Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                        | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                         |                                                                                                    |
| **FOR  THE QUARTER ENDED DECEMBER 31, 2009** |
|                                         |                                                                                                    |
| **o**                                        | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                         |                                                                                                    |
| **COMMISSION FILE NUMBER:  814-00237**       |

 

**GLADSTONE CAPITAL CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **MARYLAND**                                                    | ** ** | **54-2040781**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**1521 WESTBRANCH DRIVE, SUITE 200**

**MCLEAN, VIRGINIA 22102**

(Addressof principal executive office)

 

**(703) 287-5800**

(Registrant’stelephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  Noo.

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o  Noo

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer o |   | Accelerated  filer x         |
|----------------------------|--------|------------------------------|
|                       |   |                         |
| Non-accelerated filer o    |   | Smaller reporting company o. |

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).  Yes o  No x.

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date. The number of shares of the issuer’s Common Stock, $0.001 par value,outstanding as of February 1, 2010 was 21,087,574.

 

 

 

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**TABLE OF CONTENTS**

 
| PART I.  |   | FINANCIAL  INFORMATION                                                                                                  |   |   |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |   |                                                                                                                    |   |   |
| Item 1.       |   | Financial  Statements (Unaudited)                                                                                       |   |   |
|          |   |                                                                                                                    |   |   |
|          |   | Condensed Consolidated Statements of Assets and  Liabilities as of December 31, 2009 and September 30, 2009   |   | 2      |
|          |   | Condensed  Consolidated Schedules of Investments as of December 31, 2009 and  September 30, 2009              |   | 3      |
|          |   | Condensed  Consolidated Statements of Operations for the three months ended  December 31, 2009 and 2008            |   | 11     |
|          |   | Condensed  Consolidated Statements of Changes in Net Assets for the three months ended  December 31, 2009 and 2008 |   | 12     |
|          |   | Condensed  Consolidated Statements of Cash Flows for the three months ended  December 31, 2009 and 2008            |   | 13     |
|          |   | Financial  Highlights for the three months ended December 31, 2009 and 2008                                        |   | 14     |
|          |   | Notes to  Condensed Consolidated Financial Statements                                                                   |   | 15     |
|          |   |                                                                                                                    |   |   |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |   | 29     |
|          |   | Overview                                                                                                                |   | 29     |
|          |   | Results  of Operations                                                                                                  |   | 32     |
|          |   | Liquidity and Capital Resources                                                                                         |   | 36     |
|          |   |                                                                                                                    |   |   |
| Item 3.       |   | Quantitative  and Qualitative Disclosure About Market Risk                                                              |   | 46     |
|          |   |                                                                                                                    |   |   |
| Item 4.       |   | Controls and  Procedures                                                                                                |   | 46     |
|          |   |                                                                                                                    |   |   |
| PART II. |   | OTHER INFORMATION                                                                                                       |   |   |
|          |   |                                                                                                                    |   |   |
| Item 1.       |   | Legal Proceedings                                                                                                       |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 1A.      |   | Risk Factors                                                                                                            |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 2.       |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                            |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 3.       |   | Defaults  Upon Senior Securities                                                                                        |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 4.       |   | Submission  of Matters to a Vote of Security Holders                                                                    |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 5.       |   | Other Information                                                                                                       |   | 47     |
|          |   |                                                                                                                    |   |   |
| Item 6.       |   | Exhibits                                                                                                                |   | 47     |
|          |   |                                                                                                                    |   |   |
| SIGNATURES    |   | 47                                                                                                                      |

 

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Table ofContents

 

