** **

**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**

 

**FORTHE QUARTER ENDED MARCH 31, 2003.**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSIONFILE 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 check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months and (2) has been subject to suchfiling requirements for the past 90 days.

Yes ý No o.

 

Indicate by check mark whether the registrant is an acceleratedfiler (as defined in Rule 12 b-2 of the Securities Exchange Act of 1934).

Yes ý No o.

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.  The number of shares of the issuer’s CommonStock, $0.001 par value, outstanding as of April 23, 2003 was 10,071,844.

 

 

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**GLADSTONECAPITAL CORPORATION**

**TABLEOF CONTENTS**

 
| PART I.        | FINANCIAL  INFORMATION                                                                                            |
|----------------|-------------------------------------------------------------------------------------------------------------------|
|           |                                                                                                              |
| Item 1.        | Financial Statements  (Unaudited)                                                                                 |
|           |                                                                                                              |
|           | Consolidated Balance Sheets  as of March 31, 2003 and September 30, 2002                                          |
|           | Schedule of Investments as of  March 31, 2003 and September 30, 2002                                              |
|           | Consolidated  Statements of Operations for the three months ended March 31, 2003 and March  31, 2002              |
|           | Consolidated  Statements of Operations for the six months ended March 31, 2003 and March  31, 2002                |
|           | Consolidated  Statements of Stockholders’ Equity for the six months ended March 31, 2003  and March 31, 2002 |
|           | Consolidated  Statements of Cash Flows for the six months ended March 31, 2003 and March  31, 2002                |
|           | Financial Highlights for the three  and six months ended March 31, 2003 and March 31, 2002                        |
|           | Notes  to Consolidated Financial Statements                                                                       |
|           |                                                                                                              |
| Item 2.        | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                       |
|           |                                                                                                              |
|           | Overview                                                                                                          |
|           | Results of Operations                                                                                             |
|           | Liquidity and Capital  Resources                                                                                  |
|           |                                                                                                              |
| Item 3.        | Quantitative and Qualitative  Disclosure About Market Risk                                                        |
|           |                                                                                                              |
| Item 4.        | Controls and  Procedures                                                                                          |
|           |                                                                                                              |
| PART II.       | OTHER INFORMATION                                                                                                 |
|           |                                                                                                              |
| Item 1.        | Legal Proceedings                                                                                                 |
|           |                                                                                                              |
| Item 2.        | Changes in Securities  and Use of Proceeds                                                                        |
|           |                                                                                                              |
| Item 3.        | Defaults Upon  Senior Securities                                                                                  |
|           |                                                                                                              |
| Item 4.        | Submission of  Matters to a Vote of Security Holders                                                              |
|           |                                                                                                              |
| Item 5.        | Other Information                                                                                                 |
|           |                                                                                                              |
| Item 6.        | Exhibits and  Reports on Form 8-K                                                                                 |
|           |                                                                                                              |
| SIGNATURES     |
|           |                                                                                                              |
| CERTIFICATIONS |

 

2

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**PART I****—FINANCIAL INFORMATION**

 

**GladstoneCapital Corporation**

 

**ConsolidatedFinancial Statements**

 

**(Unaudited)**

 

**March31, 2003**

 

**CONTENTS**

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

 

3

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**GLADSTONECAPITAL CORPORATION**

 

**CONSOLIDATED BALANCESHEETS**

 

 
|                                                                                                        |   | **March 31,  2003** |        | **September 30,  2002** |   |
|-------------------------------------------------------------------------------------------------------------|--------|---------------------|-------------|-------------------------|--------|
|                                                                                                        |   | **(Unaudited)**     |        |                    |   |
| **ASSETS**                                                                                                  |   |                |        |                    |   |
| Investments at  fair value (Cost 3/31/2003: $101,294,476; 9/30/2002: $79,718,354)                           |   | $                   | 102,036,900 |                    | $      | 79,718,354 |   |
| Cash and cash  equivalents                                                                                  |   | 31,154,246          |        | 51,930,529              |   |
| Cash and cash  equivalents pledged as collateral                                                            |   | 65,011,213          |        | 39,998,799              |   |
| Interest  receivable – investments in debt securities                                                  |   | 942,777             |        | 685,274                 |   |
| Interest  receivable – cash and cash equivalents                                                       |   | 969                 |        | 4,389                   |   |
| Interest  receivable – officers                                                                        |   | 109,737             |        | 109,874                 |   |
| Prepaid assets                                                                                              |   | 312,165             |        | 357,955                 |   |
| Other assets                                                                                                |   | 278,750             |        | 116,865                 |   |
|                                                                                                        |   |                |        |                    |   |
| **TOTAL ASSETS**                                                                                            |   | $                   | 199,846,757 |                    | $      | 172,922,039 |   |
|                                                                                                        |   |                |        |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                               |   |                |        |                    |   |
|                                                                                                        |   |                |        |                    |   |
| **LIABILITIES**                                                                                             |   |                |        |                    |   |
| Dividends  Payable                                                                                          |   | $                   | 2,517,961   |                    | $      | 2,115,087 |   |
| Accrued expenses  and deferred liabilities                                                                  |   | 1,715,561           |        | 944,960                 |   |
| Repurchase  agreement                                                                                       |   | 63,710,277          |        | 39,198,719              |   |
|                                                                                                        |   |                |        |                    |   |
| **Total Liabilities**                                                                                       |   | $                   | 67,943,799  |                    | $      | 42,258,766 |   |
|                                                                                                        |   |                |        |                    |   |
| **STOCKHOLDERS’ EQUITY**                                                                               |   |                |        |                    |   |
| Common stock,  $0.001 par value, 50,000,000 shares authorized and 10,071,844 shares issued  and outstanding |   | $                   | 10,072      |                    | $      | 10,072 |   |
| Capital in  excess of par value                                                                             |   | 140,266,684         |        | 140,266,684             |   |
| Notes receivable  – officers                                                                           |   | (8,983,796          | )           | (8,983,796              | )      |
| Net unrealized  appreciation on investments                                                                 |   | 742,424             |        | —                  |   |
| Declared  distributions in excess of undistributed earnings                                                 |   | (132,426            | )           | (629,687                | )      |
|                                                                                                        |   |                |        |                    |   |
| **Total Stockholders’ Equity**                                                                         |   | $                   | 131,902,958 |                    | $      | 130,663,273 |   |
|                                                                                                        |   |                |        |                    |   |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                         |   | $                   | 199,846,757 |                    | $      | 172,922,039 |   |

 

SEE ACCOMPANYING NOTES.

 

4

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**GLADSTONECAPITAL CORPORATION**

 

**SCHEDULE OF INVESTMENTS**

 

**ASOF MARCH 31, 2003**

 

**(UNAUDITED)**

 
| **COMPANY(1)**                                                                |   | **INDUSTRY**                            |   | **INVESTMENT**                          |   | **COST**   |        | **FAIR VALUE** |   |
|-------------------------------------------------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|------------|-------------|----------------|--------|
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| America’s Water  Heater Rentals, LLC                                     |   | Water heater  rentals and servicing     |   | Senior Term  Debt(2)                    |   | $          | 12,000,000  |           | $      | 12,000,000 |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| ARI Holdings,  Inc.                                                           |   | Manufacturing  auto parts               |   | Junior  Subordinated Term Debt(3)(4)    |   | 8,459,234  |        | 8,448,660      |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Coyne  International Enterprises Corp.                                        |   | Industrial  services                    |   | Senior Term  Debt(2)(3)(4)              |   | 20,231,286 |        | 20,003,684     |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Finn Corporation                                                              |   | Manufacturing  landscape equipment      |   | Senior  Subordinated Term Debt(4)       |   | 10,500,000 |        | 10,500,000     |   |
|                                                                          |   |                                    |   | Common Stock  Warrants for 2% ownership |   | 37,000     |        | 490,323        |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Home Care  Supply, Inc.                                                       |   | Medical  equipment rental               |   | Senior Term  Debt(2)(4)(5)              |   | 18,000,000 |        | 18,576,964     |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Inca Metal Products  Corp. Kingway Acquisition, Inc. Clymer Acquisition, Inc. |   | Material  handling and storage products |   | Senior Term  Debt(2)                    |   | 5,925,000  |        | 5,925,000      |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Kozy Shack  Enterprises, Inc.                                                 |   | Food production  and sales              |   | Senior Term  Debt(2)(4)                 |   | 4,200,000  |        | 4,205,250      |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Marcal Paper  Mills, Inc.                                                     |   | Manufacturing  paper products           |   | Senior  Subordinated Term Debt(2)(4)    |   | 7,325,000  |        | 7,270,063      |   |
|                                                                          |   |                                    |   | First Mortgage Debt(3)                  |   | 9,116,956  |        | 9,116,956      |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Wing Stop  Restaurants International, Inc.                                    |   | Restaurant –  fast food            |   | Senior Term Debt                        |   | 2,000,000  |        | 2,000,000      |   |
|                                                                          |   |                                    |   | Senior Term Debt                        |   | 3,500,000  |        | 3,500,000      |   |
|                                                                          |   |                                    |   |                                    |   |       |        |           |   |
| Totals                                                                        |   |                                    |   |                                    |   | $          | 101,294,476 |           | $      | 102,036,900 |   |

 

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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 isliquidated then the holder of the Last Out Tranche is paid after the seniordebt.

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

(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 $666,964.

 

SEE ACCOMPANYING NOTES.

 

5

----

 

**GLADSTONECAPITAL CORPORATION**

 

**SCHEDULEOF INVESTMENTS**

 

**ASOF SEPTEMBER 30, 2002**

 

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

 

----

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

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

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

 

SEE ACCOMPANYING NOTES.

