000,000            |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| ARI Holdings, Inc.                                |       | Manufacturing-auto  parts                                 |       | Senior Term Debt (2)  (3)  Second Lien Term Debt (2) |       | 3,511,667  1,500,000  |            | 3,511,667  1,500,000  |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Coyne International Enterprises                   |       | Industrial services                                       |       | Senior Term Debt (2)  (3) (4)                        |       | 15,421,740            |            | 15,306,077            |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Finn Corporation                                  |       | Manufacturing-landscape  equipment                        |       | Senior Subordinated  Term Debt (4)                   |       | 10,500,000            |            | 10,421,250            |       |
|                                              |       |                                                      |       | Common Stock Warrants                                |       | 37,000                |            | 431,111               |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Fugate and Associates,  Inc.  (d/b/a ERS Imaging) |       | Aggregator &  Reseller -Printer Cartridges, etc.      |       | Senior Term Debt (4)  Senior Term Debt (4)           |       | 3,412,500  1,833,333  |            | 3,412,500  1,833,333  |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Home Care Supply, Inc.                            |       | Medical equipment  rental                                 |       | Senior Term Debt (2)  (4) (5)                        |       | 18,000,000            |            | 18,428,400            |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Inca Metal Products  Corporation                  |       | Material handling and  storage products                   |       | Senior Term Debt (2)  (4)                            |       | 5,775,000             |            | 4,995,375             |       |
| Kingway Acquistion, Inc.                          |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Clymer Acquistion, Inc.                           |       |                                                      |       |                                                 |       |                  |            |                  |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Kozy Shack Enterprises, Inc.                      |       | Food production and  sales                                |       | Senior Term Debt (2)  (4)                            |       | 900,000               |            | 909,000               |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Marcal Paper Mills, Inc.                          |       | Manufacturing-paper  products                             |       | Senior Term Debt (2)  (4)                            |       | 6,975,000             |            | 6,922,687             |       |
|                                              |       |                                                      |       | First Mortgage Debt (3)                              |       | 9,163,653             |            | 9,163,653             |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Mistras Holdings Corp.                            |       | Nondestructive testing  instruments, systems and services |       | Senior Term Debt (2)  Senior Term Debt (2)           |       | 10,000,000  5,000,000 |            | 10,000,000  5,000,000 |       |
|                                              |       |                                                      |       |                                                 |       |                  |            |                  |       |
| Wingstop Restaurants International, Inc.          |       | Restaurant - fast food                                    |       | Senior Term Debt (4)                                 |       | 3,500,000             |            | 3,482,500             |       |
|                                              |       |                                                      |       | Senior Debt (4)                                      |       | 2,000,000             |            | 1,990,000             |       |
| **Total:**                                        | ** ** | ** **                                                | ** ** | ** **                                           | ** ** | **$**                 | **109,529,893** | ** **            | **$**      | **109,307,553** | ** ** |
|                                                   |            |                                                           |            |                                                      |            |                       |                 |                       |            |  |  |

 

----

(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 “Summary of SignificantAccounting Policies” of Form 10-K for the fiscal year ended September 30,2003.

(4) Fair value was based on valuation prepared and provided byStandard & Poor’s Loan Evaluation Services.

(5) Includes a success fee with a fair value of $473,400 and nocost basis.

 

SEE ACCOMPANYINGNOTES.

 

4

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENT OF OPERATIONS**

 

**(UNAUDITED)**

 
| ** **                                                                             | ** ** | **Three Months Ended  June 30, 2004** | ** ** | **Three Months Ended  June 30, 2003** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| INVESTMENT INCOME                                                                      |       |                                       |       |                                       |       |
| Interest income – investments                                                     |       | $                                          | 5,700,139  |                                       | $          | 3,684,284 |   |
| Interest income – cash and cash equivalents                                       |       | 15,268                                     |       | 79,073                                     |       |
| Interest income – notes receivable from officers                                  |       | 112,528                                    |       | 109,737                                    |       |
| Managerial assistance fees                                                             |       | 399,375                                    |       | 125,000                                    |       |
| Other income                                                                           |       | 482,500                                    |       | 61,650                                     |       |
| Total investment income                                                                |       | 6,709,810                                  |       | 4,059,744                                  |       |
|                                                                                   |       |                                       |       |                                       |       |
| EXPENSES                                                                               |       |                                       |       |                                       |       |
| Salaries and benefits                                                                  |       | 1,253,073                                  |       | 493,901                                    |       |
| Rent                                                                                   |       | 34,873                                     |       | 54,899                                     |       |
| Professional fees                                                                      |       | 59,279                                     |       | 101,211                                    |       |
| Directors fees                                                                         |       | 28,000                                     |       | 20,290                                     |       |
| Insurance                                                                              |       | 63,369                                     |       | 71,883                                     |       |
| Stockholder related costs                                                              |       | 10,643                                     |       | 12,227                                     |       |
| Financing fees                                                                         |       | 185,855                                    |       | 62,355                                     |       |
| Interest                                                                               |       | 133,735                                    |       | —                                     |       |
| Loss on derivative                                                                     |       | 114,376                                    |       | —                                     |       |
| General and administrative                                                             |       | 230,619                                    |       | 127,242                                    |       |
| Total expenses                                                                         |       | 2,113,822                                  |       | 944,008                                    |       |
|                                                                                   |       |                                       |       |                                       |       |
| NET INVESTMENT INCOME                                                                  |       | 4,595,988                                  |       | 3,115,736                                  |       |
|                                                                                   |       |                                       |       |                                       |       |
| Net unrealized appreciation (depreciation) on  investments                             |       | 1,013,905                                  |       | (744,837                                   | )          |
|                                                                                   |       |                                       |       |                                       |       |
| NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM  OPERATIONS                   |       | $                                          | 5,609,893  |                                       | $          | 2,370,899 |   |
|                                                                                   |       |                                       |       |                                       |       |
| NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM  OPERATIONS PER COMMON SHARE: |       |                                       |       |                                       |       |
| Basic                                                                                  |       | $                                          | 0.56       |                                       | $          | 0.24 |   |
| Diluted                                                                                |       | $                                          | 0.54       |                                       | $          | 0.23 |   |
|                                                                                   |       |                                       |       |                                       |       |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                                   |       |                                       |       |                                       |       |
| Basic                                                                                  |       | 10,105,270                                 |       | 10,071,844                                 |       |
| Diluted                                                                                |       | 10,301,390                                 |       | 10,256,790                                 |       |

 

SEE ACCOMPANYINGNOTES.

 

5

----

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATED STATEMENT OF OPERATIONS**

 

**(UNAUDITED)**

 
| ** **                                                                             | ** ** | ** **

**Nine  Months Ended****June 30, 2004** | ** ** | **Nine Months Ended  June 30, 2003** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|
| INVESTMENT INCOME                                                                      |       |                                                     |       |                                      |       |
| Interest income – investments                                                     |       | $                                                        | 13,118,652 |                                      | $          | 9,887,909 |   |
| Interest income – cash and cash equivalents                                       |       | 81,223                                                   |       | 390,577                                   |       |
| Interest income – notes receivable from officers                                  |       | 330,698                                                  |       | 329,078                                   |       |
| Managerial assistance fees                                                             |       | 1,010,606                                                |       | 483,000                                   |       |
| Other income                                                                           |       | 504,500                                                  |       | 63,906                                    |       |
| Total investment income                                                                |       | 15,045,679                                               |       | 11,154,470                                |       |
|                                                                                   |       |                                                     |       |                                      |       |
| EXPENSES                                                                               |       |                                                     |       |                                      |       |
| Salaries and benefits                                                                  |       | 2,063,549                                                |       | 1,405,002                                 |       |
| Rent                                                                                   |       | 106,597                                                  |       | 164,044                                   |       |
| Professional fees                                                                      |       | 519,229                                                  |       | 302,478                                   |       |
| Directors fees                                                                         |       | 85,210                                                   |       | 54,647                                    |       |
| Insurance                                                                              |       | 200,654                                                  |       | 216,724                                   |       |
| Stockholder related costs                                                              |       | 130,623                                                  |       | 123,659                                   |       |
| Financing fees                                                                         |       | 479,890                                                  |       | 62,355                                    |       |
| Interest                                                                               |       | 158,337                                                  |       | —                                    |       |
| Loss on derivative                                                                     |       | 114,376                                                  |       | —                                    |       |
| General and administrative                                                             |       | 531,032                                                  |       | 378,079                                   |       |
| Total expenses                                                                         |       | 4,389,497                                                |       | 2,706,988                                 |       |
|                                                                                   |       |                                                     |       |                                      |       |
| NET INVESTMENT INCOME                                                                  |       | 10,656,182                                               |       | 8,447,482                                 |       |
|                                                                                   |       |                                                     |       |                                      |       |
| Realized gain on sale of investment                                                    |       | 12,500                                                   |       | —                                    |       |
|                                                                                   |       |                                                     |       |                                      |       |
| Net unrealized depreciation on investments                                             |       | (849,132                                                 | )          | (2,413                                    | )          |
|                                                                                   |       |                                                     |       |                                      |       |
| NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM  OPERATIONS                   |       | $                                                        | 9,819,550  |                                      | $          | 8,445,069 |   |
|                                                                                   |       |                                                     |       |                                      |       |
| NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM  OPERATIONS PER COMMON SHARE: |       |                                                     |       |                                      |       |
| Basic                                                                                  |       | $                                                        | 0.97       |                                      | $          | 0.84 |   |
| Diluted                                                                                |       | $                                                        | 0.95       |                                      | $          | 0.83 |   |
|                                                                                   |       |                                                     |       |                                      |       |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                                   |       |                                                     |       |                                      |       |
| Basic                                                                                  |       | 10,091,576                                               |       | 10,071,844                                |       |
| Diluted                                                                                |       | 10,336,733                                               |       | 10,160,350                                |       |

 

SEE ACCOMPANYINGNOTES.

 

6

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’****EQUITY**

 

**(UNAUDITED)**

 
|                                                                 |   | **Common Stock** |       | **Capital in  Excess of** | ** ** | **Notes  Receivable  From Sale of** | ** ** | **Under/(Over)  Distributed Net  Investment** | ** ** | **Realized  Gain on  Sale of** | ** ** | **Unrealized  Appreciation/  (Depreciation)** | ** ** | **Total  Stockholders’** |       |
|----------------------------------------------------------------------|--------|------------------|------------|---------------------------|------------|-------------------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------------------------|------------|-------------------------------|------------|
|                                                                 |   | **Shares**       | ** ** | **Amount**                | ** ** | **Par Value**                       | ** ** | **Common Stock**                              | ** ** | **Income**                     | ** ** | **Investment**                                | ** ** | **of Investments**            | ** ** | **Equity** |   |
|                                                                 |   |             |       |                      |       | ** **                          | ** ** | ** **                                    | ** ** | ** **                     | ** ** | ** **                                    | ** ** | ** **                    | ** ** | ** ** |   |
| Balance at  September 30, 2003                                  |   | 10,081,844       |       | $                         | 10,082     |                                | $          | 140,416,674                                   |       | $                              | (8,985,940 | )                                             | $          | (416,094                      | )          | $ | — |   | $ | (222,340 | ) | $ | 130,802,382 |   |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Issuance of Common Stock  Under Stock Option Plan                    |   | 31,600           |       | 32                        |       | 479,837                             |       | (350,010                                      | )          |                           |       |                                          |       |                          |       | 129,859 |   |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Repayment of Principal on  Notes Receivable                          |   |             |       |                      |       |                                |       | 103,252                                       |       |                           |       |                                          |       |                          |       | 103,252 |   |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Shelf Offering                                                       |   |             |       |                      |       | (43,598                             | )          |                                          |       |                           |       |                                          |       |                          |       | (43,598 | ) |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Net Increase in  Stockholders’ Equity Resulting from Operations |   |             |       |                      |       |                                |       |                                          |       | 10,656,182                     |       | 12,500                                        |       | (849,132                      | )          | 9,819,550 |   |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Distributions Declared  ($1.005 per common share)                    |   |             |       |                      |       |                                |       |                                          |       | (10,142,870                    | )          |                                          |       |                          |       | (10,142,870 | ) |
|                                                                 |   |             |       |                      |       |                                |       |                                          |       |                           |       |                                          |       |                          |       |   |   |
| Balance at June 30,  2004                                       |   | 10,113,444       |       | $                         | 10,114     |                                | $          | 140,852,913                                   |       | $                              | (9,232,698 | )                                             | $          | 97,218                        |       | $ | 12,500 |   | $ | (1,071,472 | ) | $ | 130,668,575 |   |

 

SEE ACCOMPANYINGNOTES.