**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)**

**(UNAUDITED)**

 
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2009**              | ** ** | **2009**               | ** ** |
| ASSETS                                                                                                                                                                |       |                  |       |                   |       |
| Non-Control/Non-Affiliate investments (Cost  12/31/09: $293,830; 9/30/09: $312,043)                                                                                   |       | $                     | 272,380    |                   | $          | 286,997 |   |
| Control investments (Cost 12/31/09: $53,634;  9/30/09: $52,350)                                                                                                       |       | 34,258                |       | 33,972                 |       |
| Total investments at fair value (Cost 12/31/09:  $347,464; 9/30/09: $364,393)                                                                                         |       | 306,638               |       | 320,969                |       |
| Cash                                                                                                                                                                  |       | 6,374                 |       | 5,276                  |       |
| Interest receivable – investments in debt securities                                                                                                             |       | 3,159                 |       | 3,048                  |       |
| Interest receivable – employees (Refer to Note 4)                                                                                                                |       | 113                   |       | 85                     |       |
| Due from custodian                                                                                                                                                    |       | 9,770                 |       | 3,059                  |       |
| Due from Adviser (Refer to Note 4)                                                                                                                                    |       | —                |       | 69                     |       |
| Deferred financing fees                                                                                                                                               |       | 640                   |       | 1,230                  |       |
| Prepaid assets                                                                                                                                                        |       | 381                   |       | 341                    |       |
| Receivable from portfolio companies, less allowance  for uncollectible receivables of $32 and $0 at December 31, 2009 and  September 30, 2009, respectively |       | 611                   |       | 1,528                  |       |
| Other assets                                                                                                                                                          |       | 828                   |       | 305                    |       |
| TOTAL ASSETS                                                                                                                                                          |       | $                     | 328,514    |                   | $          | 335,910 |   |
|                                                                                                                                                                  |       |                  |       |                   |       |
| LIABILITIES                                                                                                                                                           |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                      |       | $                     | —     |                   | $          | 67 |   |
| Interest payable                                                                                                                                                      |       | 339                   |       | 378                    |       |
| Fee due to Administrator (Refer to Note 4)                                                                                                                            |       | 178                   |       | 216                    |       |
| Due to Adviser (Refer to Note 4)                                                                                                                                      |       | 1,285                 |       | 834                    |       |
| Borrowings under line of credit at fair value (Cost  12/31/09: $73,400; 9/30/09: $83,000)                                                                             |       | 73,531                |       | 83,350                 |       |
| Accrued expenses and deferred liabilities                                                                                                                             |       | 1,688                 |       | 1,800                  |       |
| Funds held in escrow                                                                                                                                                  |       | 44                    |       | 189                    |       |
| TOTAL LIABILITIES                                                                                                                                                     |       | 77,065                |       | 86,834                 |       |
| NET ASSETS                                                                                                                                                            |       | $                     | 251,449    |                   | $          | 249,076 |   |
|                                                                                                                                                                  |       |                  |       |                   |       |
| ANALYSIS OF NET ASSETS                                                                                                                                                |       |                  |       |                   |       |
| Common stock, $0.001 par value, 50,000,000 shares  authorized and 21,087,574 shares issued and outstanding at December 31,  2009 and September 30, 2009     |       | $                     | 21         |                   | $          | 21 |   |
| Capital in excess of par value                                                                                                                                        |       | 328,164               |       | 328,203                |       |
| Notes receivable – employees (Refer to Note 4)                                                                                                                   |       | (8,504                | )          | (9,019                 | )          |
| Net unrealized depreciation on investments                                                                                                                            |       | (40,826               | )          | (43,425                | )          |
| Net unrealized appreciation on borrowings under line  of credit                                                                                                       |       | (131                  | )          | (350                   | )          |
| Accumulated Net Realized Losses                                                                                                                                       |       | (27,275               | )          | (26,354                | )          |
| TOTAL NET ASSETS                                                                                                                                                      |       | $                     | 251,449    |                   | $          | 249,076 |   |
| NET ASSETS PER SHARE                                                                                                                                                  |       | $                     | 11.92      |                   | $          | 11.81 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESECONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF DECEMBER 31, 2009**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