 

6

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**GLADSTONECAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENT OF OPERATIONS**

 

**(UNAUDITED)**

 
|                                                                                      |   | **Three Months Ended  March 31, 2003** |      | **Three Months Ended  March 31, 2002** |   |
|-------------------------------------------------------------------------------------------|--------|----------------------------------------|-----------|----------------------------------------|--------|
| **INVESTMENT INCOME**                                                                     |   |                                   |      |                                   |   |
| Interest income  – investments                                                       |   | $                                      | 3,275,962 |                                   | $      | 1,596,970 |   |
| Interest income  – cash and cash equivalents                                         |   | 113,338                                |      | 368,570                                |   |
| Interest income  – notes receivable from officers                                    |   | 109,737                                |      | 107,409                                |   |
| Managerial  assistance fees                                                               |   | 358,000                                |      | 29,102                                 |   |
| Other income                                                                              |   | 2,256                                  |      | 47,500                                 |   |
| Total Investment  Income                                                                  |   | $                                      | 3,859,293 |                                   | $      | 2,149,551 |   |
|                                                                                      |   |                                   |      |                                   |   |
| **EXPENSES**                                                                              |   |                                   |      |                                   |   |
| Salaries and  benefits                                                                    |   | $                                      | 477,861   |                                   | $      | 327,158 |   |
| Rent                                                                                      |   | 54,525                                 |      | 36,227                                 |   |
| Professional  fees                                                                        |   | 86,577                                 |      | 114,061                                |   |
| Directors fees                                                                            |   | 20,857                                 |      | 5,000                                  |   |
| Insurance                                                                                 |   | 73,686                                 |      | 50,329                                 |   |
| Stockholder  related costs                                                                |   | 74,342                                 |      | 62,045                                 |   |
| General and  administrative                                                               |   | 151,854                                |      | 146,249                                |   |
| Total  Expenses                                                                      |   | $                                      | 939,702   |                                   | $      | 741,069 |   |
|                                                                                      |   |                                   |      |                                   |   |
| **NET INVESTMENT INCOME**                                                                 |   | $                                      | 2,919,591 |                                   | $      | 1,408,482 |   |
|                                                                                      |   |                                   |      |                                   |   |
| Net unrealized  appreciation on investments                                               |   | 742,424                                |      | —                                 |   |
|                                                                                      |   |                                   |      |                                   |   |
| **NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING  FROM OPERATIONS**                  |   | $                                      | 3,662,015 |                                   | $      | 1,408,482 |   |
|                                                                                      |   |                                   |      |                                   |   |
| **NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING  FROM OPERATIONS PER COMMON SHARE** |   |                                   |      |                                   |   |
| Basic                                                                                     |   | $                                      | 0.36      |                                   | $      | 0.14 |   |
| Diluted                                                                                   |   | $                                      | 0.36      |                                   | $      | 0.14 |   |
|                                                                                      |   |                                   |      |                                   |   |
| **WEIGHTED AVERAGE SHARES OF COMMON STOCK  OUTSTANDING**                                  |   |                                   |      |                                   |   |
| Basic                                                                                     |   | 10,071,844                             |      | 10,060,178                             |   |
| Diluted                                                                                   |   | 10,100,062                             |      | 10,160,417                             |   |

 

SEE ACCOMPANYING NOTES.

 

7

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**GLADSTONECAPITAL CORPORATION**

 

**CONSOLIDATED****STATEMENT OF OPERATIONS**

 

**(UNAUDITED)**

 
|                                                                                            |   | **Six Months Ended  March 31, 2003** |      | **Six Months Ended  March 31, 2002** |   |
|-------------------------------------------------------------------------------------------------|--------|--------------------------------------|-----------|--------------------------------------|--------|
| **INVESTMENT INCOME**                                                                           |   |                                 |      |                                 |   |
| Interest income  – investments                                                             |   | $                                    | 6,203,625 |                                 | $      | 1,926,627 |   |
| Interest income  – cash and cash equivalents                                               |   | 311,504                              |      | 1,009,085                            |   |
| Interest income  – notes receivable from officers                                          |   | 219,341                              |      | 214,827                              |   |
| Managerial  assistance fees                                                                     |   | 358,000                              |      | 640,911                              |   |
| Other income                                                                                    |   | 2,256                                |      | 47,500                               |   |
| Total Investment  Income                                                                        |   | $                                    | 7,094,726 |                                 | $      | 3,838,950 |   |
|                                                                                            |   |                                 |      |                                 |   |
| **EXPENSES**                                                                                    |   |                                 |      |                                 |   |
| Salaries and  benefits                                                                          |   | $                                    | 911,101   |                                 | $      | 604,342 |   |
| Rent                                                                                            |   | 109,145                              |      | 47,280                               |   |
| Professional  fees                                                                              |   | 201,267                              |      | 215,482                              |   |
| Directors fees                                                                                  |   | 34,357                               |      | 7,000                                |   |
| Insurance                                                                                       |   | 144,841                              |      | 97,664                               |   |
| Stockholder  related costs                                                                      |   | 111,432                              |      | 71,262                               |   |
| General and  administrative                                                                     |   | 250,837                              |      | 190,458                              |   |
| Total  Expenses                                                                            |   | $                                    | 1,762,980 |                                 | $      | 1,233,488 |   |
|                                                                                            |   |                                 |      |                                 |   |
| **NET INVESTMENT INCOME**                                                                       |   | $                                    | 5,331,746 |                                 | $      | 2,605,462 |   |
|                                                                                            |   |                                 |      |                                 |   |
| Net unrealized  appreciation on investments                                                     |   | 742,424                              |      | —                               |   |
|                                                                                            |   |                                 |      |                                 |   |
| **NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING  FROM OPERATIONS**                        |   | $                                    | 6,074,170 |                                 | $      | 2,605,462 |   |
|                                                                                            |   |                                 |      |                                 |   |
| **NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING  FROM OPERATIONS  PER COMMON SHARE** |   |                                 |      |                                 |   |
| Basic                                                                                           |   | $                                    | 0.60      |                                 | $      | 0.26 |   |
| Diluted                                                                                         |   | $                                    | 0.60      |                                 | $      | 0.26 |   |
|                                                                                            |   |                                 |      |                                 |   |
| **WEIGHTED AVERAGE SHARES OF COMMON STOCK  OUTSTANDING**                                        |   |                                 |      |                                 |   |
| Basic                                                                                           |   | 10,071,844                           |      | 10,060,178                           |   |
| Diluted                                                                                         |   | 10,112,129                           |      | 10,153,223                           |   |

 

SEE ACCOMPANYING NOTES.

 

8

----

 

**GLADSTONECAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

 

**(UNAUDITED)**

 
|                                                                |   | **Common Stock** |   | **Capital in  Excess of  Par Value** |   | **Notes  Receivable  From Sale of  Common  Stock** |   | **(Distributions)  in Excess of  Undistributed  Earnings** |   | **Unrealized  Appreciation  (Depreciation)  of Investments** |       | **Total  Stockholders’  Equity** |   |
|---------------------------------------------------------------------|--------|------------------|--------|--------------------------------------|--------|----------------------------------------------------|--------|------------------------------------------------------------|--------|--------------------------------------------------------------|------------|---------------------------------------|--------|
| **Shares**                                                          |   | **Amount**       |
| For the Six Months Ended March 31, 2002:                            |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Balance at September 30, 2001                                       |   | 10,060,178       |   | $                                    | 10,060 |                                               | $      | 140,131,778                                                |   | $                                                            | (8,800,050 | )                                     | $      | (92,644 | ) | $ | — |   | $ | 131,249,144 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Offering Costs                                                      |   |             |   |                                 |   | (50,971                                            | )      |                                                       |   |                                                         |       |                                  |   | (50,971 | ) |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Repayment of Principal on Notes Receivable                          |   |             |   |                                 |   |                                               |   | 931                                                        |   |                                                         |       |                                  |   | 931 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Net Increase in Stockholders’ Equity Resulting from Operations |   |             |   |                                 |   |                                               |   |                                                       |   | 2,605,462                                                    |       | —                                |   | 2,605,462 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Distributions Declared ($0.18 per common share)                     |   |             |   |                                 |   |                                               |   |                                                       |   | (3,923,469                                                   | )          |                                  |   | (3,923,469 | ) |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Balance at March 31, 2002                                           |   | 10,060,178       |   | $                                    | 10,060 |                                               | $      | 140,080,807                                                |   | $                                                            | (8,799,119 | )                                     | $      | (1,410,651 | ) | $ | — |   | $ | 129,881,097 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| For the Six Months Ended March 31, 2003:                            |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Balance at September 30, 2002                                       |   | 10,071,844       |   | $                                    | 10,072 |                                               | $      | 140,266,684                                                |   | $                                                            | (8,983,796 | )                                     | $      | (629,687 | ) | $ | — |   | $ | 130,663,273 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Net Increase in Stockholders’ Equity Resulting from Operations |   |             |   |                                 |   |                                               |   |                                                       |   | 5,331,746                                                    |       | 742,424                               |   | 6,074,170 |   |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Distributions Declared ($0.48 per common share)                     |   |             |   |                                 |   |                                               |   |                                                       |   | (4,834,485                                                   | )          |                                  |   | (4,834,485 | ) |
|                                                                |   |             |   |                                 |   |                                               |   |                                                       |   |                                                         |       |                                  |   |   |   |
| Balance at March 31, 2003                                           |   | 10,071,844       |   | $                                    | 10,072 |                                               | $      | 140,266,684                                                |   | $                                                            | (8,983,796 | )                                     | $      | (132,426 | ) | $ | 742,424 |   | $ | 131,902,958 |   |

 

SEE ACCOMPANYING NOTES.