 

7

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

 

**(UNAUDITED)**

 
| ** **                                                                                                                                   | ** ** | **Nine months  ended  June 30, 2004** | ** ** | **Nine months  ended  June 30, 2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                                    |       |                                       |       |                                       |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| Net increase in stockholders’ equity resulting from  operations                                                                         |       | $                                          | 9,819,550  |                                       | $          | 8,445,069 |   |
| Adjustments to reconcile net increase in  stockholders’ equity resulting from operations to net cash provided by  operating activities: |       |                                       |       |                                       |       |
| Depreciation                                                                                                                                 |       | 24,356                                     |       | 21,236                                     |       |
| Amortization of premiums                                                                                                                     |       | 835                                        |       | —                                     |       |
| Change in net unrealized depreciation                                                                                                        |       | 849,132                                    |       | 2,413                                      |       |
| Decrease (increase) in interest receivable                                                                                                   |       | 338,894                                    |       | (398,367                                   | )          |
| Decrease in funds due from custodian                                                                                                         |       | 579,328                                    |       | —                                     |       |
| Increase in other assets                                                                                                                     |       | (211,042                                   | )          | (1,686                                     | )          |
| Decrease in prepaid assets                                                                                                                   |       | 102,301                                    |       | 77,355                                     |       |
| Increase in accounts payable                                                                                                                 |       | 122,885                                    |       | 330,269                                    |       |
| Increase in accrued expenses and deferred  liabilities                                                                                       |       | 324,804                                    |       | 602,350                                    |       |
| Increase in investment balance due to payment in  kind interest                                                                              |       | (412,659                                   | )          | (659,203                                   | )          |
| Net cash provided by operating activities                                                                                                    |       | 11,538,384                                 |       | 8,419,436                                  |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                                                                   |       |                                       |       |                                       |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| Purchase of investments                                                                                                                      |       | (82,267,500                                | )          | (27,000,000                                | )          |
| Principal repayments on investments                                                                                                          |       | 33,890,716                                 |       | 2,400,000                                  |       |
| Proceeds from repurchase agreements                                                                                                          |       | 240,114,596                                |       | 166,621,973                                |       |
| Repayment of repurchase agreements                                                                                                           |       | (264,655,000                               | )          | (142,114,693                               | )          |
| Receipt of principal on notes receivable - officers                                                                                          |       | 103,252                                    |       | —                                     |       |
| Disposal (purchase) of furniture and equipment, net                                                                                          |       | 9,498                                      |       | (81,127                                    | )          |
| Net cash used in investing activities                                                                                                        |       | (72,804,438                                | )          | (173,847                                   | )          |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                                                                   |       |                                       |       |                                       |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| Prepaid financing fees                                                                                                                       |       | (74,989                                    | )          | (1,151,993                                 | )          |
| Increase in borrowings from the line of credit                                                                                               |       | 33,520,666                                 |       | —                                     |       |
| Shelf offering                                                                                                                               |       | (43,598                                    | )          | —                                     |       |
| Increase in accrued offering costs                                                                                                           |       | (59,842                                    | )          | —                                     |       |
| Distributions paid                                                                                                                           |       | (13,469,879                                | )          | (6,949,574                                 | )          |
| Exercise of employee stock options                                                                                                           |       | 129,851                                    |       | —                                     |       |
| Net cash provided by (used in) financing activities                                                                                          |       | 20,002,209                                 |       | (8,101,567                                 | )          |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **NET (DECREASE) INCREASE IN CASH AND  CASH EQUIVALENTS**                                                                                    |       | (41,263,845                                | )          | 144,022                                    |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                                                                                          |       | 101,166,221                                |       | 91,929,328                                 |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH AND CASH EQUIVALENTS, END OF  PERIOD**                                                                                                |       | $                                          | 59,902,376 |                                       | $          | 92,073,350 |   |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **CASH PAID DURING PERIOD FOR  INTEREST**                                                                                                    |       | $                                          | 129,910    |                                       | $          | — |   |
|                                                                                                                                         |       |                                       |       |                                       |       |
| **NON-CASH FINANCING ACTIVITIES**                                                                                                            |       |                                       |       |                                       |       |
|                                                                                                                                         |       |                                       |       |                                       |       |
| Notes receivable issued in exchange for common stock  associated with the exercise of employee stock options                                 |       | $                                          | 350,010    |                                       | $          | — |   |

 

SEE ACCOMPANYINGNOTES.

 

8

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**FINANCIAL HIGHLIGHTS**

 

**(UNAUDITED)**

 
| ** **                                                         | ** ** | **Three months  ended  June 30, 2004** | ** **  | **Three months  ended  June 30, 2003** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|-------------|---------------------------------------------|------------|
|                                                               |       |                                        |        |                                        |       |
| Per Share Data (1)                                                 |       |                                        |        |                                        |       |
| Net asset value at beginning of period                             |       | $                                           | 12.71       |                                        | $          | 13.09 |   |
| Net investment income                                              |       | 0.45                                        |        | 0.31                                        |       |
| Realized gain on sale of investment                                |       | —                                      |        | —                                      |       |
| Net unrealized gain/(loss) on investments                          |       | 0.10                                        |        | (0.07                                       | )          |
| Issuance of common stock under stock option plan                   |       | (0.01                                       | )           | —                                      |       |
| Distributions from net investment income                           |       | (0.34                                       | )           | (0.29                                       | )          |
| Repayment of principal on notes receivable                         |       | —                                      |        | —                                      |       |
| Net asset value at end of period                                   |       | $                                           | 12.91       |                                        | $          | 13.04 |   |
|                                                               |       |                                        |        |                                        |       |
| Per share market value at beginning of period                      |       | $                                           | 22.41       |                                        | $          | 16.18 |   |
| Per share market value at end of period                            |       | 20.15                                       |        | 20.48                                       |       |
| Total Return (2)(3)                                                |       | -5.73                                       | %           | 28.37                                       | %          |
| Shares outstanding at end of period                                |       | 10,113,444                                  |        | 10,071,844                                  |       |
|                                                               |       |                                        |        |                                        |       |
| Ratios/Supplemental Data                                           |       |                                        |        |                                        |       |
| Net assets at end of period                                        |       | $                                           | 130,668,575 |                                        | $          | 131,353,022 |   |
| Average net assets                                                 |       | $                                           | 128,285,309 |                                        | $          | 132,823,516 |   |
| Ratio of expenses to average net assets – annualized          |       | 6.59                                        | %           | 2.86                                        | %          |
| Ratio of net investment income to average net assets  - annualized |       | 14.33                                       | %           | 7.18                                        | %          |

 
| ** **                                                         | ** ** | **Nine months  ended  June 30, 2004** | ** **  | **Nine months  ended  June 30, 2003** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|-------------|--------------------------------------------|------------|
|                                                               |       |                                       |        |                                       |       |
| Per Share Data (1)                                                 |       |                                       |        |                                       |       |
| Net asset value at beginning of period                             |       | $                                          | 12.97       |                                       | $          | 12.97 |   |
| Net investment income                                              |       | 1.06                                       |        | 0.84                                       |       |
| Realized gain on sale of investment                                |       | —                                     |        | —                                     |       |
| Net unrealized loss on investments                                 |       | (0.08                                      | )           | —                                     |       |
| Issuance of common stock under stock option plan                   |       | (0.04                                      | )           | —                                     |       |
| Distributions from net investment income                           |       | (1.01                                      | )           | (0.77                                      | )          |
| Repayment of principal on notes receivable                         |       | 0.01                                       |        | —                                     |       |
| Net asset value at end of period                                   |       | $                                          | 12.91       |                                       | $          | 13.04 |   |
|                                                               |       |                                       |        |                                       |       |
| Per share market value at beginning of period                      |       | $                                          | 19.45       |                                       | $          | 16.88 |   |
| Per share market value at end of period                            |       | 20.15                                      |        | 20.48                                      |       |
| Total Return (2)(3)                                                |       | 8.61                                       | %           | 25.89                                      | %          |
| Shares outstanding at end of period                                |       | 10,113,444                                 |        | 10,071,844                                 |       |
|                                                               |       |                                       |        |                                       |       |
| Ratios/Supplemental Data                                           |       |                                       |        |                                       |       |
| Net assets at end of period                                        |       | $                                          | 130,668,575 |                                       | $          | 131,353,022 |   |
| Average net assets                                                 |       | $                                          | 128,269,663 |                                       | $          | 132,170,641 |   |
| Ratio of expenses to average net assets – annualized          |       | 4.56                                       | %           | 2.74                                       | %          |
| Ratio of net investment income to average net assets  - annualized |       | 11.08                                      | %           | 8.54                                       | %          |

 

----

(1)          Basic per share data.

(2)          Amounts were not annualized for the results of the three andnine-month periods ended June 30, 2004 and June 30, 2003.

(3)          Total return equals the increase of the ending market value overthe beginning market value plus monthly dividends divided by the monthlybeginning market value.

 

SEE ACCOMPANYINGNOTES**.**

 

9

----

 

**GLADSTONE CAPITAL CORPORATION**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMEN****TS**

 

**JUNE 30, 2004**

 

**(UNAUDITED)**

 

NOTE 1. ORGANIZATION

 

Gladstone Capital Corporation (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 Capital Advisers, Inc., a wholly-ownedsubsidiary of the Company, conducts the daily administrative operations of theCompany.  The financial statements ofthis subsidiary are consolidated with those of the Company.

 

Gladstone Business Loan LLC, a wholly-owned subsidiaryof the Company, was established on February 3, 2003 for the purpose ofowning the Company’s portfolio of loan investments.  The financial statements of the subsidiaryare consolidated with those of the Company.

 

NOTE 2. UNAUDITED INTERIM FINANCIAL STATEMENTS

 

Interim financial statements of the Company areprepared in accordance with generally accepted accounting principles (“GAAP”)for interim financial information and pursuant to the requirements forreporting on Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain disclosures accompanyingannual financial statements 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, 2003, as filed with the Securities andExchange Commission.