** **
| **Company (1)**                                    | ** **                                         | **Industry**                                                   | ** **                                         | **Investment (2)**                                             | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|---------------------------------------------------------|----------------------------------------------------|----------------------------------------------------------------|----------------------------------------------------|---------------------------------------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                                              | ** **                                         | ** **                                                     | ** **                                         | ** **                                                          | ** ** | ** ** | ** ** |                |       |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS**              |                                               |                                                           |                                               |                                                                |       |       |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| ***Non-syndicated Loans:***                             |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Access Television Network, Inc.                    |                                               | Service-cable  airtime (infomercials)                          |                                               | Senior Term Debt  (14.5%, Due 12/2009) (5) (11)                |       | $          | 963        |                | $          | 770 |   |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| ACE Expediters, Inc                                     |                                               | Service-over-the-ground  logistics                             |                                               | Senior Term Debt  (13.5%, Due 9/2014) (5) (12)                 |       | 5,157      |       | 5,015               |       |
|                                                    |                                               |                                                           |                                               | Common Stock  Warrants (8)                                          |       | 200        |       | 447                 |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| ActivStyle Acquisition Co.                              |                                               | Service-medical  products distribution                         |                                               | Senior Term Debt  (13.0%, Due 4/2014) (3) (9)                  |       | 4,000      |       | 4,021               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Allison Publications, LLC                               |                                               | Service-publisher  of consumer oriented magazines              |                                               | Senior Term Debt  (10.0%, Due 9/2012) (5)                           |       | 9,554      |       | 8,848               |       |
|                                                    | Senior Term Debt  (13.0%, Due 12/2010) (5)         |                                                           | 260                                                |                                                                | 254        |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Anitox Acquisition Company                              |                                               | Manufacturing-preservatives  for animal feed                   |                                               | Line of Credit,  $3,000 available (4.5%, Due 1/2011) (5)            |       | 1,500      |       | 1,498               |       |
|                                                    |                                               |                                                           | Senior Term Debt  (8.5%, Due 1/2012) (5)           |                                                                | 2,877      |       | 2,855      |                |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (10.5%, Due 1/2012) (3) (5)                  |       | 3,688      |       | 3,623               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| BAS Broadcasting                                        |                                               | Service-radio  station operator                                |                                               | Senior Term Debt  (11.5%, Due 7/2013) (5)                           |       | 7,435      |       | 6,691               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| CCS, LLC                                                |                                               | Service-cable TV  franchise owner                              |                                               | Senior Term Debt  (non-accrual, Due 8/2008) (5) (10) (11) |       | 631        |       | 319                 |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Chinese Yellow Pages Company                       |                                               | Service-publisher  of Chinese language directories             |                                               | Line of Credit,  $700 available (7.3%, Due 9/2010) (5)              |       | 450        |       | 429                 |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (7.3%, Due 9/2010) (5)                            |       | 486        |       | 462                 |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| CMI Acquisition, LLC                                    |                                               | Service-recycling                                              |                                               | Senior  Subordinated Term Debt (10.3%, Due 11/2012) (5)             |       | 6,236      |       | 5,987               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Doe & Ingalls Management LLC                   |                                               | Distributor-specialty  chemicals                               |                                               | Senior Term Debt  (6.8%, Due 11/2010) (5)                           |       | 2,100      |       | 2,074               |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (7.8%, Due 11/2010) (3) (5)                  |       | 4,354      |       | 4,299               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Finn Corporation                                        |                                               | Manufacturing-landscape  equipment                             |                                               | Common Stock  Warrants (8)                                          |       | 37         |       | 1,005               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| GFRC Holdings LLC                                       |                                               | Manufacturing-glass-fiber  reinforced concrete                 |                                               | Line of Credit,  $2,000 available (4.5%, Due 12/2010)               |       | —     |       | —              |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (9.0%, Due 12/2012) (5)                           |       | 6,599      |       | 6,508               |       |