 

9

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**GLADSTONECAPITAL CORPORATION**

 

**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

 

**(UNAUDITED)**

 
|                                                                                                                                                   |   | **Six Months  Ended  March 31, 2003** |       | **Six Months  Ended  March 31, 2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|---------------------------------------|--------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                               |   |                                  |       |                                  |   |
| Net increase in  stockholders’ equity resulting from operations                                                                                   |   | $                                     | 6,074,170  |                                  | $      | 2,605,462 |   |
| Adjustments to  reconcile net increase in stockholders’ equity resulting from operations to  net cash provided by (used in) operating activities: |   |                                  |       |                                  |   |
| Depreciation                                                                                                                                           |   | 13,791                                |       | —                                |   |
| Net unrealized  (appreciation)                                                                                                                         |   | (742,424                              | )          | —                                |   |
| Increase in  interest receivable                                                                                                                       |   | (253,946                              | )          | (465,006                              | )      |
| Increase in  other assets                                                                                                                              |   | (121,559                              | )          | (200,358                              | )      |
| Increase in  accrued expenses and deferred liabilities                                                                                                 |   | 770,601                               |       | 18,834                                |   |
| Decrease in  prepaid assets                                                                                                                            |   | 45,790                                |       | 69,678                                |   |
| Increase in  accounts payable                                                                                                                          |   | —                                |       | 130,500                               |   |
| Increase in  investment balance due to payment in kind interest                                                                                        |   | (426,122                              | )          | (96,927                               | )      |
| Net Cash  Provided by Operating Activities                                                                                                             |   | $                                     | 5,360,301  |                                  | $      | 2,062,183 |   |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                                                                                               |   |                                  |       |                                  |   |
| Purchase of  furniture and equipment                                                                                                                   |   | $                                     | (54,115    | )                                     | $      | — |   |
| Purchase of  investments                                                                                                                               |   | (21,500,000                           | )          | (42,083,211                           | )      |
| Principal  repayments on investments                                                                                                                   |   | 350,000                               |       | —                                |   |
| Proceeds from  repurchase agreements                                                                                                                   |   | 102,915,974                           |       | —                                |   |
| Repayment of  repurchase agreements                                                                                                                    |   | (78,404,416                           | )          | —                                |   |
| Net Cash  Provided by (Used in) Investing Activities                                                                                                   |   | $                                     | 3,307,443  |                                  | $      | (42,083,211 | ) |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                                                                               |   |                                  |       |                                  |   |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| Offering costs                                                                                                                                         |   | $                                     | —     |                                  | $      | (50,971 | ) |
| Increase  (decrease) in accrued offering costs                                                                                                         |   | —                                |       | (590,382                              | )      |
| Repayment of  principal on notes receivable – officers                                                                                            |   | —                                |       | 931                                   |   |
| Distributions  paid                                                                                                                                    |   | (4,431,613                            | )          | (1,810,832                            | )      |
| Net Cash (Used  in) Financing Activities                                                                                                               |   | $                                     | (4,431,613 | )                                     | $      | (2,451,254 | ) |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                                                                                              |   | $                                     | 4,236,131  |                                  | $      | (42,472,282 | ) |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD(1)**                                                                                                 |   | $                                     | 91,929,328 |                                  | $      | 131,824,080 |   |
|                                                                                                                                                   |   |                                  |       |                                  |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD (Note  9)**                                                                                                 |   | $                                     | 96,165,459 |                                  | $      | 89,351,798 |   |

 

----

(1)  Cash and cashequivalents consist of demand deposits and highly liquid investments withoriginal maturities of three months or less.

 

SEE ACCOMPANYING NOTES.

 

10

----

 

**GLADSTONECAPITAL CORPORATION**

 

**FINANCIAL HIGHLIGHTS**

 

**(UNAUDITED)**

 
|                                                                    |   | **Three Months  Ended March 31, 2003** |        | **Three Months  Ended March 31, 2002** |   |
|-------------------------------------------------------------------------|--------|----------------------------------------|-------------|----------------------------------------|--------|
| Per Share Data(1)                                                       |   |                                   |        |                                   |   |
| Net asset value  at beginning of period                                 |   | $                                      | 12.98       |                                   | $      | 12.98 |   |
| Net investment  income                                                  |   | 0.29                                   |        | 0.14                                   |   |
| Net unrealized  gain on investments                                     |   | 0.07                                   |        | 0                                      |   |
| Distributions  from net investment income                               |   | (0.25                                  | )           | (0.21                                  | )      |
| Net asset value  at end of period                                       |   | $                                      | 13.09       |                                   | $      | 12.91 |   |
|                                                                    |   |                                   |        |                                   |   |
| Per share market  value at beginning of period                          |   | $                                      | 16.47       |                                   | $      | 18.69 |   |
| Per share market  value at end of period                                |   | 16.18                                  |        | 17.80                                  |   |
| Total  Return(2)(3)                                                     |   | -0.24                                  | %           | -3.64                                  | %      |
| Shares  outstanding at end of period                                    |   | 10,071,844                             |        | 10,060,178                             |   |
|                                                                    |   |                                   |        |                                   |   |
| Ratios/Supplemental Data                                                |   |                                   |        |                                   |   |
| Net assets at  end of period                                            |   | $                                      | 131,902,958 |                                   | $      | 129,881,097 |   |
| Average net  assets                                                     |   | $                                      | 132,125,265 |                                   | $      | 130,819,578 |   |
| Ratio of  operating expenses to average net assets – annualized    |   | 2.85                                   | %           | 2.28                                   | %      |
| Ratio of net  investment income to average net assets – annualized |   | 11.09                                  | %           | 4.32                                   | %      |

 
|                                                                    |   | **Six Months  Ended March 31, 2003** |        | **Six Months  Ended March 31, 2002** |   |
|-------------------------------------------------------------------------|--------|--------------------------------------|-------------|--------------------------------------|--------|
| Per Share Data(1)                                                       |   |                                 |        |                                 |   |
| Net asset value  at beginning of period                                 |   | $                                    | 12.97       |                                 | $      | 13.05 |   |
| Net investment  income                                                  |   | 0.53                                 |        | 0.26                                 |   |
| Net unrealized  gain on investments                                     |   | 0.07                                 |        | 0                                    |   |
| Distributions  from net investment income                               |   | (0.48                                | )           | (0.39                                | )      |
| Offering costs                                                          |   | 0                                    |        | (0.01                                | )      |
| Net asset value  at end of period                                       |   | $                                    |  13.09 |                                 | $      |  12.91 |   |
|                                                                    |   |                                 |        |                                 |   |
| Per share market  value at beginning of period                          |   | $                                    |  16.88 |                                 | $      |  16.14 |   |
| Per share market  value at end of period                                |   | 16.18                                |        | 17.80                                |   |
| Total  Return(2)(3)                                                     |   | -1.30                                | %           | 12.70                                | %      |
| Shares  outstanding at end of period                                    |   | 10,071,844                           |        | 10,060,178                           |   |
|                                                                    |   |                                 |        |                                 |   |
| Ratios/Supplemental Data                                                |   |                                 |        |                                 |   |
| Net assets at  end of period                                            |   | $                                    | 131,902,958 |                                 | $      | 129,881,097 |   |
| Average net  assets                                                     |   | $                                    | 131,844,204 |                                 | $      | 131,052,167 |   |
| Ratio of  operating expenses to average net assets – annualized    |   | 2.67                                 | %           | 1.88                                 | %      |
| Ratio of net  investment income to average net assets – annualized |   | 9.21                                 | %           | 1.99                                 | %      |

 

----

(1)          Basic per share data.

(2)          Amounts were not annualized for theresults of the three and six month periods ended March 31, 2003 and March 31,2002.

(3)          Total return equals the increase ofthe ending market value over the beginning market value plus dividends dividedby the beginning market value.

 

SEE ACCOMPANYING NOTES**.**

 

11

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**GLADSTONECAPITAL CORPORATION**

 

**NOTES TO FINANCIALSTATEMENTS**

 

**MARCH31, 2003**

 

**(UNAUDITED)**

 

NOTE 1. UNAUDITEDINTERIM FINANCIAL STATEMENTS

 

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

 

NOTE 2.ORGANIZATION

 

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

 

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

 

NOTE 3. STOCKOPTIONS

 

In December 2002,the Financial Accounting Standards Board (FASB) approved the issuance ofStatement of Financial Accounting Standards (SFAS) Statement No. 148“Accounting for Stock-Based Compensation — Transition and Disclosure”.  The statement amended SFAS Statement No. 123“Accounting for Stock-Based Compensation” to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock based employee compensation.  Furthermore, SFAS No. 148 amended the disclosure requirements ofSFAS No. 123 to require more prominent disclosures in both annual and interimfinancial statements about the method and related effect on results of accountingfor stock-based employee compensation, effective for fiscal year and interimperiods beginning after December 15, 2002.