 

10

----

 

NOTE 3. STOCK OPTIONS

 

The following tables set forth the pro-forma effect offair value option accounting for the three and nine months ended June 30,2004 and June 30, 2003 in accordance with Statement of Financial AccountingStandards (SFAS) Statement No. 148 “Accounting for Stock-Based Compensation –Transition and Disclosure”.

 
| ** **                                                                                                  | ** ** | **Three Months Ended  June 30, 2004** | ** ** | **Three Months Ended  June 30, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
|                                                                                                        |       |                                       |       |                                       |       |
| Increase in stockholders’  equity from operations, as reported                                         |       | $                                          | 5,609,893  |                                       | $          | 2,370,899 |   |
|                                                                                                        |       |                                       |       |                                       |       |
| Deduct: total stock-based  employee compensation expense determined under fair value method for all  awards |       | (436,209                                   | )          | (684,573                                   | )          |
|                                                                                                        |       |                                       |       |                                       |       |
| Pro-forma increase in stockholders’ equity from operations                                             |       | $                                          | 5,173,684  |                                       | $          | 1,686,326 |   |
|                                                                                                        |       |                                       |       |                                       |       |
| Increase in stockholders’  equity from operations per share                                            |       |                                       |       |                                       |       |
| Basic, as reported                                                                                          |       | $                                          | 0.56       |                                       | $          | 0.24 |   |
| Basic, pro-forma                                                                                            |       | $                                          | 0.52       |                                       | $          | 0.17 |   |
|                                                                                                        |       |                                       |       |                                       |       |
| Diluted, as reported                                                                                        |       | $                                          | 0.54       |                                       | $          | 0.23 |   |
| Diluted, pro-forma                                                                                          |       | $                                          | 0.50       |                                       | $          | 0.16 |   |

 
| ** **                                                                                                  | ** ** | **Nine Months Ended June 30, 2004** | ** ** | **Nine Months Ended June 30, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
|                                                                                                        |       |                                     |       |                                     |       |
| Increase in stockholders’  equity from operations, as reported                                         |       | $                                        | 9,819,550  |                                     | $          | 8,445,069 |   |
|                                                                                                        |       |                                     |       |                                     |       |
| Deduct: total stock-based  employee compensation expense determined under fair value method for all  awards |       | (1,250,990                               | )          | (2,053,718                               | )          |
|                                                                                                        |       |                                     |       |                                     |       |
| Pro-forma increase in stockholders’ equity from operations                                             |       | $                                        | 8,568,560  |                                     | $          | 6,391,351 |   |
|                                                                                                        |       |                                     |       |                                     |       |
| Increase in stockholders’  equity from operations per share                                            |       |                                     |       |                                     |       |
| Basic, as reported                                                                                          |       | $                                        | 0.97       |                                     | $          | 0.84 |   |
| Basic, pro-forma                                                                                            |       | $                                        | 0.85       |                                     | $          | 0.63 |   |
|                                                                                                        |       |                                     |       |                                     |       |
| Diluted, as reported                                                                                        |       | $                                        | 0.95       |                                     | $          | 0.83 |   |
| Diluted, pro-forma                                                                                          |       | $                                        | 0.83       |                                     | $          | 0.63 |   |

 

11

----

 

NOTE 4. INCREASE IN STOCKHOLDERS’ EQUITY FROMOPERATIONS PER SHARE

 

The following table sets forth the computation ofbasic and diluted net increase in stockholders’ equity resulting fromoperations per share for the three and nine months ended June 30, 2004 andJune 30, 2003:

 
| ** **                                                                                                      | ** ** | **Three Months Ended June 30, 2004** | ** ** | **Three Months Ended June 30, 2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
|                                                                                                            |       |                                      |       |                                      |       |
| Numerator for basic and  diluted net increase in stockholders’ equity resulting from operations per  share |       | $                                         | 5,609,893  |                                      | $          | 2,370,899 |   |
|                                                                                                            |       |                                      |       |                                      |       |
| Denominator for basic  weighted average shares                                                                  |       | 10,105,270                                |       | 10,071,844                                |       |
|                                                                                                            |       |                                      |       |                                      |       |
| Dilutive potential shares                                                                                       |       | 196,120                                   |       | 184,946                                   |       |
|                                                                                                            |       |                                      |       |                                      |       |
| Denominator for diluted  weighted average shares                                                                |       | 10,301,390                                |       | 10,256,790                                |       |
|                                                                                                            |       |                                      |       |                                      |       |
| Basic net increase in  stockholders’ equity resulting from operations per common share                     |       | $                                         | 0.56       |                                      | $          | 0.24 |   |
| Diluted net increase in  stockholders’ equity resulting from operations per common share                   |       | $                                         | 0.54       |                                      | $          | 0.23 |   |

 
| ** **                                                                                                      | ** ** | **Nine Months Ended June 30, 2004** | ** ** | **Nine Months Ended June 30, 2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
|                                                                                                            |       |                                     |       |                                     |       |
| Numerator for basic and  diluted net increase in stockholders’ equity resulting from operations per  share |       | $                                        | 9,819,550  |                                     | $          | 8,445,069 |   |
|                                                                                                            |       |                                     |       |                                     |       |
| Denominator for basic  weighted average shares                                                                  |       | 10,091,576                               |       | 10,071,844                               |       |
|                                                                                                            |       |                                     |       |                                     |       |
| Dilutive potential shares                                                                                       |       | 245,157                                  |       | 88,506                                   |       |
|                                                                                                            |       |                                     |       |                                     |       |
| Denominator for diluted  weighted average shares                                                                |       | 10,336,733                               |       | 10,160,350                               |       |
|                                                                                                            |       |                                     |       |                                     |       |
| Basic net increase in  stockholders’ equity resulting from operations per common share                     |       | $                                        | 0.97       |                                     | $          | 0.84 |   |
| Diluted net increase in  stockholders’ equity resulting from operations per common share                   |       | $                                        | 0.95       |                                     | $          | 0.83 |   |

 

12

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NOTE 5. DIVIDENDS

 

The Company is required to pay out as a dividend 90%of its ordinary income and short-term capital gains for each taxable year inorder to maintain its status as a RIC under Subtitle A, Chapter 1 of SubchapterM of the Code.  It is the policy of theCompany to pay out as a dividend up to 100% of those amounts.  The amount to be paid out as a dividend isdetermined by the Board of Directors each quarter and is based on the annualearnings estimated by the management of the Company.  Based on that estimate, a dividend isdeclared each quarter.  At year-end theCompany may pay a bonus dividend, in addition to the quarterly dividends, toensure that it has paid out at least 90% of its ordinary income and short-termcapital gains for the year.  The Companyhas a policy of retaining long-term capital gains, if any, and not paying themout as dividends.  Effective October 31,2003, the Company began paying a monthly dividend.  The following table illustrates the 2004fiscal year monthly dividends per share and the 2003 fiscal year quarterlydividends per share:

 

| **Record Date**     | ** ** | **Payment Date**   | ** ** | **Dividend per  Share** | ** ** | **Monthly  or  Quarterly** | ** ** |
|---------------------|------------|--------------------|------------|-------------------------|------------|----------------------------|------------|
| Sep. 17, 2004       |       | Sep. 30, 2004      |       | $                       | 0.12       |                       | Monthly    |   |
| Aug. 18, 2004       |       | Aug. 31, 2004      |       | $                       | 0.12       |                       | Monthly    |   |
| Jul. 19, 2004       |       | Jul. 30, 2004      |       | $                       | 0.12       |                       | Monthly    |   |
| Jun. 17, 2004       |       | Jun. 30, 2004      |       | $                       | 0.115      |                       | Monthly    |   |
| May 17, 2004        |       | May 28, 2004       |       | $                       | 0.115      |                       | Monthly    |   |
| Apr. 19, 2004       |       | Apr. 30, 2004      |       | $                       | 0.115      |                       | Monthly    |   |
| Mar. 18, 2004       |       | Mar. 31, 2004      |       | $                       | 0.11       |                       | Monthly    |   |
| Feb. 16, 2004       |       | Feb. 27, 2004      |       | $                       | 0.11       |                       | Monthly    |   |
| Jan. 19, 2004       |       | Jan. 30, 2004      |       | $                       | 0.11       |                       | Monthly    |   |
| Dec. 18, 2003       |       | Dec. 31, 2003      |       | $                       | 0.11       |                       | Monthly    |   |
| Nov. 17, 2003       |       | Nov. 28, 2003      |       | $                       | 0.11       |                       | Monthly    |   |
| Oct. 20, 2003       |       | Oct. 31, 2003      |       | $                       | 0.11       |                       | Monthly    |   |
|                |       |               |       |                    |       |                       |       |
| Sept. 30, 2003      |       | Oct. 6, 2003       |       | $                       | 0.33       |                       | Quarterly  |   |
| June 30, 2003  |       | July 7, 2003  |       | $                       | 0.29       |                       | Quarterly  |   |
| March 31, 2003 |       | April 7, 2003 |       | $                       | 0.25       |                       | Quarterly  |   |
| Dec. 31, 2002       |       | Jan 7, 2003        |       | $                       | 0.23       |                       | Quarterly  |   |

 

NOTE 6. INVESTMENT VALUATION

 

The Company carries its investments at fair value, asdetermined by its Board of Directors. Securities that are publicly traded are valued at the closing price onthe valuation date.  Securities for whicha market exists, such as participations in syndicated loans, are valued at thebid price on the valuation date.  Debtand equity securities that are not publicly traded are valued at fair value asdetermined in good faith by the Board of Directors. Beginning inMarch 2003, the Company engaged Standard & Poor’s Loan EvaluationService (S&P) to perform independent valuations of its investments.  The Board of Directors uses the recommendedvaluations as prepared by S&P as a component of the foundation for thefinal fair value determination.  Inmaking such determination, the Board of Directors values non-convertible debtsecurities at cost plus amortized original issue discount plus payment inkind(“PIK”) interest, if any, unless adverse factors lead to a determination ofa lesser valuation.  In valuingconvertible debt, equity, success or exit fees or other equity like securities,the Board of Directors determines the fair value based on the collateral, theissuer’s ability to make payments, the earnings of the issuer, sales to thirdparties of similar securities, the comparison to publicly traded securities,discounted cash flow and other pertinent factors.  Due to the uncertainty inherent in thevaluation process, such estimates of fair value may differ significantly fromthe values that would have resulted had a ready market for the securitiesexisted, and the differences could be material. Additionally, changes in themarket environment and other events that may occur over the life of theinvestments may cause the gains ultimately realized on these investments to bedifferent than the valuation currently assigned.  Because there is a lag between when theCompany closes a loan and when the loan can be evaluated by S&P, new loansare not valued immediately by S&P; rather, the Board of Directors makes itsown determination about the value of the loan in accordance with the Company’svaluation policy.  Because S&P doesnot perform independent valuations of mortgage loans or equity securities, theBoard of Directors also determines the fair value of these investments withoutthe input of S&P.  The Board ofDirectors considers a number of qualitative and quantitative factors in currentmarket conditions when performing valuations.

 

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NOTE 7. LOAN AND MANAGERIAL ASSISTANCE FEES

 

The 1940 Act requires that a business developmentcompany make available managerial assistance to its portfolio companies.  The Company provides managerial assistance toits portfolio companies through its wholly-owned subsidiary, Gladstone CapitalAdvisers, Inc.  The Company receives feeincome for managerial assistance it renders to portfolio companies inconnection with its investments.  Suchfees are normally paid at the closing of the Company’s investments and aregenerally non-recurring.  Thesemanagerial assistance services vary by investment, but generally consist ofreviewing existing credit facilities, arranging bank financing, arrangingequity financing, structuring financing from multiple lenders, structuringfinancing from equity investors, restructuring existing loans, raising equityand debt capital, and providing general financial advice.  For the three and nine months endedJune 30, 2004 these fees totaled $399,375 and $1,010,606, respectively,and $125,000 and $483,000 for the three and nine months ended June 30,2003, respectively.

 

From time to time, the Company will be invited toparticipate as a co-lender in a transaction. Where the Company does not provide significant managerial assistanceservices in connection with its investment, loan fees paid to the Company insuch situations will be deferred and amortized over the life of the loan.