|                                                    |                                               |                                                           |                                               | Senior  Subordinated Term Debt (11.5%, Due 12/2012) (3) (5)    |       | 6,666      |       | 6,507               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Global Materials Technologies, Inc.                |                                               | Manufacturing-steel  wool products and metal fibers            |                                               | Senior Term Debt  (13.0%, Due 6/2010) (3) (5)                  |       | 4,360      |       | 3,270               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Heartland Communications Group                          |                                               | Service-radio  station operator                                |                                               | Senior Term Debt  (10.0%, Due 5/2011) (5)                           |       | 4,563      |       | 2,499               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Interfilm Holdings, Inc.                           |                                               | Service-slitter  and distributor of plastic films              |                                               | Senior Term Debt  (12.3%, Due 10/2012) (5)                          |       | 4,937      |       | 4,752               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| International Junior Golf Training Acquisition  Company |                                               | Service-golf  training                                         |                                               | Line of Credit,  $1,500 available (9.0%, Due 5/2010) (5)            |       | 700        |       | 693                 |       |
|                                                    |                                               |                                                           | Senior Term Debt  (8.5%, Due 5/2012) (5)           |                                                                | 1,987      |       | 1,938      |                |
|                                                    |                                               |                                                           | Senior Term Debt  (10.5%, Due 5/2012) (3) (5) |                                                                | 2,500      |       | 2,406      |                |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| KMBQ Corporation                                        |                                               | Service-AM/FM  radio broadcaster                               |                                               | Line of Credit,  $200 available (11.0%, Due 3/2010) (5)             |       | 153        |       | 38                  |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (11.0%, Due 3/2010) (5)                           |       | 1,783      |       | 445                 |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Legend Communications of Wyoming LLC                    |                                               | Service-operator  of radio stations                            |                                               | Line of Credit,  $500 available (12.0%, Due 6/2011) (5)             |       | 497        |       | 423                 |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (12.0%, Due 6/2013) (5)                           |       | 9,373      |       | 7,967               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Newhall Holdings, Inc.                             |                                               | Service-distributor  of personal care products and supplements |                                               | Line of Credit,  $3,000 available (11.3%, Due 5/2010) (5)           |       | 1,000      |       | 930                 |       |
|                                                    | Senior Term Debt  (5) (11.3%, Due 5/2012) (5) |                                                           | 3,870                                              |                                                                | 3,599      |       |
|                                                    |                                               |                                                           |                                               | Senior Term Debt  (14.3%, Due 5/2012) (3) (5)                  |       | 4,410      |       | 4,057               |       |
|                                                    |                                               |                                                           |                                               |                                                                |       |       |       |                |       |
| Northern Contours, Inc.                            |                                               | Manufacturing-veneer  and laminate components                  |                                               | Senior  Subordinated Term Debt (10.0%, Due 5/2010) (5)              |       | 6,475      |       | 5,439               |       |
|                                                         |                                                    |                                                                |                                                    |                                                                     |            |            |            |                     |            |  |  |