 

The followingtables set forth the pro-forma effect of fair value option accounting for thethree and six months ended March 31, 2003 and March 31, 2002:

 

12

----

 
|                                                                                                             |   | **Three  Months  Ended March 31,  2003** |      | **Three  Months**

**Ended  March 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|-----------|-----------------------------------------------|--------|
|                                                                                                             |   |                                     |      |                                          |   |
| Increase in stockholders’  equity from operations, as reported                                              |   | $                                        | 3,662,015 |                                          | $      | 1,408,482 |   |
|                                                                                                             |   |                                     |      |                                          |   |
| Deduct:  total stock-based employee compensation  expense determined under fair value method for all awards |   | (157,720                                 | )         | (29,850                                       | )      |
|                                                                                                             |   |                                     |      |                                          |   |
| Pro-forma increase in stockholders’ equity from operations                                                  |   | $                                        | 3,504,295 |                                          | $      | 1,378,632 |   |
|                                                                                                             |   |                                     |      |                                          |   |
| Increase in stockholders’  equity from operations per share                                                 |   |                                     |      |                                          |   |
| Basic, as reported                                                                                               |   | $                                        | 0.36      |                                          | $      | 0.14 |   |
| Basic, pro-forma                                                                                                 |   | $                                        | 0.35      |                                          | $      | 0.14 |   |
|                                                                                                             |   |                                     |      |                                          |   |
| Diluted, as reported                                                                                             |   | $                                        | 0.36      |                                          | $      | 0.14 |   |
| Diluted, pro-forma                                                                                               |   | $                                        | 0.35      |                                          | $      | 0.14 |   |

 
|                                                                                                             |   | **Six Months  Ended March 31,  2003** |      | **Six Months  Ended March 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|-----------|---------------------------------------|--------|
|                                                                                                             |   |                                  |      |                                  |   |
| Increase in stockholders’  equity from operations, as reported                                              |   | $                                     | 6,074,170 |                                  | $      | 2,605,462 |   |
|                                                                                                             |   |                                  |      |                                  |   |
| Deduct:  total stock-based employee compensation  expense determined under fair value method for all awards |   | (315,441                              | )         | (59,700                               | )      |
|                                                                                                             |   |                                  |      |                                  |   |
| Pro-forma increase in stockholders’ equity from operations                                                  |   | $                                     | 5,758,729 |                                  | $      | 2,545,762 |   |
|                                                                                                             |   |                                  |      |                                  |   |
| Increase in stockholders’  equity from operations per share                                                 |   |                                  |      |                                  |   |
| Basic, as reported                                                                                               |   | $                                     | 0.60      |                                  | $      | 0.26 |   |
| Basic, pro-forma                                                                                                 |   | $                                     | 0.57      |                                  | $      | 0.25 |   |
|                                                                                                             |   |                                  |      |                                  |   |
| Diluted, as reported                                                                                             |   | $                                     | 0.60      |                                  | $      | 0.26 |   |
| Diluted, pro-forma                                                                                               |   | $                                     | 0.57      |                                  | $      | 0.25 |   |

 

NOTE 4. INCREASEIN STOCKHOLDERS’ EQUITY FROM OPERATIONS PER SHARE

 

The followingtables set forth the computation of basic and diluted increase in stockholders’ equity fromoperations per share for the three and six months ended March 31, 2003and March 31, 2002:

 
|                                                                                             |   | **Three  Months  Ended March 31,  2003** |      | **Three  Months  Ended March 31,  2002** |   |
|--------------------------------------------------------------------------------------------------|--------|------------------------------------------|-----------|------------------------------------------|--------|
|                                                                                             |   |                                     |      |                                     |   |
| Numerator for basic and  diluted increase in stockholders’ equity from operations per share |   | $                                        | 3,662,015 |                                     | $      | 1,408,482 |   |
|                                                                                             |   |                                     |      |                                     |   |
| Denominator for basic  weighted average shares                                                   |   | 10,071,844                               |      | 10,060,178                               |   |
|                                                                                             |   |                                     |      |                                     |   |
| Dilutive potential shares                                                                        |   | 28,218                                   |      | 100,239                                  |   |
|                                                                                             |   |                                     |      |                                     |   |
| Denominator for diluted  weighted average shares                                                 |   | 10,100,062                               |      | 10,160,417                               |   |
|                                                                                             |   |                                     |      |                                     |   |
| Employee stock options                                                                           |   | 931,664                                  |      | 723,330                                  |   |
|                                                                                             |   |                                     |      |                                     |   |
| Basic increase in  stockholders’ equity from operations per common share                    |   | 0.36                                     |      | 0.14                                     |   |
| Diluted increase in  stockholders’ equity from operations per common share                  |   | 0.36                                     |      | 0.14                                     |   |
|                                                                                                  |        |                                          |           |                                          |        |  |  |

 

13

----

 
|                                                                                             |   | **Six Months  Ended March 31,  2003** |      | **Six Months  Ended March 31,  2002** |   |
|--------------------------------------------------------------------------------------------------|--------|---------------------------------------|-----------|---------------------------------------|--------|
|                                                                                             |   |                                  |      |                                  |   |
| Numerator for basic and  diluted increase in stockholders’ equity from operations per share |   | $                                     | 6,074,170 |                                  | $      | 2,605,462 |   |
|                                                                                             |   |                                  |      |                                  |   |
| Denominator for basic  weighted average shares                                                   |   | 10,071,844                            |      | 10,060,178                            |   |
|                                                                                             |   |                                  |      |                                  |   |
| Dilutive potential shares                                                                        |   | 40,285                                |      | 93,045                                |   |
|                                                                                             |   |                                  |      |                                  |   |
| Denominator for diluted  weighted average shares                                                 |   | 10,112,129                            |      | 10,153,223                            |   |
|                                                                                             |   |                                  |      |                                  |   |
| Employee stock options                                                                           |   | 931,664                               |      | 723,330                               |   |
|                                                                                             |   |                                  |      |                                  |   |
| Basic increase in  stockholders’ equity from operations per common share                    |   | 0.60                                  |      | 0.26                                  |   |
| Diluted increase in  stockholders’ equity from operations per common share                  |   | 0.60                                  |      | 0.26                                  |   |
|                                                                                                  |        |                                       |           |                                       |        |  |  |

 

NOTE 5. DIVIDENDS

 

The Company isrequired to pay out as a dividend 90% of its ordinary income and short-termcapital gains for each taxable year in order to maintain its status as a RICunder Subtitle A, Chapter 1 of Subchapter M of the Code.  It is the policy of the Company to pay outas a dividend up to 100% of those amounts.  The amount to be paid out as a dividend is determined by the Boardof Directors each quarter and is based on the annual earnings estimated by themanagement of the Company.  Based onthat estimate, a dividend is declared each quarter.  At year-end the Company may pay a bonus dividend, in addition tothe quarterly dividends, to ensure that it has paid out at least 90% of itsordinary income and short-term capital gains for the year.  The Company has a policy of retaininglong-term capital gains, if any, and not paying them out as dividends.

 

On April 7, 2003,the Company paid a dividend of $0.25 per share on its common stock tostockholders of record as of March 31, 2003 and on January 7, 2003, the Companypaid a dividend of $0.23 per share on its common stock to its stockholders ofrecord as of December 31, 2002.   OnApril 8, 2002, the Company paid a dividend of $0.21 per share on its commonstock to its stockholders of record as of March 28, 2002 and on January 15, 2002,the Company paid a dividend of $0.18 per share on its common stock to itsstockholders of record as of December 31, 2001.

 

NOTE 6. INVESTMENTVALUATION

 

The Companycarries its investments at fair value, as determined by its Board ofDirectors.  Securities that are publiclytraded are valued at the closing price on the valuation date.  Debt and equity securities that are notpublicly traded are valued at fair value as determined in good faith by theBoard of Directors. Beginning in March 2003, the Company engaged Standard &Poor’s Loan Evaluation Service (S&P) to perform independent valuations ofour investments.  The Board of Directorsuses the recommended valuations as prepared by S&P as a component of thefoundation for the final fair value determination.  In making such determination, the Board of Directors valuesnon-convertible debt securities at cost plus amortized original issue discountplus PIK interest, if any, unless adverse factors lead to a determination of alesser valuation.  In valuing convertibledebt, equity, success fees or other equity like securities, the Board ofDirectors determines the fair value based on the collateral, the issuer’sability to make payments, the earnings of the issuer, sales to third parties ofsimilar securities, the comparison to publicly traded securities, discountedcash flow and other pertinent factors. Due to the uncertainty inherent in the valuation process, such estimatesof fair value may differ significantly from the values that would have resultedhad a ready market for the securities existed, and the differences could bematerial. Additionally, changes in the market environment and other events thatmay occur over the life of the investments may cause the gains ultimatelyrealized on these investments to be different than the valuation currentlyassigned.

 

NOTE 7. LOAN ANDMANAGERIAL ASSISTANCE FEES

 

The 1940 Actrequires that a business development company make available managerialassistance to its portfolio companies. The Company provides managerial assistance to its portfolio companies throughits wholly-owned subsidiary, Gladstone Advisers, Inc.  The Company receives fee income for managerial assistance itrenders to portfolio companies in connection with its investments.  Such fees are normally paid at the closingof the Company’s investments and are generally non-recurring.  These managerial assistance services vary byinvestment, but generally consist of reviewing existing credit facilities,arranging bank financing, arranging equity financing, structuring financingfrom multiple lenders, structuring

 

14

----

 

financing fromequity investors, restructuring existing loans, raising equity and debtcapital, and providing general financial advice.  These fees totaled $358,000 for the three and six months endedMarch 31, 2003, $29,102 for the three months ended March 31, 2002 and $640,911for the six months ended March 31, 2002.

 

From time to time,the Company will be invited to participate as a co-lender in atransaction.  Where the Company does notprovide significant managerial assistance services in connection with itsinvestment, loan fees paid to the Company in such situations will be deferredand amortized over the life of the loan.

 

NOTE 8. PAYMENT INKIND INTEREST

 

The Company hasloans in its portfolio, which contain a payment in kind (“PIK”) provision. ThePIK interest is added to the principal balance of the loan and recorded asincome.  To maintain the Company’sstatus as a RIC (as discussed in Note 6, above), this non-cash source of incomemust be paid out to stockholders in the form of dividends, even though theCompany has not yet collected the cash. For the three months ended March 31,2003 and March 31, 2002, the Company recorded PIK income of $223,754 and$130,459 respectively and for the six months ended March 31, 2003 and March 31,2002, PIK income of $435,076 and $130,459 respectively.  At March 31, 2003 and September 30, 2002 theCompany had accrued on its balance sheet, a total in PIK income of $819,022 and$400,490 respectively.  The Company doesnot have any original issue discount income.

 

NOTE 9. REPURCHASEAGREEMENT

 

A repurchaseagreement involves the purchase by an investor, such as the Company, of aspecified security and the simultaneous agreement by the seller to repurchaseit at an agreed upon future date and at a price which is greater than thepurchase price by an amount that reflects an agreed-upon interest rate. Suchinterest rate is effective for the period of time during which the investor’smoney is invested in the arrangement and is related to current market interestrates rather than the coupon rate on the purchased security. The Companyrequires the continual maintenance by its custodian or the correspondent in itsaccount with the Federal Reserve/Treasury Book Entry System of underlyingsecurities in an amount at least equal to the repurchase price. If the sellerwere to default on its repurchase obligation, the Company might suffer a lossto the extent that the proceeds from the sale of the underlying securities wereless than the repurchase price. A seller’s bankruptcy could delay or prevent asale of the underlying securities.