 

NOTE 8. PAYMENT IN KIND INTEREST

 

The Company has loans in its portfolio, that contain apayment in kind (“PIK”) provision. The PIK interest is added to the principalbalance of the loan and recorded as income. To maintain the Company’s status as a RIC (as discussed in Note 5,above), this non-cash source of income must be paid out to stockholders in theform of dividends, even though the Company has not yet collected the cash. Forthe three and nine months ended June 30, 2004, the Company recorded PIKincome of $136,647 and $413,052, respectively, and for the three and ninemonths ended June 30, 2003, the Company recorded PIK income of $232,572and $667,648, respectively.  AtJune 30, 2004 and September 30, 2003 the Company had accrued on itsbalance sheets, a total in PIK income of $998,440 and $608,572 respectively.  The Company does not hold any investments issuedat original issue discount and accordingly, has not realized any original issuediscount income for the three and nine months ended June 30, 2004 orJune 30, 2003.

 

NOTE 9. REPURCHASE AGREEMENT

 

A repurchase agreement involves the purchase by aninvestor, such as the Company, of a specified security and the simultaneousagreement by the seller to repurchase it at an agreed upon future date and at aprice which is greater than the purchase price by an amount that reflects anagreed-upon interest rate. Such interest rate is effective for the period oftime during which the investor’s money is invested in the arrangement and isrelated to current market interest rates rather than the coupon rate on thepurchased security. The Company requires the continual maintenance by itscustodian or the correspondent in its account with the Federal Reserve/TreasuryBook Entry System of underlying securities in an amount at least equal to therepurchase price. If the seller were to default on its repurchase obligation, theCompany might suffer a loss to the extent that the proceeds from the sale ofthe underlying securities were less than the repurchase price. A seller’sbankruptcy could delay or prevent a sale of the underlying securities.

 

On June 30, 2004, the Company entered into aRepurchase Agreement with UBS Paine Webber for $53,908,596, which agreement wassettled on July 1, 2004.  TheRepurchase Agreement was recorded at cost and was fully collateralized by aUnited States Treasury Bill with a fair value of $55,020,000 and a carryingvalue of $55,006,917 that matured on July 8, 2004.  The interest rate on the Repurchase Agreementwas 1.09%.  On September 30, 2003,the Company entered into a Repurchase Agreement with UBS for $78,449,000, whichagreement was settled on October 1, 2003. The Repurchase Agreement was recorded at cost and was fullycollateralized by a United States Treasury Bill with a fair value of$80,050,000 and a carrying value of $80,022,249 that matured onOctober 16, 2003.  The interest rateon the Repurchase Agreement was 0.80%.

 

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NOTE 10. CONTRACTUAL OBLIGATIONS

 

The Company occupies its McLean, Virginia office spacepursuant to a license agreement scheduled to expire on October 31,2004.  The Company’s New York, New Yorkoffice facility has a service agreement scheduled to expire August 31,2004.  During May 2004 the Company alsoentered into a service agreement for the Chicago, Illinois office, scheduled toexpire on June 30, 2005.  The futurescheduled payments are as follows:

 
| ** **                   | ** ** | **Payment due by period** | ** ** |
|------------------------------|------------|---------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                 | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
| Office Lease Obligations     |       | $                         | 108,801    |   | $ | 103,060 |   | $ | 5,741 |   | — |   | — |   |
| **Total**                    |       | $                         | 108,801    |   | $ | 103,060 |   | $ | 5,741 |   | — |   | — |   |

 

NOTE 11. LINES OF CREDIT

 

In June 2004, the Company entered into a $15.0 millionline of credit agreement with Branch Banking and Trust Company (“BB&TAgreement”) which matures on June 1, 2005. Interest on outstanding borrowings is based upon the one month LondonInterbank Offered Rate (“LIBOR”) plus 2.5% per annum.  The unused portion of the line of credit issubject to a fee of 0.2% per annum.  TheBB&T Agreement requires the Company to meet and maintain certain covenantsand ratios with respect to leverage and liquidity. As of June 30, 2004,there was $12.25 million outstanding under the BB&T line of credit at aninterest rate of 3.625%.  AtJune 30, 2004 the Company was in compliance with all covenants under theBB&T Agreement.

 

Through its wholly-ownedsubsidiary Gladstone Business Loan LLC (“Business Loan”), the Company hasobtained a $100 million revolving credit facility.  On May 19, 2003, the Company executed aPurchase and Sale Agreement pursuant to which it agreed to sell certain loansto Business Loan in consideration of a membership interest therein.  Simultaneously, Business Loan executed aCredit Agreement with CIBC World Markets Inc., as administrative agent, andothers, pursuant to which Business Loan pledged the loans purchased from theCompany to secure future advances by certain institutional lenders.  Interest rates charged on the advances underthe facility are based on LIBOR, the Prime Rate or the Federal Funds Rate,depending on market conditions, and adjusts periodically.  As of June 30, 2004, the outstandingprincipal balance under this credit facility was approximately $21.3 million atan interest rate of 2.44%.

 

The facility containscovenants that require Business Loan to maintain its status as a separateentity; prohibit certain significant corporate transactions (such as mergers,consolidations, liquidations or dissolutions); and restrict material changes tothe Company’s credit and collection policies. The facility also restricts some of the terms and provisions (includinginterest rates, terms to maturity and payments schedules) and limits theborrower and industry concentrations of loans that are eligible to secureadvances.  As of June 30, 2004,Business Loan was in compliance with all of the facility covenants.  The Company currently intends to securitizeall of the loans held by Business Loan and will use the proceeds from thesecuritization to pay down any amounts then outstanding under the revolvingcredit facility.

 

Gladstone CapitalAdvisers, Inc. (“Advisers”), the Company’s servicing subsidiary, services theloans pledged under the facility.  As acondition to this servicing arrangement, the Company executed a PerformanceGuaranty pursuant to which it guaranteed that Advisers would comply fully withall of its obligations under the facility. The Performance Guaranty requires the Company to maintain a minimum networth of $100 million and to maintain “asset coverage” with respect to “seniorsecurities representing indebtedness” of at least 200%, in accordance withSection 18 of the 1940 Act.  As ofJune 30, 2004, the Company was in compliance with all covenants under thePerformance Guaranty.

 

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NOTE 12. INTEREST RATE CAP AGREEMENT

 

Pursuant to the CIBC WorldMarkets, Inc. line of credit, the Company agreed to enter into hedgingtransactions, and as such purchased an interest rate cap agreement inFebruary 2004 as a result of borrowings under the line of credit.  The transaction effectively limits the interestrate on a portion of these borrowings.

 

The use of a cap involvesrisks that are different from those associated with ordinary portfoliosecurities transactions.  Cap agreementsmay be considered to be illiquid.  Althoughthe Company will not enter into any such agreements unless it believes that theother party to the transaction is creditworthy, the Company does bear the riskof loss of the amount expected to be received under such agreements in theevent of default or bankruptcy of the agreement counterparty.

 

In February 2004,the Company entered into an interest rate cap agreement with a notional amountof $35.0 million at a cost of $304,000 and a current fair value ofapproximately $169,000 which is recorded in other assets on the Company’sconsolidated balance sheet at June 30, 2004.  The agreement provides that the Company’sfloating interest rate or cost of funds on a portion of the portfolio’sborrowings will be capped at 5% when the LIBOR rate is in excess of 5%.

 

NOTE 13. DEFERRED COMPENSATION PLAN

 

The Company has adopted a deferred compensation plan(the “Plan”) effective January 1, 2002. The Plan permits an employee to defer the lesser of 75% of his or hertotal compensation or the applicable Internal Revenue Service (“IRS”)limit.  The employees are eligible toparticipate in the Plan upon completion of 1,000 hours of service within thefirst six months of employment or after one year of service.  The service requirement is waived for thoseemployees who were employed as of January 1, 2002.    The Company has funded $23,987 incontributions to the Plan that were accrued in the fiscal year endedSeptember 30, 2003.  The Company hasreceived a determination letter from the IRS concurring that the deferredcompensation plan satisfies the qualification requirements of the Code.

 

NOTE 14. ADVISORY AGREEMENT WITH GLADSTONE MANAGEMENTCORPORATION

 

At the Company’s 2004 annual meeting of stockholders,the stockholders approved a proposal to enter into an advisory agreement withGladstone Management Corporation (“Gladstone Management”), an affiliate of theCompany, whereby the Company would pay Gladstone Management an annual advisoryfee of 1.25% of total assets (as reduced by cash and cash equivalents pledgedto creditors), payable in quarterly increments of 0.3125%, and an annualadministrative fee of 0.75% of total assets (as reduced by cash and cashequivalents pledged to creditors), payable in quarterly increments of 0.1875%.The Company would continue to pay direct expenses including, but not limitedto, directors fees, legal and accounting fees, and stockholder relatedexpenses.  Under the proposed advisoryagreement, Gladstone Management will also provide the managerial assistanceservices that the Company has historically made available to its portfoliocompanies.  The Company expects to engageGladstone Management effective October 1, 2004, the first day of the 2005fiscal year, however the Company cannot predict with certainty when thisengagement will take effect.

 

NOTE 15. SUBSEQUENT EVENTS

 

In July 2004, the Company entered into a $4.0 million seniorterm debt with Allied Extruders, Inc., a manufacturer of polyethylene film.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**All statements contained herein, other thanhistorical facts, may constitute “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. Thesestatements 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 , Terry Lee Brubaker, or George Stelljes III; (4)our inability to maintain a credit facility on terms reasonably acceptable tous, if at all; (5) our inability to successfully securitize our loan portfolioon terms 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, 2003. We caution readers not to place undue reliance on anysuch forward-looking statements, which are made pursuant to the PrivateSecurities Litigation Reform Act of 1995 and, as such, speak only as of thedate made. We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise, after the date of this Form 10-Q**.

 

*The following analysis of our financialcondition and results of operations should be read in conjunction with ourfinancial statements and the notes thereto contained elsewhere 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 notes,senior subordinated notes and junior subordinated notes, of established privatebusinesses that are backed by leveraged buyout funds, venture capital funds orothers, with a particular emphasis on senior subordinated notes.  In addition, we may acquire existing loans,which meet this profile, from leveraged buyout funds, venture capital funds andothers. We also seek to provide our stockholders with long-term capital growththrough the appreciation in the value of warrants, or other equity instrumentsthat we may receive when we extend loans. We operate as a closed-end,non-diversified management investment company, and have elected to be treatedas a business development 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 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 on ourbalance sheet as of June 30, 2004 was approximately $998,000.

 

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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 principal generallybeing deferred for several years. The principal amount of the loans and anyaccrued but unpaid interest generally become due at maturity at five to sevenyears. When we receive a warrant to purchase stock in a borrower in connectionwith a loan, the warrant will typically have an exercise price equal to thefair value of the portfolio company’s common stock at the time of the loan andentitle 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 Capital Advisers, Inc. Such fees are typically paid inpart at the time a prospective portfolio company signs a non-binding term sheetwith us, with the remainder paid at the closing of the investments. These feesare generally 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.

 

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. We have historically recognized this as management feerevenue upon execution of the non-binding term sheet.  Following the externalization of ourmanagement, these services will be provided by Gladstone Management.

 

Our business planhas historically called for managerial assistance fee revenue to equal orexceed our operating expenses (excluding interest expense). However, during thequarters ended June 30, 2004, and June 30, 2003, operating expenses(excluding interest expense) exceeded managerial assistance fee revenue byapproximately $1.4 million and $819,000, respectively, and approximately $3.1million and $1.6 million for the nine months ended June 30, 2004 andJune 30, 2003, respectively. Because we typically generate managerial assistance fee revenue onlywhen we make new loans, our relatively slow pace of loans during the 2003 ledto this shortfall.  Although the pace ofloans in fiscal year 2004 has increased, a number of the investments we havemade this year have been syndicated loan investments which did not have thesemanagerial fees associated with them, which is customary for such loans.