 

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| **Company (1)**                            | ** **                                             | **Industry**                                                    | ** ** | **Investment (2)**                                    | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------|--------------------------------------------------------|-----------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------|------------|---------------------|------------|
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Northstar Broadband, LLC                        |                                                   | Service-cable TV  franchise owner                               |       | Senior Term Debt  (0.7%, Due 12/2012) (5)                  |       | $        | 156        |                | $          | 128 |   |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Pinnacle Treatment Centers, Inc.           |                                                   | Service-Addiction  treatment centers                            |       | Senior Term Debt  (10.5%, Due 12/2011) (5)                 |       | 2,550    |       | 2,509               |       |
|                                            | Senior Term Debt  (10.5%, Due 12/2011) (3) (5)    |                                                            | 7,500      |                                                       | 7,237      |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Precision Acquisition Group Holdings, Inc. |                                                   | Manufacturing-consumable  components for the aluminum industry  |       | Equipment Note  (8.5%, Due 10/2011) (5)                    |       | 1,000    |       | 973                 |       |
|                                            | Senior Term Debt  (8.5%, Due 10/2010) (5)              |                                                            | 4,125      |                                                       | 4,012      |     |
|                                            | Senior Term Debt  (11.5%, Due 10/2010) (3) (5)    |                                                            | 4,053      |                                                       | 3,941      |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| PROFITSystems Acquisition Co.                   |                                                   | Service-design  and develop ERP software                        |       | Line of Credit,  $350 available (4.5%, Due 7/2010)         |       | —   |       | —              |       |
|                                            | Senior Term Debt  (8.5%, Due 7/2011) (5)               |                                                            | 1,450      |                                                       | 1,339      |     |
|                                            | Senior Term Debt  (10.5%, Due 7/2011) (3) (5)     |                                                            | 2,900      |                                                       | 2,650      |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| RCS Management Holding Co.                      |                                                   | Service-healthcare  supplies                                    |       | Senior Term Debt  (8.5%, Due 1/2011) (3) (5)          |       | 2,312    |       | 2,289               |       |
|                                            | Senior Term Debt  (10.5%, Due 1/2011) (4) (5)     |                                                            | 3,060      |                                                       | 3,014      |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Reliable Biopharmaceutical Holdings, Inc.  |                                                   | Manufacturing-pharmaceutical  and biochemical intermediates     |       | Line of Credit,  $5,000 available (9.0%, Due 10/2010) (5)  |       | 700      |       | 695                 |       |
|                                            | Mortgage Note  (9.5%, Due 10/2014) (5)                 |                                                            | 7,315      |                                                       | 7,279      |     |
|                                            | Senior Term Debt  (9.0%, Due 10/2012) (5)              |                                                            | 1,418      |                                                       | 1,407      |     |
|                                            | Senior Term Debt  (11.0%, Due 10/2012) (3) (5)    |                                                            | 11,783     |                                                       | 11,577     |     |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (12.0%, Due 10/2013) (5)    |       | 6,000    |       | 5,790               |       |
|                                            |                                                   |                                                            |       | Common Stock  Warrants (8)                                 |       | 209      |       | —              |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Saunders & Associates                  |                                                   | Manufacturing-equipment  provider for frequency control devices |       | Senior Term Debt  (9.8%, Due 5/2013) (5)                   |       | 10,780   |       | 10,686              |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| SCI Cable, Inc.                            |                                                   | Service-cable,  internet, voice provider                        |       | Senior Term Debt  (non-accrual, Due 10/2008) (5) (10) (11) |       | 2,945    |       | 442                 |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Sunburst Media - Louisiana, LLC                 |                                                   | Service-radio  station operator                                 |       | Senior Term Debt  (10.5%, Due 6/2011) (5)                  |       | 6,406    |       | 5,913               |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Sunshine Media Holdings                         |                                                   | Service-publisher  regional B2B trade magazines                 |       | Senior Term Debt  (11.0%, Due 5/2012) (5)                  |       | 16,948   |       | 16,143              |       |
|                                            | Senior Term Debt  (13.5%, Due 5/2012) (3) (5)     |                                                            | 10,700     |                                                       | 10,085     |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Thibaut Acquisition Co.                         |                                                   | Service-design  and disbribute wall covering                    |       | Line of Credit,  $1,000 available (9.0%, Due 1/2011) (5)   |       | 1,000    |       | 944                 |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (8.5%, Due 1/2011) (5)                   |       | 1,488    |       | 1,404               |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (12.0%, Due 1/2011) (3) (5)         |       | 3,000    |       | 2,786               |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| VantaCore                                       |                                                   | Service-acquisition  of aggregate quarries                      |       | Senior  Subordinated Term Debt (12.0%, Due 8/2013) (5)     |       | 13,658   |       | 13,590              |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Viapack, Inc.                              |                                                   | Manufacturing-polyethylene  film                                |       | Senior Real  Estate Term Debt (10.0%, Due 3/2011) (5)      |       | 725      |       | 711                 |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (13.0%, Due 3/2011) (3) (5)         |       | 4,058    |       | 3,977               |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Visual Edge Technology, Inc.               |                                                   | Service-office  equipment distribution                          |       | Line of credit,  $3,000 available (10.8%, Due 9/2011) (5)  |       | 2,915    |       | 2,302               |       |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (15.5%, Due 8/2011) (5)     |       | 5,000    |       | 3,950               |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Westlake Hardware, Inc.                    |                                                   | Retail-hardware  and variety                                    |       | Senior  Subordinated Term Debt (9.0%, Due 1/2011) (5)      |       | 15,000   |       | 14,588              |       |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (10.3%, Due 1/2011) (5)     |       | 10,000   |       | 9,625               |       |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| Winchester Electronics                          |                                                   | Manufacturing-high  bandwidth connectors and cables             |       | Senior Term Debt  (5.3%, Due 5/2013) (5)                   |       | 1,250    |       | 1,241               |       |
|                                            | Senior Term Debt  (5.7%, Due 5/2013) (5)               |                                                            | 1,690      |                                                       | 1,648      |     |
|                                            | Senior  Subordinated Term Debt (14.0%, Due 6/2013) (5) |                                                            | 9,925      |                                                       | 9,528      |     |
|                                            |                                                   |                                                            |       |                                                       |       |     |       |                |       |
| *Subtotal  - Non-syndicated loans*              |                                                   |                                                            |       | 283,820                                                    |       | 264,471  |       |
|                                                 |                                                        |                                                                 |            |                                                            |            |          |            |                     |            |  |  |

 