 

On March 31, 2003,the Company entered into a Repurchase Agreement with UBS Paine Webber for$63,710,277, which was settled on April 1, 2003.  The Repurchase Agreement was recorded at cost and was fullycollateralized by a United States Treasury Bill with a fair value of$65,045,000 and a carrying value of $65,011,213 that matured on April 17, 2003.  The interest rate on the Repurchase Agreementwas 1.16%.  On September 30, 2002, theCompany entered into a Repurchase Agreement with UBS Paine Webber for$39,198,719, which agreement was settled on October 1, 2002.  The Repurchase Agreement was recorded atcost and was fully collateralized by a United States Treasury Bill with a fairvalue of $40,004,000 and a carrying value of $39,998,799 that matured onOctober 1, 2002.  The interest rate onthe Repurchase Agreement was 1.85%.     In the future the Company plans to use a similar form of repurchaseagreements as an investment option or in order to satisfy certain assetdiversification requirements and maintain the Company’s status as a RIC.

 

NOTE 10. DEFERREDCOMPENSATION PLAN

 

The Company hasadopted a deferred compensation plan (the “Plan”) effective January 1,2002.  The Plan permits an employee todefer the lesser of 75% of his or her total compensation or the applicableInternal Revenue Service (“IRS”) limit. The employees are eligible to participate in the Plan upon completion of1,000 hours of service within the first six months of employment or after oneyear of service.  The servicerequirement is waived for those employees who were employed as of January 1,2002.    The Company has funded $23,569in contributions to the Plan that were recorded for the fiscal year endedSeptember 30,2002.  The Company hasreceived a determination letter from the IRS concurring that the deferredcompensation plan satisfies the qualification requirements of the Code.

 

NOTE 11.SUBSEQUENT EVENT

 

The Company hasagreed to sell its Inca Metal Products Corp., Kingway Acquisition Inc., ClymerAcquisitions, Inc. note to American Capital Strategies and expects to completethe sale in May 2003.

 

15

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**ITEM 2. MANAGEMENT’S****DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS.**

 

**Allstatements contained herein, other than historical facts, may constitute“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended. These statements may relate to, among other things,future events or our future performance or financial condition. In some cases,you can identify forward-looking statements by terminology such as “may,”“might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,”“growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,”“possible,” “potential” or the negative of such terms or comparableterminology. These forward-looking statements involve known and unknown risks,uncertainties and other factors that may cause our actual results, levels ofactivity, performance or achievements to be materially different from anyfuture results, levels of activity, performance or achievements expressed orimplied by such forward-looking statements. Such factors include, among others:(1) adverse changes in interest rates; (2) our failure or inability toestablish or maintain referral arrangements with leveraged buyout funds andventure capital funds to generate loan opportunities; (3) the loss of one ormore of our executive officers, in particular David Gladstone or Terry LeeBrubaker; (4) our inability to establish or maintain a credit facility on termsreasonably acceptable to us, if at all; (5) our inability to successfullysecuritize our loan portfolio on terms reasonably acceptable to us, if at all;(6) the decision of our competitors to aggressively seek to make senior andsubordinated loans to small and medium-sized businesses on terms more favorablethan we intend to provide; and (7) those factors listed under the caption “RiskFactors” of the Annual Report on Form 10-K as filed with the Securities andExchange Commission on December 11, 2002. We caution readers not to place unduereliance on any such forward-looking statements, which are made pursuant to thePrivate Securities Litigation Reform Act of 1995 and, as such, speak only as ofthe date 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**.

 

*Thefollowing analysis of our financial condition and results of operations shouldbe read in conjunction with our financial statements and the notes theretocontained elsewhere in this report.*

 

**OVERVIEW**

 

We were incorporated under the General CorporationLaws of the State of Maryland on May 30, 2001. Our investment objectives are toachieve a high level of current income by investing in debt securities,consisting primarily of senior term debts, senior subordinated term debts andjunior subordinated term debts, of established private businesses that arebacked by leveraged buyout funds, venture capital funds or others. In someinstances some of the senior term debts may be “last out tranches” meaning ourdebt is part of the senior term debt but is paid last from those paymentscoming to the senior term debt holders if the borrower is liquidated. We alsoprovide first and second mortgage debt secured by business real estate. Wenormally do not provide revolving lines of credit. In addition, we may acquireexisting loans made by others if those loans meet our profile. We also seek toprovide our stockholders with long-term capital growth through the appreciationin the value of warrants, success fees or other equity-type instruments that wemay receive when we provide debt. We operate as a closed-end, non-diversifiedmanagement investment company, and have elected to be treated as a businessdevelopment company under the 1940 Act.

 

We seek out small and medium-sized businesses thatmeet certain criteria, including (1) the potential for growth in cash flow, (2)adequate assets for loan collateral, (3) experienced management teams with asignificant ownership interest in the borrower, (4) profitable operations basedon the borrower’s cash flow, (5) reasonable capitalization of the borrower(usually by leveraged buyout funds or venture capital funds) and (6) thepotential to realize appreciation and gain liquidity in our equity position, ifany. We anticipate that liquidity in our equity position will be achievedthrough a merger or acquisition of the borrower, a public offering by theborrower or by exercise of our right to require the borrower to buy back itswarrants. We lend to borrowers that need funds to finance growth, restructuretheir balance sheets or effect a change of control.

 

Our loans typically range from $5 million to $15million, mature in no more than seven years and accrue interest at a fixed orvariable rate that exceeds the prime rate. A number of our loans have aprovision that calls for some portion of the interest payments to be deferredand added to the principal balance so that the interest is paid, together withthe principal, at maturity. This form of deferred interest is often called“paid-in-kind” or “PIK” interest, and, when earned, we record PIK interest asinterest income and add the PIK interest to the principal balance of the loans.The amount of PIK interest accrued and on our books as of March 31, 2003 wasapproximately $819,000.

 

Because our loans will generally be subordinated debtof private companies who typically cannot or will not expend the resources tohave their debt securities rated by a credit rating agency, we expect thatmost, if not all, of the debt securities

 

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we acquire will beunrated. We cannot accurately predict what ratings these loans might receive ifthey were in fact rated, and therefore we cannot determine whether or not theycould be considered to be “investment grade” quality.

 

To the extent possible, our loans generally arecollateralized by a security interest in the borrower’s assets. Interestpayments are generally made monthly or quarterly (except to the extent of anyPIK interest) with amortization of principal generally being deferred forseveral years. The principal amount of the loans and any accrued but unpaidinterest generally become due at maturity at five to seven years. When wereceive a warrant to purchase stock in a borrower in connection with a loan,the warrant will typically have an exercise price equal to the fair value ofthe portfolio company’s common stock at the time of the loan and entitle us topurchase a modest percentage of the borrower’s stock.

 

In addition, as a business development company underthe 1940 Act, we are required to make available significant managerialassistance to our portfolio companies. We provide these services, for which wereceive fees, through our wholly owned subsidiary, Gladstone Advisers, Inc.Such fees are typically paid in part at the time a prospective portfoliocompany signs a non-binding term sheet with us, with the remainder paid at theclosing of the investments. These fees are generally non-recurring, however insome instances they may have a recurring component. The specific services weprovide vary by portfolio company, but generally consist of reviewing existingcredit facilities, arranging bank financing, arranging equity financing,structuring financing from multiple lenders, structuring financing from equityinvestors, restructuring existing loans, raising equity and debt capital andproviding general financial advice. We record these fees as managerialassistance fee revenue in the period in which the fees are earned.

 

Our business plan calls for managerial assistance feerevenue to equal or exceed our operating expenses (excluding interest expense).During the quarter and six months ended March 31, 2003, the Company recordedmanagerial assistance fee revenue of $358,000, stemming from two newinvestments during the quarter. However, during the quarter and six months ended March 31, 2003,operating expenses (excluding interest expense) exceeded managerial assistancefee revenue by approximately $582,000 and $1.4 million, respectively.  Because we typically generate managerialassistance fee revenue only when we make new loans, our relatively slow pace ofloans during the quarter and six months ended March 31, 2003 led to this shortfall.In the future, we will need to make loans at a faster pace in order to meetthis objective. However, we believe that, as the economic environment improves,we will be able to make sufficient new investments so that over time ourmanagerial assistance fee revenue will equal or exceed our operating expenses(excluding interest expense), although there can be no guarantee that we willbe able to do so.

 

Prior to making an investment, we ordinarily enterinto a non-binding term sheet with the potential borrower. These non-bindingterm sheets are generally subject to a number of conditions, including but notlimited to the satisfactory completion of our due diligence investigations ofthe potential borrower’s business and reaching agreement on the legaldocumentation for the loan. Typically, upon execution of the non-binding termsheet, the potential borrower pays us a non-refundable fee for our servicesrendered through the date of the non-binding term sheet. Where the fee paid isnon-refundable, we recognize this fee as revenue upon execution of thenon-binding term sheet.

 

In the event that we expend significant effort inconsidering and negotiating a potential investment that ultimately is notconsummated, we generally will seek reimbursement from the proposed borrowerfor our reasonable expenses incurred in connection with the proposedtransaction. Any amounts collected are recognized as “other income” in thequarter in which such reimbursement is received. Also, in the event that wehave incurred significant legal fees in connection with the transaction, wewill typically also seek reimbursement for these expenses from the proposedborrower. However, there can be no guarantee that we will be successful incollecting any such reimbursements.