 

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 is received.Also, in the event that we have incurred significant legal fees in connectionwith the transaction, we will typically also seek reimbursement for theseexpenses from the proposed borrower.  Following our engagement of Gladstone Management, any amounts collectedfor expenses incurred by Gladstone Management in connection with unconsummatedinvestments will be reimbursed to Gladstone Management.  Amounts collected for these expenses incurredby us will continue to be reimbursed to us. However, there can be no guaranteethat we will be successful in collecting any such reimbursements.

 

The onlysignificant continuing revenue associated with the investments we have alreadyclosed is interest income and, potentially, capital gains realized inconnection with the liquidation of any associated equity interest (e.g.,warrants). While in some instances we may also receive on-going managerialassistance fee revenue in connection with a consummated investment, any suchamounts have been, and in the future are expected to be, insignificant.

 

The generaleconomic climate during the quarter and nine months ended June 30, 2004and the previous fiscal year ended September 30, 2003 wasunfavorable.  Many businesses saw theirsales and business prospects decline during the year.  Consequently, many of these companies wereforced to lay off employees and engage in other cost cutting measures.  As a result of the difficult businessclimate, we determined it prudent to proceed cautiously in making loans duringthese periods.  Since our initial publicoffering in August 2001, we have made 39different loans to, or investments in, 23****companies for a total of approximately $214.2****million. During the nine months ended June 30, 2004, three companies paid infull their outstanding loan balances in the aggregate of approximately $24.3million and we entered into new loans with 9 companies, in the aggregate amountof approximately $82.3 million.

 

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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 cannot 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.

 

In July 2003,we entered into an expense sharing arrangement with Gladstone ManagementCorporation (“Gladstone Management”), a registered investment adviser thatserves as the external adviser to Gladstone Commercial Corporation, a realestate investment trust affiliated with us. Under this expense sharingarrangement, Gladstone Management reimburses Gladstone Capital Advisers for aportion of our total payroll and benefits expenses (based on the percentage oftotal hours worked by each employee on Gladstone Commercial matters). GladstoneManagement also reimburses Gladstone Capital Advisers for its pro rata portionof all other general expenses (based on the percentage of total hours worked byall employees on Gladstone Commercial matters). Gladstone Management furtherpasses its share of these expenses along to Gladstone Commercial under aseparate advisory agreement. As a result of this expense sharing arrangement,certain of our expenses, such as rent and insurance, declined during thequarter and nine months ended June 30, 2004. The actual amount of our expenses in future periods will depend upon therelative time that our personnel spend on our and Gladstone Commercialmatters.   In the near term, we expect tohire additional personnel that will devote a substantial portion of their timeto our matters, resulting in an increase in our expenses as compared to thequarter ended June 30, 2004.  Weexpect these expenses to continue to increase in subsequent periods until theexternalization of our management as described below. **  **Followingour engagement of Gladstone Management, Gladstone Management will pay itspayroll, benefits, and general expenses directly.  Thus, the expense sharing arrangement betweenGladstone Capital Advisers and Gladstone Management will terminate upon theexternalization of our management.

 

At our 2004 annualmeeting of stockholders our stockholders approved a proposal to enter into anadvisory agreement with Gladstone Management, whereby we would pay GladstoneManagement an annual advisory fee of 1.25% of our total assets (as reduced bycash and cash equivalents pledged to creditors), payable in quarterlyincrements of 0.3125%, and an annual administrative fee of 0.75% of our totalassets (as reduced by cash and cash equivalents pledged to creditors), payablein quarterly increments of 0.1875%. We would continue to pay direct expensesincluding, but not limited to, directors fees, legal and accounting fees, andstockholder related expenses.  While weexpect to engage Gladstone Management effective October 1, 2004, the firstday of our 2005 fiscal year, we cannot determine with certainty when thisengagement will take effect.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported consolidated amounts ofassets and liabilities, and disclosure of contingent assets and liabilities atthe date of the financial statements, and revenues and expenses during theperiod reported. Actual results could differ materially from thoseestimates.  Our accounting policies aremore fully described in the “Notes to Consolidated Financial Statements”contained elsewhere in this report.  Wehave identified our investment valuation process as our most criticalaccounting policy.

 

**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 valuations of our investments in portfolio companies using the mostrecent portfolio company financial statements and forecasts.  These individuals also consult with portfoliocompany senior management to obtain further updates on the portfolio company’sperformance, including information such as industry trends, new productdevelopment, and other operational issues. As of March 31, 2003, we engaged Standard & Poor’s LoanEvaluation Service (S&P) to help evaluate the value of the majority of ourloan securities.  Since June 30,2003, our S&P engagement includes evaluations on exit (also known as“success”) fees (conditional interest included in some loan securities).  We and S&P only evaluate the value of anexit fee if the probability of receiving the exit fee on a given loan is above6-8%, a threshold of significance, in which case a value is assigned.  Upon completing the data collection, thevaluation data is presented to S&P. S&P makes its independent assessment of the data and assesses itsown data to determine market values for the securities.  With regard to its work, S&P has issuedthe following paragraph:

 

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S&P providesevaluated price opinions which are reflective of what S&P believes the bidside of the market would be for each loan after careful review and analysis ofdescriptive, market and credit information. Each price reflects S&P’s best judgment based upon carefulexamination of a variety of market factors. Because of fluctuation in the market and in other factors beyond itscontrol, S&P cannot guarantee these evaluations.  The evaluations reflect the market prices, orestimates thereof, on the date specified. The prices are based on comparable market prices for similarsecurities.  Market information has beenobtained from reputable secondary market sources.  Although these sources are consideredreliable, S&P cannot guarantee their accuracy.

 

With ourassessment and S&P value estimates as a backdrop, our Board of Directorsvotes to accept or not accept the analyses and values recommended by managementand S&P.  At June 30, 2004, theBoard of Directors elected to accept the valuations recommended by S&P onthose loans as denoted on the Schedule of Investments as of June 30,2004 in our consolidated financial statements. Because there is a lag between when we close a loan and when the loancan be evaluated by S&P, new loans are not valued immediately by S&P;rather, the Board of Directors makes its own determination about the value ofthese loans in accordance with our valuation policy.  Because S&P does not provide values formortgage loans or equity securities, the Board of Directors also determines thefair value of these investments using our valuation policy without the input ofS&P.

 

*GeneralValuation Policy:* We carry our investments at fair value, asdetermined by our Board of Directors. Securities that are publicly traded, if any, are valued at the closingprice on the valuation date. Securities for which a market exists, such asparticipations in syndicated loans, are valued at the bid price on thevaluation date.  Debt and equitysecurities that are not publicly traded or for which we have various degrees oftrading restrictions, are valued at fair value as determined in good faith byour Board of Directors.  In making thegood faith determination of the securities, we start with the cost basis of thesecurity, which includes the amortized original issue discount, exit fee(conditional interest) and PIK interest, if any.  We then apply the methods set out below inValuation Methods.  Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have been obtained had a readymarket for the securities existed, and the differences could be material.  Additionally, changes in the marketenvironment and other events that may occur over the life of the investmentsmay cause the gains or losses ultimately realized on these investments to bedifferent than the valuations currently assigned.  No single standard for determining fair valuein good faith exists since fair value depends upon circumstances of eachindividual case.  In general, fair valueis the amount that we might reasonably expect to receive upon the current saleof the security.

 

*CreditInformation:*****Wemonitor a wide variety of key credit statistics that provide informationregarding our portfolio companies to help us assess credit quality andportfolio performance.  We require our portfoliocompanies to provide annual audited and monthly, unaudited financialstatements.  Using these statements, wecalculate and evaluate the credit statistics. For purposes of analyzing the financial performance of our portfoliocompanies, we may make certain adjustments to their cash flow statements toreflect the pro forma results of a company consistent with a change of controltransaction, to reflect anticipated cost savings resulting from a merger orrestructuring, costs related to new product development, compensation toprevious owners, and other acquisition or restructuring related items.

 

*LoanGrading and Risk Rating:*****Ourloan grading system uses a scale of 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 rate each of our debtsecurities.  The risk rating systemcovers both qualitative and quantitative aspects of the business and thesecurities we hold.

 

We seek to haveour risk rating system mirror the risk rating systems of major risk ratingorganizations such as those provided by nationally recognized statisticalrating organizations (“NRSRO”) as defined in Rule 2a-7 under the 1940 Act.While we seek to mirror the NRSRO systems, we cannot provide any assurance thatour risk rating system provides the same risk rating as a NRSRO. The followingchart is an estimate of the relationship of our risk rating system to thedesignations used by two NRSROs as they risk rate debt securities of majorcompanies.  Because we have establishedour system to rate debt securities of companies that are unrated by any NRSROthere can be no assurance that the correlation to the NRSRO set out below isaccurate. It is our understanding that most debt securities of middle marketcompanies do not exceed the grade of BBB on a NRSRO scale; so there would be nodebt securities in the middle market that would meet the definition of AAA, AAor A.  Therefore, our scale begins withthe designation BBB as the best risk rating.

 

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| **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**                     |       | Baa3             |       | BBB-              |       | PD is 5% and the EL is  1% to 2%                                                                     |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10% and the EL is  2% to 3%                                                                    |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16% and the EL is  3% to 4%                                                                    |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8% and the EL  is 4% to 5%                                                                  |
| **6**                      |       | B1               |       | B+                |       | PD is 22.0% and the EL  is 5% to 6.5%                                                                |
| **5**                      |       | B2               |       | B                 |       | PD is 25% and the EL is  6.5% to 8%                                                                  |
| **4**                      |       | B3               |       | B-                |       | PD is 27% and the EL is  8% to 10%                                                                   |
| **3**                      |       | Caa1             |       | CCC+              |       | PD is 30% and the EL is  10.0% to 13.3%                                                              |
| **2**                      |       | Caa2             |       | CCC               |       | PD is 35% and the EL is  13.3% to 16.7%                                                              |
| **1**                      |       | Caa3             |       | CC                |       | PD is 65% and the EL is  16.7% to 20%                                                                |
| **0**                      |       | N/a              |       | D                 |       | PD is 85% or there is a  Payment Default: and the EL is greater than 20%                             |

 

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*(a)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.*

* *

AtSeptember 30, 2003, the average debt security was risk rated 7.8 for alldebt securities and the weighted average risk rating was 7.6 for all the debtsecurities.  At June 30, 2004 theaverage debt security was risk rated 7.4 for all debt securities and theweighted average risk rating was 7.3 for all debt securities. The highest ratedloan was 9.0 and the lowest was 5.0. The above scale gives an indication of theprobability of default and the magnitude of the loss if there is a defaultusing the expanded risk rating scale.

 
| **Rating**       | ** ** | **June 30, 2004** | ** ** | **March 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------|------------|------------------------|------------|-------------------------|------------|----------------------------|------------|
| Average          |       | **7.4**                |       | 7.7                     |       | 7.8                        |       |
| Weighted Average |       | **7.3**                |       | 7.7                     |       | 7.6                        |       |
| Highest          |       | **9.0**                |       | 9.0                     |       | 9.0                        |       |
| Lowest           |       | **5.0**                |       | 6.0                     |       | 7.0                        |       |

 

Our policy is tostop accruing interest on an investment if we determine that interest is nolonger collectible. To date we have not placed any investments on non-accrual.At September 30, 2003 and June 30, 2004 no payments were past due onany of our debt securities. We do not risk rate our equity securities.