4

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Table of Contents

 
| **Company (1)**                             | ** **         | **Industry**                                             | ** **                   | **Investment (2)**                                                    | ** **  | **Cost**   | ** **  | **Fair Value** | ** ** |
|--------------------------------------------------|--------------------|----------------------------------------------------------|------------------------------|----------------------------------------------------------------------------|-------------|------------|-------------|---------------------|------------|
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| ***Syndicated Loans:***                          |               |                                                     |                         |                                                                       |        |       |        |                |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| GTM Holdings, Inc.                          |               | Manufacturing-socks                                      |                         | Senior  Subordinated Term Debt (11.8%, Due 4/2014) (13)                    |        | $          | 500         |                | $          | 337 |   |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| Puerto Rico Cable  Acquisition Company, Inc.     |               | Service-telecommunications                               |                         | Senior  Subordinated Term Debt (7.8%, Due 1/2012) (6)                      |        | 7,170      |        | 5,998               |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| WP Evenflo Group Holdings Inc.                   |               | Manufacturing-infant  and                                |                         | Senior Term Debt  (8.0%, Due 2/2013) (6)                                   |        | 1,896      |        | 1,574               |       |
|                                             | juvenile  products |                                                     | Senior Preferred  Equity (8) |                                                                       | 333         |       | —      |                |
|                                             |               |                                                     |                         | Junior Preferred  Equity (8)                                               |        | 111        |        | —              |       |
|                                             |               |                                                     |                         | Common Stock (8)                                                           |        | —     |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| *Subtotal - Syndicated loans*                    |               |                                                     |                         | 10,010                                                                     |        | 7,909      |        |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| **Total Non-Control/Non-Affiliate  Investments** |               |                                                     | ** **                   | **$**                                                                      | **293,830** | ** ** | **$**       | **272,380**         |       |
| * *                                         |               |                                                     |                         |                                                                       |        |       |        |                |       |
| **CONTROL INVESTMENTS**                          |               |                                                     |                         |                                                                       |        |       |        |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| BERTL, Inc.                                 |               | Service-web-based  evaluator of digital imaging products |                         | Line of Credit,  $842 available (non-accrual, Due 10/2010) (7)(10)(13)     |        | $          |  930   |                | $          |  — |   |
|                                             |               |                                                     |                         | Common Stock  (7) (8)                                                 |        | 423        |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| Clinton Holdings, LLC                            |               | Distribution-aluminum  sheets and stainless steel        |                         | Senior  Subordinated Term Debt (12.0%, Due 1/2013) (5)                     |        | 17,140     |        | 13,712              |       |
|                                             |               |                                                     |                         | Common Stock  Warrants (7) (8)                                        |        | 109        |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| Defiance Integrated Technologies, Inc.      |               | Manufacturing-trucking  parts                            |                         | Senior Term Debt  (11.0%, Due 4/2013) (3) (5)                         |        | 7,354      |        | 7,355               |       |
|                                             |               |                                                     |                         | Common Stock  (7) (8)                                                 |        | 1          |        | —              |       |
|                                             |               |                                                     |                         | Guaranty ($250)                                                            |        |       |        |                |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| Lindmark Acquisition, LLC                        |               | Service-advertising                                      |                         | Senior  Subordinated Term Debt (11.3%, Due 10/2012) (7)                    |        | 12,000     |        | 10,500              |       |
|                                             |               |                                                     |                         | Senior  Subordinated Term Debt (13.0%, Due Upon Demand) (7)                |        | 1,553      |        | 1,058               |       |
|                                             |               |                                                     |                         | Common Stock  (7) (8)                                                 |        | 1          |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| LYP Holdings Corp.                               |               | Service-yellow pages  publishing                         |                         | Line of credit,  $1,850 available (10.0%, Due 12/2010) (7)                 |        | 1,248      |        | 1,248               |       |
|                                             |               |                                                     |                         | Senior Term Debt  (12.5%, Due 2/2012) (7)                                  |        | 325        |        | 222                 |       |
|                                             |               |                                                     |                         | Line of Credit,  $3,000 available (non-accrual, Due 6/2010) (7) (10)  |        | 1,170      |        | —              |       |
|                                             |               |                                                     |                         | Senior Term Debt  (non-accrual, Due 6/2011) (7) (10)                  |        | 2,688      |        | —              |       |
|                                             |               |                                                     |                         | Senior Term Debt  (non-accrual, Due 6/2011) (3) (7) (10)         |        | 2,750      |        | —              |       |
|                                             |               |                                                     |                         | Common Stock  Warrants (7) (8)                                        |        | —     |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| U.S. Healthcare Communications, Inc.        |               | Service-magazine  publisher/operator                     |                         | Line of credit,  $400 available (non-accrual, Due 12/2010) (7) (10)   |        | 169        |        | 163                 |       |
|                                             |               |                                                     |                         | Line of credit,  $450 available (non-accrual, Due 12/2010) (7) (10)   |        | 450        |        | —              |       |
|                                             |               |                                                     |                         | Common Stock  (7) (8)                                                 |        | 2,470      |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| Western Directories, Inc.                   |               | Service-directory  publisher                             |                         | Line of credit,  $1,280 available (non-accrual, Due 12/2009) (7) (10) |        | 1,268      |        | —              |       |
|                                             |               |                                                     |                         | Preferred Stock  (7) (8)                                              |        | 1,584      |        | —              |       |
|                                             |               |                                                     |                         | Common Stock  (7) (8)                                                 |        | 1          |        | —              |       |
|                                             |               |                                                     |                         |                                                                       |        |       |        |                |       |
| **Total Control Investments**                    | ** **         | ** **                                               | ** **                   | **$**                                                                      | **53,634**  | ** ** | **$**       | **34,258**          |       |
| ** **                                       | ** **         | ** **                                               | ** **                   |                                                                       |        |       |        |                |       |
| **Total Investments**                            |               |                                                     |                         |                                                                       | ** **  | **$**      | **347,464** | ** **          | **$**      | **306,638** |   |