 

The only significant continuing revenue associatedwith the investments we have already closed is interest paid and, potentially,capital gains received in connection with the liquidation of any associatedequity interest (e.g., warrants). While in some instances we may also receiveon-going managerial assistance fee revenue in connection with a consummatedinvestment, any such amounts have been, and in the future are expected to be,insignificant.

 

The generaleconomic climate during the fiscal year ended September 30, 2002 and thequarter and six months ended March 31, 2003****was unfavorable. Many businesses saw their sales and businessprospects decline during this time. Consequently, many of these companies wereforced to lay off employees and engage in other cost cutting measures. As aresult of the difficult business climate, we determined it prudent to proceedcautiously in making loans during the 2002 fiscal year and in the quarter andsix months ended March 31, 2003. Since our initial public offering in August2001, we have made 13****differentloans to, or investments in, 10****companiesfor a total of approximately $110****million(including the maximum aggregate amount outstanding under an $8 million line ofcredit in favor of one of our portfolio companies, that has subsequently beenretired). This was below our objective set at the beginning of the 2002 fiscalyear.

 

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In spite of the economic environment, we are earnestlyworking toward the consummation of more investments. These prospective loansare subject to, among other things, the satisfactory completion of our duediligence investigation of each borrower, acceptance of terms and structure andnecessary consents. With respect to each prospective loan, we will only agreeto provide the loan if, among other things, the results of our due diligenceinvestigations are satisfactory, the terms and conditions of the loan areacceptable and all necessary consents are received. Our management hasinitiated its due diligence investigations of the potential borrowers, howeverwe can not assure you that we will not discover facts in the course ofcompleting our due diligence that would render a particular investmentimprudent or that any of these loans will actually be made.

 

**DividendHistory**

 

The Company isclassified as a registered investment company (RIC), and in order to qualify asa RIC and to avoid corporate level tax on the income distributed tostockholders, we are required, in accordance with Subchapter M of the Code, todistribute at least 90% of our ordinary income and short-term capital gains toour stockholders on an annual basis.  Incompliance with these requirements, we declared and paid quarterly cashdividends as follows:

 
| **Quarter Ended**  |   | **Dividend  Per Share** |   |
|--------------------|--------|-------------------------|--------|
| March 31, 2003     |   | $                       | 0.25   |   |
| December 31, 2002  |   | $                       | 0.23   |   |
| September 30, 2002 |   | $                       | 0.21   |   |
| June 30, 2002      |   | $                       | 0.21   |   |
| March 31, 2002     |   | $                       | 0.21   |   |
| December 31, 2001  |   | $                       | 0.18   |   |

 

**CriticalAccounting Policies**

 

Our accounting policies are more fully described inthe “Notes to Financial Statements” contained elsewhere in this report. Asdisclosed in the “Notes to Financial Statements”, the preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, and disclosure of contingentassets and liabilities at the date of the financial statements, and revenuesand expenses during the period reported. Actual results could differ from thoseestimates. Refer to note 2 “Summary of Significant Accounting Policies” in the“Notes to Financial Statements” of our form 10-K for the fiscal year endedSeptember 30, 2002.

 

In December 2002, the Financial Accounting Standards Boardapproved the issuance of FASB Statement No. 148 “Accounting for Stock-BasedCompensation – Transition and Disclosure.” The statement amends FASB StatementNo. 123 “Accounting for Stock-Based Compensation” to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock based employee compensation. In addition Statement No. 148amends the disclosure requirements of Statement No. 123 to require moreprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. This statement is effective for financialstatements for fiscal years ending and for interim periods beginning afterDecember 15, 2002, accordingly our “Notes to Financial Statements” now includethese new disclosures.

 

**InvestmentValuation**

 

The most significant estimate inherent in thepreparation of our consolidated financial statements is the valuation of investmentsand the related amounts of unrealized appreciation and depreciation ofinvestments recorded.

 

We value ourinvestment portfolio each quarter. Members of our portfolio management teamprepare the portfolio company valuations using the most recent portfoliocompany financial statements and forecasts. These individuals also consult withthe respective principal who originated the portfolio investment to obtainfurther updates on the portfolio company’s performance, including informationsuch as industry trends, new product development, and other operationalissues.  Beginning with this quarter,the Company has engaged Standard & Poor’s to help evaluate the value ofsome of its loan securities.  Uponcompleting gathering of data, the valuation data is then presented to Standard& Poor’s Loan Evaluation Service (S&P).  S&P makes its own assessment of the data and applies its owndata in order to determine the value for the securities.  With regard to its work, S&P has issuedthe following paragraph:

 

S&P providesevaluated price opinions which are reflective of what S&P believes the bidside of the

 

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market would befor each loan after careful review and analysis of descriptive, market andcredit information.  Each price reflectsS&P’s best judgment based upon careful examination of a variety of marketfactors.  Because of fluctuation in themarket and in other factors beyond its control, S&P cannot guarantee theseevaluations.  The evaluations reflectthe market prices, or estimate thereof, on the date specified.  The prices are based on comparable marketprices for similar securities.  Marketinformation has been obtained from reputable secondary market sources.  Although these sources are considered reliable,S&P cannot guarantee their accuracy.

 

Once the board reviews the S&P prices, it votes toaccept or not accept the price data presented by S&P.  At March 31, 2003, the board elected toaccept the prices set by S&P on those loans as denoted on the Schedule ofInvestments in the Consolidated Financial Statements.  Because there is a lag between when we close a loan and when wecan get the loan evaluated by S&P, new loans are not valued immediately byS&P but rather the board makes its own determination about the value of theloan in accordance with the Company’s valuation policy.  Since S&P does not provide values formortgage loans, equity securities or the success fees (conditional interest),the directors determine their fair value using the following policy:

 

General Valuation Policy: We carry our investments atfair value, as determined by our board of directors. Securities that arepublicly traded, if any, are valued at the closing price on the valuation date.Debt and equity securities that are not publicly traded or for which we havevarious degrees of trading restrictions, are valued at fair value as determinedin good faith by our board of directors. In making the good faith determinationof the securities, we start with the cost basis of the security, which includesthe amortized original issue discount, success fee (defined interest) and PIKinterest, if any. We then apply the methods set out below in Valuation Methods.Due to the uncertainty inherent in the valuation process, such estimates of fairvalue may differ significantly from the values that would have been obtainedhad a ready market for the securities existed, and the differences could bematerial. Additionally, changes in the market environment and other events thatmay occur over the life of the investments may cause the gains or lossesultimately realized on these investments to be different than the valuationscurrently assigned.  No single standardfor determining fair value in good faith exists since fair value depends uponcircumstances of each individual case. In general, fair value is the amountthat the company might reasonably expect to receive upon the current sale ofthe security.

 

CreditInformation:****We monitor a widevariety of key credit statistics that provide information regarding ourportfolio companies to help us assess credit quality and portfolio performance.We require our portfolio companies to provide annual audited and monthly,unaudited financial statements. Using these statements, we calculate andevaluate the credit statistics. For purposes of analyzing the financialperformance of our portfolio companies, we may make certain adjustments totheir cash flow statements to reflect the pro forma results of a companyconsistent with a change of control transaction, to reflect anticipated costsavings resulting from a merger or restructuring, costs related to new productdevelopment, compensation to previous owners, and other acquisition orrestructuring related items.

 

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

 

We seek to 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.

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

 

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

 

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At September 30,2002, all debt investments were grade 3 under the 1-to-4 loan grading system.The rating of 3 on the 1-4 system means that the portfolio companies wereperforming as agreed and they have paid on time.  Using the expanded scale, at December 31, 2002 and March 31,2003, the average, weighted average and highest rated loan and lowest ratedloan were as follows:

 
| **Rating**       |   | **December  31, 2002** |   | **March 31,  2003** |   |
|------------------|--------|------------------------|--------|---------------------|--------|
| Average          |   | 7.5                    |   | 7.7                 |   |
| Weighted Average |   | 7.5                    |   | 7.7                 |   |
| Highest          |   | 9.0                    |   | 9.0                 |   |
| Lowest           |   | 6.0                    |   | 6.0                 |   |

 

The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default using the expanded risk rating scale.

 

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, 2002 and March 31, 2003, no payments were past due on any ofour debt securities. We do not risk rate our equity securities.

 

Valuation Methods:**** For debt securities, we first determine if there is a market forthe debt security. If there is a market, then we will determine the value basedon the market prices for the security, even if that market is not robust. AtMarch 31, 2003 and September 30, 2002 there was no market for any of the debtsecurities we hold. If there is no market for the debt securities, then webegin with the risk rating designation of the security described above.  Using the risk rating designation above, weseek to determine the value of the security as if we intended to sell thesecurity in a current sale. To determine the current sale price of thesecurity, we may use some or all of the following items: financial standing ofthe issuer of the security, comparison of the business and financial plan ofthe issuer with actual results, the cost of the security, the size of the securityheld as it relates to the liquidity of the market for such securities,contractual restrictions on the disposition of the security, pending publicoffering of the issuer of the security, pending reorganization activityaffecting the issuer such as mergers or debt restructuring, reported prices ofsimilar securities of the issuer or comparable issuers, ability of the issuerto obtain needed financing, changes in the economy affecting the issuer, recentpurchases or sale of a security of the issuer, pricing by other buyers orsellers of similar securities, financial statements of the borrower, the typeof security, cost at date of purchase, size of holding, discount from marketvalue of unrestricted securities of the same class at the time of purchase, specialreports prepared by analysts, information as to any transactions or offers withrespect to the security, existence of merger proposals or tender offersaffecting the securities, the collateral, the issuer’s ability to makepayments, the current and forecasted earnings of the issuer, sales to thirdparties of similar securities, statistical ratios compared to lendingstandards, statistical ratios compared to other similar securities and otherpertinent factors.