 

*ValuationMethods:*  For debtsecurities, we first determine if there is a market for the debt security.  If there is a market, then we will determinethe value based on the market prices for the security, even if that market isnot robust.  At September 20, 2003,there was no market for any of the debt securities in our portfolio. AtJune 30, 2004, we determined that there was a market for five debtsecurities in our portfolio.  For debtsecurities where there is no market, we begin with the risk rating designationof the security described above.  Usingthe risk rating designation above, we seek to determine the value of thesecurity as if we intended to sell the security in a current sale.  To determine the current sale price of thesecurity, we may use some or all of the following items:

 

•                  financial standing of the issuer ofthe security;

•                  comparison of the business andfinancial plan of the issuer with actual results;

•                  the cost of the security;

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

•                  contractual restrictions on the dispositionof the security;

•                  pending public offering of the issuerof the security;

•                  pending reorganization activityaffecting the issuer such as mergers or debt restructuring;

•                  reported prices of similar securitiesof the issuer or comparable issuers;

•                  ability of the issuer to obtainneeded financing;

•                  changes in the economy affecting theissuer;

•                  recent purchases or sale of asecurity of the issuer;

•                  pricing by other buyers or sellers ofsimilar securities;

•                  financial statements of the borrower;

•                  reports from portfolio company seniormanagement and ownership;

•                  the type of security;

•                  cost at date of purchase;

 

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•                  size of holding;

•                  discount from market value ofunrestricted securities of the same class at the time of purchase;

•                  special reports prepared by analysts;

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

•                  existence of merger proposals ortender offers affecting the securities;

•                  the collateral;

•                  the issuer’s ability to makepayments;

•                  the current and forecasted earningsof the issuer;

•                  sales to third parties of similarsecurities;

•                  statistical ratios compared tolending standards;

•                  statistical ratios compared to othersimilar securities; and

•                  other pertinent factors.

 

For convertibledebt, equity, exit fees or other equity like securities, we first determine ifthere is any market for the security.  Ifthere is a market, then we determine the value based on the market prices for thesecurity, even if that market is not robust. At June 30, 2004 and September 30, 2003 there was no marketfor any of the equity securities we owned. If there is no market for the equity securities, then we use the sameinformation we would use for a debt security valuation described above, exceptrisk-rating, as well as standard valuation techniques used by major valuationfirms to value the equity securities of private companies.  These valuation techniques consist of:discounted cash flow of the expected sales price in the future and valuation ofthe securities based on the recent sale of comparable transactions and a reviewof similar companies that are publicly traded and the market multiple of theirequity securities.  At June 30, 2004we had $37,000 invested, at cost, in equity securities compared to our debtportfolio with a cost basis of $158,281,500.

 

At June 30,2004, America’s Water Heater Rentals senior loan had an appreciation of$720,000 in its value as a result of the value applied to the exit fee.  Also, the value of our warrants in FinnCorporation had an appreciation of $455,284 at June 30, 2004.  This aforementionned appreciation plusappreciation of $226,634 on certain other investments, overall appreciation of$1,401,918, partially offsets total depreciation of $2,473,388, which wasmainly composed of our senior subordinated term debt investment in FinnCorporation (excluding the warrants) of $1,260,000, our senior subordinatedterm debt investment in Marcal Paper Mills, Inc. of $595,000, and our seniorterm debt investment in Inca Metal Products Corporation of $256,907.

 

**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 Capital Advisers, Inc. and receive fees for ourmanagerial assistance services. These fees are normally paid at the closing ofour investments 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, structuringfinancing from 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.  Following our transition toexternal management these managerial assistance services will be made availableby Gladstone Management.

 

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**RESULTSOF OPERATIONS**

 

*Comparison of the three months ended June 30, 2004to the three months ended June 30, 2003*

 

**Investment Income**

 

Investment incomefor the three months ended June 30, 2004 was approximately $6.7 million ascompared to $4.1 million for the three months ended June 30, 2003. Thisincrease was primarily a result of increased interest income from an increasednumber of investments as compared to the same period of the prior year as wellas the collection of approximately $1.5 million in exit fees upon the fullrepayment of two loans during the three months ended June 30, 2004.

 

Interest incomefrom our investments in debt securities of private companies was approximately$5.7 million, including $137,000 of PIK interest, for the three months endedJune 30, 2004 as compared to $3.7 million for the three months ended June 30,2003, which included $233,000 of PIK interest. This increase****wasprimarily a result of an increase in investments of $53.3 million atJune 30, 2004 as compared to investments at June 30, 2003, as well asthe collection of approximately $1.5 million of exit fees upon the fullrepayment of two loans during the three months ended June 30, 2004.

 

The annualizedweighted average yield on our portfolio for the three months endedJune 30, 2004 was 15.99% (without giving effect to PIK interest) and16.37% (after giving effect to PIK interest). The annualized weighted averageyield on our portfolio for the three months ended June 30, 2003 was 13.24%(without giving effect to PIK interest) and 15.25% (after giving effect to PIKinterest).

 

Interest incomefrom invested cash and cash equivalents for the three months endedJune 30, 2004 was approximately $15,000, as compared to $79,000 for thethree months ended June 30, 2003. This decrease****was primarily a result of a decrease in invested cash andcash equivalents because of the $102.3 million of new investments made betweenJune 30, 2003 and June 30, 2004.

 

For the threemonths ended June 30, 2004 and June 30, 2003, we recordedapproximately $113,000 and $110,000, respectively, in interest income fromloans to our employees in connection with the exercise of employee stockoptions.

 

Managerialassistance fees were $399,000 for the three months ended June 30, 2004, ascompared to $125,000 for the three months ended June 30, 2003. This increase was a result of the closing of threeinvestments in the aggregate of $19.75 million (Benetech, Inc., MistrasHoldings Corp. and A and G, Inc.) providing such fees during the three monthsended June 30, 2004 as compared to closing of $5.5 million investments(Fugate and Associates) providing such fees during the three months endedJune 30, 2003.

 

**OperatingExpenses**

 

Operating expensesfor the three months ended June 30, 2004 were approximately $2.1 million,as compared to approximately $944,000 for the three months ended June 30,2003. This increase****was mainly aresult of an increase in salaries and benefits, directors fees, financing fees,and interest expense.

 

Salaries andbenefits for the three months ended June 30, 2004 were approximately $1.3million, as compared to approximately $494,000 for the three months endedJune 30, 2003. The increase is attributable primarily to our Board ofDirectors declaration of an $800,000 quarterly bonus to employees based on ourperformance during the three months ended June 30, 2004.  While salaries and benefits are allocatedaccording to the expense sharing arrangement with Gladstone Management whichallocates expenses to Gladstone Management based on each employee’s time spenton Gladstone Commercial Corporation’s matters, no portion of the quarterlybonus was allocated to Gladstone Management as it was solely attributable tothe performance of Gladstone Capital Corporation.  Without giving effect to this bonus, salariesand benefits were roughly unchanged for the three months ended June 30,2004, as compared to the three months ended June 30, 2003.  Although personnel count was significantlyhigher as of June 30, 2004 than June 30, 2003, this increase wasoffset by savings attributable to the expense sharing arrangement withGladstone Management.

 

Rent expense forthe three months ended June 30, 2004 was approximately $34,000, ascompared to approximately $55,000 for the three months ended June 30,2003.  The decrease in rent is dueprimarily to the expense sharing arrangement with Gladstone Management, whichallocates general expenses to Gladstone Management based on the ratio of allemployees’ time spent on Gladstone Commercial Corporation’s matters to totaltime spent.

 

Professional fees,consisting primarily of legal and audit fees, for the three months endedJune 30, 2004 were approximately $59,000, as compared to approximately$101,000 for the three months ended June 30, 2003.  The decrease is due primarily to a decreasein legal fees, resulting from the incurrence of significant legal expenses duringthe three months ended June 30, 2003 in connection with the establishmentof our warehouse line of credit.

 

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Directors’ feesfor the three months ended June 30, 2004 were approximately $28,000, as comparedto approximately $20,000 for the three months ended June 30, 2003. Theincrease is due to the addition of two new directors during the three monthsended June 30, 2004 as compared to the three months ended June 30,2003.

 

Insurance expensefor the three months ended June 30, 2004 was approximately $63,000, ascompared to approximately $72,000 for the three months ended June 30,2003. The decrease is due to the expense sharing arrangement with GladstoneManagement which allocates general expenses to Gladstone Management based onthe ratio of time spent by all employees on Gladstone Commercial Corporation’smatters to total time spent.

 

Stockholderrelated costs for the three months ended June 30, 2004 were approximately$11,000, as compared to approximately $12,000 for the three months endedJune 30, 2003.  Stockholder relatedcosts include such items as transfer agent fees, electronic filing and printingof various stockholder reports.

 

Financing feesconsist of the related service fees associated with our line of credit, backupservice, interest rate cap agreement and the amortization of deferred financingcosts.  Financing fees were approximately$186,000 for the three months ended June 30, 2004 and $62,000 for thethree months ended June 30, 2003.   As we entered into the warehouse line ofcredit in May 2003, the increase in financing fees is primarily a result of theincurrence of financing fees for the full three month period endedJune 30, 2004, as compared to a shorter period of time during the threemonths ended June 30, 2003.

 

Interest expensefor the three months ended June 30, 2004 was approximately $134,000 andwas incurred on borrowings from our lines of credit.  There was no interest expense for the threemonths ended June 30, 2003 because there were no borrowings outstanding.

 

As a result of thedecline in the fair market valuation of our interest rate cap agreement, werecognized a loss on derivative of approximately $114,000 for the three monthsended June 30, 2004.  There were noderivatives in place during the three months ended June 30, 2003.

 

General andadministrative expenses, consisting primarily of office operations, travel,data communications and supplies expenses, were approximately $231,000 for thethree months ended June 30, 2004, as compared to approximately $127,000for the three months ended June 30, 2003. This increase****is primarily a result of expenses fromincreased operations, including increased personnel and related recruiting feesduring the three months ended June 30, 2004, as compared to the threemonths ended June 30, 2003.  Generaland administrative expenses for the three months ended June 30, 2004 alsoreflect expenses incurred in connection with the disposal of several inactivefixed assets, as well as an increase in depreciation due to the purchase ofcomputer equipment for new personnel. This increase is partially offset bysavings associated with the expense sharing arrangement with GladstoneManagement, which allocates general expenses to Gladstone Management based onthe ratio of all employees’ time spent on Gladstone Commercial Corporation’smatters to total time spent.

 

**Net Unrealized Appreciation(Depreciation) on Investments**

 

For the threemonths ended June 30, 2004, we recorded net unrealized appreciation oninvestments of approximately $1.0 million as compared to net unrealizeddepreciation of approximately $745,000 for the three months ended June 30,2003.  The net unrealized appreciation ismainly attributable to America’s Water Heater Rentals, appreciation of the FinnCorporation warrants, and Bear Creek Corporation.

 

**Net Increase inStockholders’ Equity from Operations**

 

Overall, we realized a net increase in stockholders’ equityresulting from operations of approximately $5.6 million for the three monthsended June 30, 2004.  Based on aweighted-average of 10,105,270 (basic) and 10,301,390 (diluted) sharesoutstanding, our net increase in stockholders’ equity from operations perweighted average common share for the three months ended June 30, 2004 was$0.56 (basic) and $0.54 (diluted).

 

For the three months ended June 30,2003, we realizeda net increase in stockholders’ equity resulting from operations ofapproximately $2.4 million.  Based on aweighted-average of 10,071,844 (basic) and 10,256,790 (diluted) sharesoutstanding, our net increase in stockholders’ equity resulting from operationsper weighted average common share for the three months ended June 30, 2003was $0.24 (basic) and $0.23 (diluted).