 

5

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| (1)  | Certain of the  listed securities are issued by affiliate(s) of the indicated portfolio  company.                                                                                                                                                                                                                    |
|------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Percentage  represents interest rates in effect at December 31, 2009 and due date  represents the contractual maturity date.                                                                                                                                                                                         |
| (3)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt.                                                                                                                                                                      |
| (4)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt, however, the debt is also  junior to another Last Out Tranche.                                                                                                       |
| (5)  | Fair value was  based on opinions of value submitted by Standard & Poor’s Securities  Evaluations, Inc.                                                                                                                                                                                                |
| (6)  | Security valued  based on the indicative bid price on or near December 31, 2009, offered  by the respective syndication agent’s trading desk or secondary desk.                                                                                                                                                 |
| (7)  | Fair value was  based on the total enterprise value of the portfolio company using a  liquidity waterfall approach. The Company also considered discounted cash  flow methodologies.                                                                                                                                      |
| (8)  | Security is  non-income producing.                                                                                                                                                                                                                                                                                        |
| (9)  | ActivStyle’s  fair value was based on the full repayment subsequent to December 31,  2009 and includes a success fee with a fair value of $21 (see Note 10).                                                                                                                                                    |
| (10) | BERTL, CCS, SCI  Cable, U.S. Healthcare, Western Directories and a portion of LYP Holdings are  currently past due on interest payments and are on non-accrual.                                                                                                                                                           |
| (11) | Access TV’s loan  matured in December 2009, CCS’ loan matured in August 2008 and SCI  Cable’s loan matured in October 2008. The Company is actively working to  recover amounts due under these loans, however, there is no assurance that  there will be any recovery of amounts past due. |
| (12) | ACE Expediters’  interest and BERTL’s interest include paid in kind (“PIK”) interest. Please  refer to Note 2 “Summary of Significant Accounting Policies.”                                                                                                                                 |
| (13) | Security valued  based on the transaction sale price subsequent to December 31, 2009 (see  Note 10).                                                                                                                                                                                                                 |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESECONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF SEPTEMBER 30, 2009**