 

For equitysecurities, we first determine if there is any market for the equity security.If there is a market, then we determine the value based on the market pricesfor the security, even if that market is not robust. At December 31, 2002 andSeptember 30, 2002 there was no market for any of the equity securities weowned. If there is no market for the equity securities, then we use the sameinformation we would use for a debt security valuation described above, as wellas standard valuation techniques used by major valuation firms to value the equitysecurities of private companies. These valuation techniques consist of:discounted cash flow of the expected sales price in the future, the value 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 March 31, 2003 we had $37,000 invested, at cost,  in equity securities compared to our debtportfolio with a cost basis of $101,257,476.

 

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At March 31, 2003we determined that the probability of our receiving the success fee(conditional interest) on one of our loans had increased to the point that anappreciated value should be used.  Todetermine this value we estimated the probability of the payment and discountedthe value over time.  The Home CareSupply, Inc. senior loan has an appreciated value (as determined by the Boardand not S&P) of $666,964 in its value as a result of the value applied tothe success fee (conditional interest). Further, the value of our warrants in Finn Corporation became morevaluable during the quarter ended March 31, 2003 and were valued at$490,323.  This appreciation totaling$1,120,287 offset depreciation of $377,863.

 

Our new riskrating system is more detailed than our prior system. Due to the more detailednature of the risk rating system there is the likelihood that future valuationswill change more frequently.  S&Pdetermines what a loan might trade at if it was publicly traded, which alsoadds volatility to our valuations.

 

**ManagerialAssistance Fees**

 

The 1940 Act requires that a business developmentcompany make available managerial assistance to its portfolio companies. Weprovide managerial assistance to our portfolio companies in connection with ourinvestments through our wholly owned subsidiary, Gladstone Advisers, Inc. andreceive fees for our managerial assistance services. These fees are normallypaid at the closing of our investments in our portfolio companies, aregenerally non-recurring and are recognized as revenue when earned. Themanagerial assistance services we provide vary by investment, but generallyconsist of reviewing existing credit facilities, arranging bank financing,arranging equity financing, structuring financing from multiple lenders,structuring financing from equity investors, restructuring existing loans,raising equity and debt capital, and providing general financial advice. Fromtime to time, we are invited to participate as a co-lender in a transaction. Inthe event that we do not provide significant managerial assistance services inconnection with our investment, loan fees paid to us in such situations aredeferred and amortized over the life of the loan.

 

**RESULTS OF OPERATIONS**

 

*Comparison of thethree months ended March 31, 2003 to the three months ended March 31, 2002*

 

**InvestmentIncome**

 

Investment income for the three months ended March 31,2003 was approximately $3.9 million as compared to $2.1 million for the threemonths ended March 31, 2002. This increase was primarily a result of increasedinterest income from new investments and managerial fees.

 

Interest income from our investments in debtsecurities of private companies was approximately $3.3 million for the threemonths ended March 31, 2003 as compared to $1.6 million for the three monthsended March 31, 2002. This increase****was primarily a result of theincrease in new investments of $68.0 million.

 

The weighted average yield on our portfolio for thethree months ended March 31, 2003 was 14.69% (without giving effect to PIKinterest) and 15.89% (after giving effect to PIK interest). The weightedaverage yield for the three months ended March 31, 2002 was 13.98% (withoutgiving effect to PIK interest) and 15.18% (after giving effect to PIK interest).

 

Interest income from invested cash and cashequivalents for the three months ended March 31, 2003 was approximately$113,000, as compared to $369,000 for the three months ended March 31, 2002.This decrease****was primarily aresult of the $68.0 million of new investments made between March 31, 2002 andMarch 31, 2003.

 

For the three months ended March 31, 2003, we recordedapproximately $110,000 in interest income from loans to our employees inconnection with the exercise of employee stock options, as compared toapproximately $107,000 in interest income from such loans for the three monthsended March 31, 2002. This increase****wasprimarily a result of $185,000 in new employee loans.

 

Managerial assistance fees were $358,000 for the threemonths ended March 31, 2003, as compared to $29,000 for the three months endedMarch 31, 2002. This increase****was the result of two newinvestment closings during the quarter with related fees.

 

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**OperatingExpenses**

 

Operating expenses for the three months ended March31, 2003 were approximately $940,000, as compared to approximately $741,000 forthe three months ended March 31, 2002. This increase****was primarily a result of eight new employees, new officespace and operating expenses related to the increase in staff and overalloperations.

 

Salaries and benefits for the three months ended March31, 2003 were approximately $478,000, as compared to approximately $327,000 forthe three months ended March 31, 2002. This increase****was a result of the hiring of eight new employees.

 

Rent expense for the three months ended March 31, 2003was approximately $55,000, as compared to approximately $36,000 for the threemonths ended March 31, 2002. This increase****wasprimarily a result of new office space acquired in September 2002.

 

Professional fees, consisting primarily of legal andaudit fees, for the three months ended March 31, 2003 were approximately$87,000, as compared to approximately $114,000 for the three months ended March31, 2002. This decrease****was primarily a result of a declinein legal fees.

 

Directors’ fees for the three months ended March 31,2003 were approximately $21,000, as compared to approximately $5,000 for thethree months ended March 31, 2002. This increase****was primarily a result of the accounting for the annualdirectors fee pro rated over the 2004 fiscal year.

 

Insurance expense for the three months ended March 31,2002 was approximately $74,000, as compared to approximately $50,000 for thethree months ended March 31, 2002.  Themajority of this increase is due to an increase in directors’ and officers’insurance premiums.

 

Stockholder related costs for the three months endedMarch 31, 2003 were approximately $74,000, as compared to approximately $62,000for the three months ended March 31, 2002. The increase was attributable to the printing of the annual report andthe annual stockholders’ meeting.

 

General and administrative expenses, consistingprimarily of office operations, travel and data communications expenses for thethree months ended March 31, 2003 were approximately $152,000, as compared toapproximately $146,000 for the three months ended March 31, 2002. This slightincrease****was primarily a result ofthe related expenses to new employees and increased operations.

 

We believe that our current level of operatingexpenses is not necessarily indicative of our future operating expenses. Weestimate that over time, as we continue to more fully deploy the proceeds ofour initial public offering, our operating expenses will be approximately twopercent of our net assets.

 

**NetIncrease in Stockholders’ Equity from Operations**

 

As a result of theinvestment income and operating expenses described above, we had net increasein stockholders’ equity from operations of approximately $3.7 million for thethree months ended March 31, 2003. Based on a weighted-average of 10,071,844 (basic) and 10,100,062(diluted) shares outstanding, our net increase in stockholders’ equity from operationsper common share for the three months ended March 31, 2003 was $0.36 (basic)and $0.36 (diluted).

 

For the three months ended March 31, 2002, we had net increase in stockholders’equity from operations of approximately $1.4 million.  Based on a weighted-average of 10,060,178 (basic) and 10,160,417(diluted) shares outstanding, our net increase in stockholders’ equity fromoperations per common share for the three months ended March 31, 2002 was $0.14(basic) and $0.14 (diluted).

 

Net increase instockholders’ equity from operations includes approximately $742,000 of netunrealized appreciation for the quarter ended March 31, 2003.  This was the first period in which the Boardof Directors approved the fair values of the investment portfolios based onrecommendations prepared by Standard & Poor’s.  There was no unrealized appreciation or depreciation for thequarter ended March 31, 2002.

 

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*Comparison of the sixmonths ended March 31, 2003 to the six months ended March 31, 2002*

 

**InvestmentIncome**

 

Investment income for the six months ended March 31,2003 was approximately $7.1 million as compared to $3.8 million for the sixmonths ended March 31, 2002. This increase was primarily a result of increasedinterest income from investments.

 

Interest income from our investments in debtsecurities of private companies was approximately $6.2 million for the sixmonths ended March 31, 2003 as compared to $1.9 million for the six monthsended March 31, 2002. This increase****was primarily a result of theincrease in new investments of $68.0 million.

 

The weighted average yield on our portfolio for thesix months ended March 31, 2003 was 13.31% (without giving effect to PIKinterest) and 14.21% (after giving effect to PIK interest). The weightedaverage yield for the six months ended March 31, 2002 was 15.01% (withoutgiving effect to PIK interest) and 15.0% (after giving effect to PIK interest).

 

Interest income from invested cash and cashequivalents for the six months ended March 31, 2003 was approximately $312,000,as compared to $1.0 million for the six months ended March 31, 2002. Thisdecrease****was primarily a result ofthe $68.0 million of new investments made between March 31, 2002 and March 31,2003.

 

For the six months ended March 31, 2003, we recordedapproximately $219,000 in interest income from loans to our employees inconnection with the exercise of employee stock options, as compared toapproximately $215,000 in interest income from such loans for the six monthsended March 31, 2002. This increase****wasprimarily a result of $185,000 in new employee loans.

 

Managerial assistance fees were $358,000 for the sixmonths ended March 31, 2003, as compared to $641,000 for the six months endedMarch 31, 2002. This decrease****was the result of two new investmentclosings during the six months ended March 31, 2003 as compared to five newinvestment closings during the six months ended March 31, 2002 with relatedfees.

 

**OperatingExpenses**

 

Operating expenses for the six months ended March 31,2003 were approximately $1.8 million, as compared to approximately $1.2 millionfor the six months ended March 31, 2002. This increase****was primarily a result of eight newemployees, new office space and operating expenses related to the increase instaff and overall operations.

 

Salaries and benefits for the six months ended March31, 2003 were approximately $911,000, as compared to approximately $604,000 forthe six months ended March 31, 2002. This increase****was a result of the hiring of eight new employees.

 

Rent expense for the six months ended March 31, 2003was approximately $109,000, as compared to approximately $47,000 for the sixmonths ended March 31, 2002. This increase****wasprimarily a result of new office space acquired in September 2002.

 

Professional fees, consisting primarily of legal andaudit fees, for the six months ended March 31, 2003 were approximately$201,000, as compared to approximately $215,000 for the six months ended March31, 2002. This decrease****was primarily a result of adecrease in legal fees.