 

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*Comparison of the nine months ended June 30, 2004to the nine months ended June 30, 2003*

 

**Investment Income**

 

Investment incomefor the nine months ended June 30, 2004 was approximately $15.0 million ascompared to $11.1 million for the nine months ended June 30, 2003. Thisincrease was primarily a result of increased interest income from an increasednumber of investments as compared to the same period of the prior year as wellas the collection of approximately $1.5 million of exit fees upon the full repaymentof two loans.

 

Interest incomefrom our investments in debt securities of private companies was approximately$13.1 million, including $413,000 of PIK interest, for the nine months endedJune 30, 2004 as compared to $9.9 million, including $668,000 of PIKinterest, for the nine months ended June 30, 2003. This increase****wasprimarily a result of an increase in investments of $53.3 million atJune 30, 2004 as compared to investments at June 30, 2003, as well asthe collection of approximately $1.5 million of exit fees upon the fullrepayment of two loans.

 

The annualizedweighted average yield on our portfolio for the nine months ended June 30,2004 was 13.57% (without giving effect to PIK interest) and 13.89% (aftergiving effect to PIK interest). The annualized weighted average yield on ourportfolio for the nine months ended June 30, 2003 was 13.48% (withoutgiving effect to PIK interest) and 14.34% (after giving effect to PIKinterest).

 

Interest incomefrom invested cash and cash equivalents for the nine months ended June 30,2004 was approximately $81,000, as compared to $391,000 for the nine monthsended June 30, 2003. This decrease****wasprimarily a result of a decrease in invested cash and cash equivalents becauseof the $102.3 million of new investments made between June 30, 2003 andJune 30, 2004.

 

For the ninemonths ended June 30, 2004 and June 30, 2003, we recordedapproximately $331,000 and $329,000, respectively, in interest income fromloans to our employees in connection with the exercise of employee stockoptions.  In March 2004 we extendeda $350,000 loan to an employee for the exercise of employee stock options.

 

Managerialassistance fees were approximately $1.0 million for the nine months endedJune 30, 2004, as compared to $483,000 for the nine months endedJune 30, 2003. This increase****was mainly attributable to theclosing of the Gammill, Inc., Woven Electronics Corp., Benetech, Inc., Mistras Holdings Corp. ($1.0 million investment) and Aand G, Inc. investments, in the approximate aggregate amount of $48.8million providing such fees during the nine months ended June 30, 2004, ascompared to the closing of Wingstop Restaurants, America’s Water HeaterRentals, and Fugate and Associates investments, in the approximate aggregateamount of $23.0 million providing such fees during the nine months endedJune 30, 2003.

 

**OperatingExpenses**

 

Operating expensesfor the nine months ended June 30, 2004 were approximately $4.4 million,as compared to approximately $2.7 million for the nine months endedJune 30, 2003. This increase****wasprimarily a result of an increase in salaries and benefits, professional fees,directors fees, stockholder related costs, financing fees and interest expense.

 

Salaries andbenefits for the nine months ended June 30, 2004 were approximately $2.1million, as compared to approximately $1.4 million for the nine months endedJune 30, 2003. The increase is attributable primarily to our board ofdirectors’ declaration of an $800,000 quarterly bonus to employees based on ourperformance during the three months ended June 30, 2004.  While salaries and benefits are allocatedaccording to the expense sharing arrangement with Gladstone Management, whichallocates expenses to Gladstone Management based on each employee’s time spenton Gladstone Commercial Corporation’s matters, no portion of the quarterlybonus was allocated to Gladstone Management because the bonus was solelyattributable to the performance of Gladstone Capital Corporation.  Without giving effect to this bonus, salariesand benefits decreased for the nine months ended June 30, 2004, ascompared to the nine months ended June 30, 2003.  Although personnel count was significantlyhigher as of June 30, 2004 than June 30, 2003, this increase was morethan offset by savings attributable to the expense sharing arrangement withGladstone Management.

 

Rent expense forthe nine months ended June 30, 2004 was approximately $107,000, ascompared to approximately $164,000 for the nine months ended June 30,2003.  The decrease in rent is due to theexpense sharing arrangement with Gladstone Management which allocates generalexpenses to Gladstone Management based on the ratio of all employees’ timespent on Gladstone Commercial Corporation’s matters to total time spent.

 

Professional fees,consisting primarily of legal and audit fees, for the nine months endedJune 30, 2004 were approximately $519,000, as compared to approximately$302,000 for the nine months ended June 30, 2003.  The increase is due primarily to an increasein legal fees associated Securities and Exchange Commission filings, as well ascertain non-reimbursable due diligence fees incurred in connection withparticipations in syndicated investments.

 

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Directors’ feesfor the nine months ended June 30, 2004 were approximately $85,000, ascompared to approximately $55,000 for the nine months ended June 30, 2003.The increase is due to the addition of two new directors during the nine monthsended June 30, 2004 as compared to the nine months ended June 30,2003.

 

Insurance expensefor the nine months ended June 30, 2004 was approximately $201,000, ascompared to approximately $217,000 for the nine months ended June 30,2003.  The decrease is due primarily tothe expense sharing arrangement with Gladstone Management which allocatesgeneral expenses to Gladstone Management based on a ratio of all employees’time spent on Gladstone Commercial Corporation’s matters to total time spent.

 

Stockholderrelated costs for the nine months ended June 30, 2004 were approximately$131,000, as compared to approximately $124,000 for the nine months endedJune 30, 2003.

 

Financing feeswere approximately $480,000 for the nine months ended June 30, 2004, ascompared to $62,000 for the nine months ended June 30, 2003.  As we entered into the warehouse line ofcredit in May 2003, the increase in financing fees is primarily a result of theincurrence of financing fees for the full nine month period ended June 30,2004, as compared to a shorter period of time during the nine months endedJune 30, 2003.

 

Interest expensefor the nine months ended June 30, 2004 was approximately $158,000 and wasincurred on borrowings from our line of credit. There was no interest expense for the nine months ended June 30,2004 as there were no borrowings outstanding before that date.

 

As a result of thedecline in the fair market valuation of our interest rate cap agreement, werecognized a loss on derivative of approximately $114,000 for the nine monthsended June 30, 2004.  There were noderivatives in place during the nine months ended June 30, 2003.

 

General andadministrative expenses, consisting primarily of office operations, travel,data communications, and supplies expenses, were approximately $531,000 for thenine months ended June 30, 2004, as compared to approximately $378,000 forthe nine months ended June 30, 2003. This increase****was primarily a result of the relatedexpenses from increased operations, including increased personnel and relatedrecruiting fees, during the nine months ended June 30, 2004 as compared tothe nine months ended June 30, 2003. General and administrative expenses for the nine months endedJune 30, 2004 also reflect expenses incurred in connection with thedisposal of several inactive fixed assets, as well as an increase indepreciation due to the purchase of computer equipment for new personnel. Thisincrease is partially offset by savings associated with the expense sharingarrangement with Gladstone Management, which allocates general expenses toGladstone Management based on the ratio of all employees’ time spent onGladstone Commercial Corporation’s matters to total time spent.

 

**Realized Gain on Sale ofInvestment**

 

During the ninemonths ended June 30, 2004, we bought and shortly thereafter sold a $1.0million investment in Metokote Corporation for a gain of $12,500.

 

**Net Unrealized Depreciation onInvestments**

 

For the ninemonths ended June 30, 2004, we recorded net unrealized depreciation oninvestments of approximately $849,000 as compared to net unrealizeddepreciation of approximately $2,000 for the nine months ended June 30,2003.  The increase in net unrealized depreciationis due to more investments as compared to June 30, 2003.

 

**Net Increase inStockholders’ Equity from Operations**

 

We realized a net increase in stockholders’ equity resulting fromoperations of approximately $9.8 million for the nine months endedJune 30, 2004.  Based on aweighted-average of 10,091,576 (basic) and 10,336,733 (diluted) sharesoutstanding, our net increase in stockholders’ equity from operations percommon share for the nine months ended June 30, 2004 was $0.97 (basic) and$0.95 (diluted).

 

For the nine months ended June 30,2003, we realizeda net increase in stockholders’ equity resulting from operations ofapproximately $8.4 million.  Based on aweighted-average of 10,071,844 (basic) and 10,160,350 (diluted) sharesoutstanding, our net increase in stockholders’ equity resulting from operationsper common share for the nine months ended June 30, 2003 was $0.84 (basic)and $0.83 (diluted).

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

At June 30,2004, we had investments in debt securities of, or loans to, 17 privatecompanies, totaling approximately $158.3 million of total investment assets.This number includes approximately $413,000 in accrued PIK interest income forthe nine months ended June 30,2004, which as described in “Overview,” is addedto the carrying value of our investments.

 

In November 2003, we purchased a $1.0 million participationin a $55.0 million senior term loan to Burt’s Bees, Inc., a manufacturer ofpersonal and household products.

 

In December 2003 we closed two loans with GQM AcquisitionCorp. totaling $14.5 million and also containing a success fee provision.  GQM Acquisition Corp conducts business asGammill, Inc. and is the designer and assembler of quilting machines andaccessories.

 

In November 2003, Kozy Shack Enterprises repaid $900,000 tofully settle its principal obligation. In December 2003, we sold a $3.2 million principal portion of ourInca Metal Products Corp/Kingway Acquisition Inc./Clymer Acquisition Inc.investment.  The remaining portion ofthis investment currently has a cost basis of $2.5 million.

 

During March 2004, we entered into a $14.5 million loaninvestment with Woven Electronics Corporation, which specializes in customelectrical cable assemblies and also purchased a $6.0 million participationinvestment with Medassets, Inc., a pharmaceutical and healthcare grouppurchasing organization (GPO).

 

In April 2004, we sold $4.6 million of our principal portionsof our investments in Gammill, Inc.  Ourremaining investments in Gammill, subsequent to the sale, are $4.963 millionand $4.75 million.  Another portfoliocompany, Wingstop Restaurants International, Inc. repaid its $5,375,000outstanding loan obligations in April 2004.  Wingstop Restaurants International, Inc. alsoremitted related prepayment fees and an exit fee with its final payment.

 

During May 2004, we entered into a $6.5 million loan investmentwith Benetech Inc., which specializes in dust management systems for the coaland electric utility industries, purchased an additional $2.0 millionparticipation investment with Medassets, Inc., and purchased a $10.0 millionparticipation in Maidenform, Inc., a manufacturer of intimate apparel.

 

During June 2004, we extended an additional $1.0 million loanto Mistras Holdings Corp. and also invested in a $12.25 million loan to A andG, Inc. a manufacturer of activewear products. We also purchased an $8.0 million participation in MD Beauty, Inc., amaker of natural cosmetic and skincare products and a $6.0 millionparticipation in Bear Creek Corporation, a purveyor of premium catalog foodproducts.

 

In June 2004, Home Care Supply Inc. repaid its entire $18.0million outstanding loan obligation and remitted prepayment fees and a successfee with its final payment.

 

In July 2004, we entered into a $4.0 million loan investmentwith Allied Extruders, Inc., a manufacturer of polyethylene film.

 

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

 

| **Year**   | ** ** | **Amount** | ** **  |
|------------|------------|------------|-------------|
| 2004       |       | $          | 1,205,525   |   |
| 2005       |       | $          | 5,677,204   |   |
| 2006       |       | $          | 20,313,428  |   |
| 2007       |       | $          | 40,480,874  |   |
| 2008       |       | $          | 30,947,359  |   |
| Thereafter |       | $          | 59,694,110  |   |
| Total      |       | $          | 158,318,500 |   |

 

Net cash providedby operating activities for the nine months ended June 30, 2004,consisting primarily of the items described in “Results of Operations,” wasapproximately $11.5 million.  Net cashused in investing activities was approximately $72.8 million during the ninemonths ended June 30, 2004. Net cash used in investing activities wasprimarily due to new investments in the aggregate amount of $82.3 million,offset by principal repayments of $33.9 million from our portfolio companiesand, to a lesser extent, repayment of repurchase agreements in the aggregateamount of $264.7 million, offset by the proceeds of repurchase agreements inthe aggregate amount of $240.1 million. ** **Net cash provided by financingactivities was approximately $20.0 million for the nine months endedJune 30, 2004 and consisted primarily of $33.5 million borrowed under ourlines of credit in order to purchase new investments, partially offset by thepayment of dividends, in an aggregate amount of approximately $13.5 million.

 

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As a result of theabove factors, during the nine months ended June 30, 2004, cash and cashequivalents decreased from approximately $101.1 million at the beginning of theperiod to approximately $59.9 million at the end of the period.

 

On June 30,2004, we entered into a Repurchase Agreement with UBS Paine Webber for$53,908,596, which agreement was settled on July 1, 2004.  The Repurchase Agreement was recorded at costand was fully collateralized by a United States Treasury Bill with a fair valueof approximately $55.0 million and a carrying value of approximately $56.0million that matured on July 8, 2004. The interest rate on the Repurchase Agreement was 1.09%.  This repurchase agreement was reflected onour balance sheet as of June 30, 2004 as cash and cash equivalents pledgedto creditors in the amount of approximately $55.0 million, along with acorresponding liability for approximately $53.9 million. The repurchaseagreement was settled on July 1, 2004. In the future, we plan to use asimilar form of repurchase agreement as an investment option or in order tosatisfy certain asset diversification requirements and maintain our status as aRIC.

 

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 a monthly cash dividend of $0.11 per commonshare for October, November and December 2003 and January, February,and March 2004 and a monthly cash dividend of $0.115 per common share forApril, May and June 2004. We also declared a monthly cash dividend of$0.12 per common share for July, August, and September 2004. The July dividendwas paid on July 30, 2004 and the August and September dividends are expectedto be paid on the last day of each month.

 

We anticipatecontinuing to borrow funds and, from time to time issuing additional equitysecurities to obtain additional capital to make further investments. To thisend, we have filed with the Securities and Exchange Commission (“SEC”) aregistration statement that would permit us to issue, through one or moretransactions, up to an aggregate of $75 million in securities, which mayconsist of shares of our common stock, preferred stock, and/or debtsecurities.  The SEC has declared thisregistration statement effective. However, we currently have no immediate plans to issue any securitiesunder the registration statement and there can be no guarantee that we will beable to sell additional securities on terms acceptable to us, if at all.

 

**Revolving Credit Facilities**

 

Through ourwholly-owned subsidiary, Gladstone Business Loan LLC (“Business Loan”), we haveobtained a $100 million revolving credit facility.  On May 19, 2003, we executed a Purchaseand Sale Agreement pursuant to which we agreed to sell certain loans toBusiness Loan in consideration of a membership interest therein.  Simultaneously, Business Loan executed aCredit Agreement with CIBC World Markets Inc., as administrative agent, andothers, pursuant to which Business Loan pledged the loans purchased from us tosecure future advances by certain institutional lenders.  Interest rates charged on the advances underthe facility will be based on LIBOR, the Prime Rate or the Federal Funds Rate,depending on market conditions, and will adjust periodically.  As of June 30, 2004, our outstandingprincipal balance under this credit facility was approximately $21.3 million atan interest rate of 2.44%.

 

The facilitycontains covenants that, among other things, require Business Loan to maintainits status as a separate entity; prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions);and restrict material changes to our credit and collection policies.  The facility also restricts some of the termsand provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofJune 30, 2004, Business Loan was in compliance with all of the facilitycovenants.  We currently intend tosecuritize all of the loans held by Business Loan and will use the proceedsfrom the securitization to pay down any amounts then outstanding under therevolving credit facility.  However,there can be no assurance that we will be able to successfully securitize anyof these loans on terms acceptable to us, if at all.

 

Our wholly-ownedsubsidiary, Gladstone Capital Advisers, Inc. (“Advisers”), services the loanspledged under the credit facility.  As acondition to this servicing arrangement, we executed a Performance Guarantypursuant to which we guaranteed that Advisers would comply fully with all of itsobligations under the credit facility. The Performance Guaranty requires us to maintain a minimum net worth of$100 million and to maintain “asset coverage” with respect to “seniorsecurities representing indebtedness” of at least 200%, in accordance withSection 18 of the 1940 Act.  As of June 30,2004, we were in compliance with our covenants under the Performance Guaranty.

 

In June 2004,we entered into a $15.0 million line of credit agreement with Branch Bankingand Trust Company (“BB&T Agreement”) which matures on June 1,2005.  Interest on outstanding borrowingsis based on the one month London Interbank Offered Rate (“LIBOR”) plus 2.5% perannum.  The unused portion of the line ofcredit is subject to a fee of 0.2% per annum. The BB&T Agreement requires us to meet and maintain certain covenantsand ratios with respect to leverage and liquidity. As of June 30, 2004,there was $12.25 million outstanding under the BB&T line of credit at aninterest rate of 3.625%.

 

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

 

We are subject tofinancial market risks, including changes in interest rates.  We expectthat ultimately approximately 50% of the loans in our portfolio will be made atfixed rates, with approximately 50% made at variable rates.  Currently ourportfolio has approximately 33% of the total of the loan portfolio cost basisat fixed rates, approximately 40% of the total loan portfolio cost basis atvariable rates with a floor and the remaining 27% of the total loan portfoliocost basis at variable rates.

 

In addition, wehave two variable rate borrowing facilities. We have a $100 million revolving credit facility with CIBC World Marketswhich matures in May 2005.  We also havea $15 million line of credit agreement which matures in June 2005.

 

To illustrate thepotential impact of changes in interest rates on our net increase instockholders’ equity resulting from operations, we have performed the followinganalysis, which assumes that our balance sheet remains constant and no furtheractions beyond the interest rate cap agreement are taken to alter our existinginterest rate sensitivity.  Under thisanalysis, a hypothetical increase in the one month LIBOR by 1% would increaseour net increase in stockholders’ equity resulting from operations by $401,000or 3.2%, over the next twelve months, compared to the net increase instockholders’ equity resulting from operations for the latest twelve monthsended June 30, 2004.  A hypotheticaldecrease in the one month LIBOR by 1% would decrease net increase instockholders’ equity resulting from operations by $401,000, or 3.2%, over thenext twelve months, compared to the net increase in stockholders’ equityresulting from operations for the latest twelve months ended June 30,2004.  Although management believes thatthis analysis is indicative of our existing interest rate sensitivity, it doesnot adjust for potential changes in credit quality, size and composition of ourloan portfolio on the balance sheet and other business developments that couldaffect net increase in stockholders’ equity resulting from operations.  Accordingly, no assurances can be given thatactual results would not differ materially from the results under this hypotheticalanalysis.

 

In February 2004, weentered into an interest rate cap agreement in order to fulfill an obligationunder our line of credit to enter into certain hedging transactions inconnection with our borrowings under the line of credit.  We purchasedthis interest rate cap agreement with a notional amount of $35 million for aone-time, up-front payment of $304,000.  The interest rate cap agreemententitles us to receive payments, if any, equal to the amount by which interestpayments on $35 million at the pointwhich one month LIBOR exceed the payments on $35 million at 5%. The cap expires in February 2009.  This interest rate capagreement effectively caps our interest payments on our line of creditborrowing, up to the notional amount of the interest rate cap, at five percent. This mitigates our exposure to increases in interest rates on ourborrowings on our lines of credit, which are at variable rates.  At June 30, 2004, the cap agreement hada fair market value of approximately $169,000. At June 30, 2004, the one month LIBOR rate was approximately 1.36%.

 

In the event thatwe securitize a portion of our loan portfolio, we believe that we will likelybe required to enter into further hedging arrangements in the future withrespect to securitized loans.  Whilehedging activities may mitigate our exposure to adverse fluctuations ininterest rates, certain hedging transactions that we may enter into in thefuture, such as interest rate swap agreements, may also limit our ability toparticipate in the benefits of lower interest rates with respect to ourportfolio of investments.

 

**ITEM4. CONTROLS AND PROCEDURES.**

 

As of June 30, 2004, we, including our Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of our disclosure controls and procedures.  Based on that evaluation, our management,including the Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures were effective in timely alertingmanagement, including the Chief Executive Officer and Chief Financial Officer,of material information about us required to be included in periodic Securitiesand Exchange Commission filings. However, in evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated can provide only reasonable assurance of achieving the desired controlobjectives, and management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

There have been no changes in our internal control over financialreporting that occurred during the quarter ended June 30, 2004, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II–OTHERINFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

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

 

**ITEM 2****. CHANGES INSECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

Not applicable.

 

**ITEM3. DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM5. OTHER INFORMATION.**

 

Not applicable

 

**ITEM 6.  EXHIBITSAND REPORTS ON FORM 8-K**

 

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

 

See the exhibit index.

 

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

 

On May 14, 2004, we furnished to the SEC under Item 12 of Form8-K, our press release, dated May 13, 2004, announcing our results ofoperations for the quarter ended March 31, 2004.  In accordance with the regulations of theSEC, this report was deemed to be furnished to, rather than filed with, theSEC.

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

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

 

Date:August 10, 2004

 

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**EXHIBITINDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                      |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                 |
| 3.1         |       | Articles of  Amendment and Restatement of the Articles of Incorporation, incorporated by  reference to Exhibit a.2 to Pre-Effective Amendment No. 1 to the Registration  Statement on Form N-2 (File No. 333-63700), 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.                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.20       |       | Amendment No. 3  to Credit Agreement dated as of May 28, 2004.                                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.21       |       | Second Amendment  to Employment Agreement dated July 15, 2003 between the Company and  David Gladstone, incorporated by reference to Exhibit k.14 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No.  333-100385), filed July 15, 2004.                |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.22       |       | Amendment to  Employment Agreement dated July 15, 2003 between the Company and Terry  Lee Brubaker, incorporated by reference to Exhibit k.15 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No.  333-100385), filed July 15, 2004.                    |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.23       |       | Amendment to  Employment Agreement dated July 15, 2003 between the Company and George  Stelljes III, incorporated by reference to Exhibit k.16 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No.  333-100385), filed July 15, 2004.                   |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.24       |       | Third Amendment  to Employment Agreement dated April 22, 2004 between the Company and  David Gladstone, incorporated by reference to Exhibit k.17 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No. 333-100385),  filed July 15, 2004.                |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.25       |       | Second Amendment  to Employment Agreement dated May 6, 2004 between the Company and Terry Lee  Brubaker, incorporated by reference to Exhibit k.18 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No.  333-100385), filed July 15, 2004.                    |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.26       |       | Second Amendment  to Employment Agreement dated May 6, 2004 between the Company and George  Stelljes III, incorporated by reference to Exhibit k.19 to Post-Effective  Amendment No. 2 to the Registration Statement on Form N-2 (File No.  333-100385), filed July 15, 2004.                   |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 10.27       |       | Loan Agreement  dated as of June 22, 2004 between Gladstone Capital Corporation and  Branch Banking and Trust Company, incorporated by reference to Exhibit k.20  to Post-Effective Amendment No. 2 to the Registration Statement on Form N-2  (File No. 333-100385), filed July 15, 2004. |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 11          |       | Computation of  Per Share Earnings (included in the notes to the unaudited financial  statements contained in this report).                                                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 31.1        |       | Certification of  Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 31.2        |       | Certification of  Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 32.1        |       | Certification of  Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                 |
| 32.2        |       | Certification of  Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                           |

 

All other exhibits for which provision is made in the applicableregulations of the Securities and Exchange Commission are not required underthe related instruction or are inapplicable and therefore have been omitted.

 

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