 

Directors’ fees for the six months ended March 31,2003 were approximately $34,000, as compared to approximately $7,000 for thesix months ended March 31, 2002. This increase was primarily a result of theaccounting for the annual directors fee pro rated over the 2004 fiscal year.

 

Insurance expense for the six months ended March 31,2003 was approximately $145,000, as compared to approximately $98,000 for thesix months ended March 31, 2002.  Thisincrease was mainly attributable to an increase in directors’ and officers’insurance premiums.

 

Stockholder related costs for the six months endedMarch 31, 2003 were approximately $111,000, as compared to $71,000 for the sixmonths ended March 31, 2002.  Thisincrease is due to costs associated with the printing of the annual report andthe annual stockholders’ meeting.

 

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General and administrative expenses, consistingprimarily of office operations, travel and data communications related expensesfor the six months ended March 31, 2003 were approximately $251,000, ascompared to approximately $190,000 for the six months ended March 31, 2002.This increase****was primarily aresult of the related expenses to new employees and increased operations.

 

We believe that our current level of operatingexpenses is not necessarily indicative of our future operating expenses. Weestimate that over time, as we continue to more fully deploy the proceeds ofour initial public offering, our operating expenses will be approximately twopercent of our net assets.

 

**NetIncrease in Stockholders’ Equity from Operations**

 

As a result of the investment income and operating expensesdescribed above, we had net increase in stockholders’ equity from operations ofapproximately $6.1 million for the six months ended March 31, 2003.  Based on a weighted-average of 10,071,844(basic) and 10,112,129 (diluted) shares outstanding, our net increase instockholders’ equity from operations per common share for the six months endedMarch 31, 2003 was $0.60 (basic) and $0.60 (diluted).

 

For the six months ended March 31, 2002, we had net increase in stockholders’equity from operations of approximately $2.6 million.  Based on a weighted-average of 10,060,178 (basic) and 10,153,223(diluted) shares outstanding, our net increase in stockholders’ equity fromoperations per common share for the six months ended March 31, 2002 was $0.26(basic) and $0.26 (diluted).

 

Net increase instockholders’ equity from operations includes approximately $742,000 of netunrealized appreciation for the six months ended March 31, 2003.  This was the first period in which the Boardof Directors approved the fair values of the investment portfolios based onrecommendations prepared by Standard & Poor’s.  There was no unrealized appreciation or depreciation for the sixmonths ended March 31, 2002.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

At March 31, 2003, we had investments in debtsecurities of, or loans to, 9 private companies, totaling approximately $101.4million of total investment assets. This number includes approximately $819,000in accrued PIK interest, which as described in “Overview,” is added to thecarrying value of our investments.

 

In January 2003,we closed a $5.5 million investment in Wing Stop Restaurants International, Inc.,a franchiser of fast food chicken restaurants. The investment consisted of aloan with added income from a success fee if the business is successful.  In February 2003 we closed and funded a loanfor $12 million to America’s Water Heater Rentals, LLC.

 

In April 2003, weclosed a $5.5 million investment in Fugate and Associates, Inc., an imagingsupply company.  The investmentconsisted of a loan with added income from a success fee if the business issuccessful.

 

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

 
| **Fiscal Year** |   | **Amount** |        |
|-----------------|--------|------------|-------------|
| 2003            |   | $          | 1,225,000   |   |
| 2004            |   | $          | 10,849,233  |   |
| 2005            |   | $          | 12,056,956  |   |
| 2006            |   | $          | 16,457,000  |   |
| 2007            |   | $          | 27,856,287  |   |
| Thereafter      |   | $          | 32,850,000  |   |
| Total           |   | $          | 101,294,476 |   |

 

Cash provided by operating activities for the sixmonths ended March 31, 2003, consisting primarily of the items described in“Results of Operations,” was approximately $5.4 million. Net cash provided byinvesting activities was approximately $3.3 million during the six months endedMarch 31, 2003. The net cash provided by investing activities consisted of netproceeds of $24.5 million from the repurchase agreement and repayment of$350,000 of investment principal from our portfolio companies.  Partially offsetting the cash provided byinvesting activities was the $21.5 million of new investments.  Net cash used in financing activities wasapproximately $4.4 million for the six months ended March 31, 2003 andconsisted of the payment of dividends.

 

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During the six months ended March 31, 2003, cash andcash equivalents increased from approximately $91.9 million at the beginning ofthe period to approximately $96.1 million at the end of the period. Theincrease of approximately $4.2 million was mainly the result of the netproceeds from the repurchase agreement.

 

On March 31, 2003, we entered into a repurchaseagreement with UBS Paine Webber for approximately $63.7 million. The repurchaseagreement was fully collateralized by a United States treasury bill with a fairvalue of approximately $65.0 million that matured on April 17, 2003. Theinterest rate on the repurchase agreement was 1.16%. This repurchase agreementwas reflected on our balance sheet as of March 31, 2003 as an increase in cashand cash equivalents pledged to creditors of $65.0 million, along with acorresponding liability for approximately the same amount. The repurchaseagreement was settled on April 1, 2003. In the future, we plan to use a similarform of repurchase agreement as an investment option or in order to satisfycertain asset diversification requirements and maintain our status as a RIC.

 

In order to qualify as a regulated investment companyand to avoid corporate level tax on the income we distribute to ourstockholders, we are required, under Subchapter M of the Code, to distribute atleast 90% of our ordinary income and short-term capital gains to ourstockholders on an annual basis. In accordance with these requirements, wedeclared and paid quarterly cash dividends of $0.25 for the quarter ended March31, 2003 and $0.23 for the quarter ended December 31, 2002.

 

We anticipate borrowing funds and issuing additionalequity securities to obtain additional capital once the proceeds of our initialpublic offering have been fully invested. To this end, we have filed with theSecurities and Exchange Commission (“SEC”) a registration statement that wouldpermit us to issue, through one or more transactions, up to an aggregate of $75million in our securities, which may consist of shares of our common stock,preferred stock, or debt securities.  On March 19, 2003, the SEC declared the registration statementeffective, and we currently have no immediate plans to issue any securitiesunder the registration statement.

 

In addition to borrowing funds and issuing additionalsecurities, we also intend to pursue a strategy of securitizing our loanportfolio in approximately one to two years. We may use the cash we receiveupon the sale of interests in our loans to repay bank borrowings and makeadditional loans. We can not provide assurance that this securitizationstrategy will be successful.

 

**ITEM 3. QUANTITATIVE****AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

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

 

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

 

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

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

(a)          Evaluationof disclosure controls and procedures.

 

Within the 90 days prior to the filing date of thisquarterly report on Form 10-Q, we carried out an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures. This evaluation was carried out under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer. Based upon that evaluation, our Chief ExecutiveOfficer and our Chief Financial Officer have concluded that our disclosurecontrols and procedures are adequate and effective.

 

Disclosure controls and procedures are controls andother procedures that are designed to ensure that information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed in our reports filed under the Exchange Act isaccumulated and communicated to management,

 

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including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

(b)         Changesin internal controls.

 

There have been no significant changes, includingcorrective actions with regard to significant deficiencies or materialweaknesses, in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date we carried outthe evaluation discussed in paragraph (a) above.

 

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**PART II–OTHER INFORMATION**

 

**ITEM 1****.LEGAL PROCEEDINGS.**

 

Neither theCompany nor its subsidiary is currently subject to any material legalproceeding, nor, to the Company’s knowledge, is any material legal proceedingthreatened against the Company or its subsidiary.

 

**ITEM2****. CHANGES IN SECURITIES AND USE OF PROCEEDS.**

 

Not applicable.

 

**ITEM3****. DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable.

 

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

 

The Annual Meetingof Stockholders  (the “Annual Meeting”)was held on February 24, 2003.  Thestockholders voted and approved of the following matters:

 

•                  The election of two directors tohold office until the 2006 Annual Meeting of Stockholders.
| **Nominee**         |   | **Shares Voted For** |   | **Authority Withheld** |   |
|---------------------|--------|----------------------|--------|------------------------|--------|
| Terry Lee  Brubaker |   | 9,176,400            |   | 551,837                |   |
| David A.R.  Dullum  |   | 9,622,415            |   | 105,822                |   |

 

•                  An amendment to the Company’sAmended and Restated 2001 Equity Incentive plan, as amended, to increase theaggregate number of shares of common stock authorized for issuance under suchplan by 500,000 shares.

 
| Shares voted for      |   | 7,774,810 |   |
|-----------------------|--------|-----------|--------|
| Shares voted  against |   | 1,900,257 |   |
| Shares abstained      |   | 53,170    |   |

 

•                  The ratification ofPricewaterhouseCoopers LLP as independent auditors of the Company for thefiscal year ending September 30, 2003.

 
| Shares voted for      |   | 9,646,770 |   |
|-----------------------|--------|-----------|--------|
| Shares voted  against |   | 68,540    |   |
| Shares abstained      |   | 12,927    |   |

 

**ITEM5****. OTHER INFORMATION.**

 

On January 3,2003, Paul Adelgren was appointed director in order to expand the Board ofDirectors and will serve until the 2004 annual meeting of stockholders of theCompany.

 

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

 

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

 

See the exhibit indexon page 30.

 

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

 

None.

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

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

 

Date: May 12, 2003

 

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**CERTIFICATIONS**

 

I, David Gladstone, certify that:

 

1.  I havereviewed this quarterly report on Form 10-Q of Gladstone Capital Corporation;

 

2.  Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.  Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.  Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.  Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a) all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.  Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: May 12, 2003

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

 

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I, Harry Brill, certify that:

 

1.  I havereviewed this quarterly report on Form 10-Q of Gladstone Capital Corporation;

 

2.  Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.  Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.  Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.  Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a) all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.  Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: May 12, 2003

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

 

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**EXHIBIT INDEX**

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

 

All other exhibitsfor which provision is made in the applicable regulations of the Securities andExchange Commission are not required under the related instruction or areinapplicable and therefore have been omitted.

 

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