**(DOLLAR AMOUNTS IN THOUSANDS)**

 
| **Company (1)**                                    | ** **                                                   | **Industry**                                                   | ** ** | **Investment (2)**                                             | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|---------------------------------------------------------|--------------------------------------------------------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                                              | ** **                                                   | ** **                                                     | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** **          |       |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS**              |                                                         |                                                           |       |                                                                |       |       |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| ***Non-syndicated Loans:***                             |                                                         |                                                           |       |                                                                |       |       |       |                |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Access Television Network, Inc.                    |                                                         | Service-cable  airtime (infomercials)                          |       | Senior Term Debt  (14.5%, Due 12/2009) (5) (9)                 |       | $          | 963        |                | $          | 868 |   |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| ACE Expediters, Inc                                     |                                                         | Service-over-the-ground  logistics                             |       | Senior Term Debt  (13.5%, Due 9/2014) (5) (13)                 |       | 5,106      |       | 4,864               |       |
|                                                    |                                                         |                                                           |       | Common Stock  Warrants (8)                                          |       | 200        |       | 564                 |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| ActivStyle Acquisition Co.                              |                                                         | Service-medical  products distribution                         |       | Senior Term Debt  (13.0%, Due 4/2014) (3) (5)                  |       | 4,000      |       | 3,940               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Allison Publications, LLC                               |                                                         | Service-publisher  of consumer oriented magazines              |       | Senior Term Debt  (10.0%, Due 9/2012) (5)                           |       | 9,709      |       | 8,746               |       |
|                                                    | Senior Term Debt  (13.0%, Due 12/2010) (5)                   |                                                           | 260        |                                                                | 246        |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Anitox Acquisition Company                              |                                                         | Manufacturing-preservatives  for animal feed                   |       | Line of Credit,  $3,000 available (4.5%, Due 1/2010) (5)            |       | 1,700      |       | 1,681               |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (8.5%, Due 1/2012) (5)                            |       | 2,877      |       | 2,823               |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (10.5%, Due 1/2012) (3) (5)                  |       | 3,688      |       | 3,582               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| BAS Broadcasting                                        |                                                         | Service-radio  station operator                                |       | Senior Term Debt  (11.5%, Due 7/2013) (5)                           |       | 7,300      |       | 5,840               |       |
|                                                    | Senior Term Debt  (12.0%, Due 7/2009) (3) (5) (12) |                                                           | 950        |                                                                | 475        |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| CCS, LLC                                                |                                                         | Service-cable TV  franchise owner                              |       | Senior Term Debt  (non-accrual, Due 8/2008) (5) (10) (12) |       | 631        |       | 126                 |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Chinese Yellow Pages Company                            |                                                         | Service-publisher  of Chinese language directories             |       | Line of Credit,  $700 available (7.3%, Due 9/2010) (5)              |       | 450        |       | 427                 |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (7.3%, Due 9/2010) (5)                            |       | 518        |       | 488                 |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| CMI Acquisition, LLC                                    |                                                         | Service-recycling                                              |       | Senior  Subordinated Term Debt (10.3%, Due 11/2012) (5)             |       | 6,233      |       | 5,890               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Doe & Ingalls Management LLC                   |                                                         | Distributor-specialty  chemicals                               |       | Senior Term Debt  (6.8%, Due 11/2010) (5)                           |       | 2,300      |       | 2,266               |       |
|                                                    | Senior Term Debt  (7.8%, Due 11/2010) (3) (5)           |                                                           | 4,365      |                                                                | 4,267      |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Finn Corporation                                        |                                                         | Manufacturing-landscape  equipment                             |       | Common Stock  Warrants (8)                                          |       | 37         |       | 1,223               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| GFRC Holdings LLC                                       |                                                         | Manufacturing-glass-fiber  reinforced concrete                 |       | Line of Credit,  $2,000 available (4.5%, Due 12/2010)               |       | —     |       | —              |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (9.0%, Due 12/2012) (5)                           |       | 6,599      |       | 6,450               |       |
|                                                    |                                                         |                                                           |       | Senior  Subordinated Term Debt (11.5%, Due 12/2012) (3) (5)    |       | 6,665      |       | 6,432               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Global Materials Technologies, Inc.                |                                                         | Manufacturing-steel  wool products and metal fibers            |       | Senior Term Debt  (13.0%, Due 6/2010) (3) (5)                  |       | 4,410      |       | 3,528               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Heartland Communications Group                          |                                                         | Service-radio  station operator                                |       | Senior Term Debt  (10.0%, Due 5/2011) (5)                           |       | 4,567      |       | 2,726               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Interfilm Holdings, Inc.                           |                                                         | Service-slitter  and distributor of plastic films              |       | Senior Term Debt  (12.3%, Due 10/2012) (5)                          |       | 4,950      |       | 4,715               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| International Junior Golf Training Acquisition  Company |                                                         | Service-golf  training                                         |       | Line of Credit,  $1,500 available (9.0%, Due 5/2010) (5)            |       | 700        |       | 690                 |       |
|                                                    | Senior Term Debt  (8.5%, Due 5/2012) (5)                     |                                                           | 2,120      |                                                                | 2,036      |       |
|                                                    | Senior Term Debt  (10.5%, Due 5/2012) (3) (5)           |                                                           | 2,500      |                                                                | 2,366      |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| KMBQ Corporation                                        |                                                         | Service-AM/FM  radio broadcaster                               |       | Line of Credit,  $200 available (11.0%, Due 3/2010) (5)             |       | 153        |       | 69                  |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (11.0%, Due 3/2010) (5)                           |       | 1,785      |       | 801                 |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Legend Communications of Wyoming LLC                    |                                                         | Service-operator  of radio stations                            |       | Line of Credit,  $500 available (12.0%, Due 6/2011) (5)             |       | 497        |       | 450                 |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (12.0%, Due 6/2013) (5)                           |       | 9,373      |       | 8,482               |       |
|                                                    |                                                         |                                                           |       |                                                                |       |       |       |                |       |
| Newhall Holdings, Inc.                             |                                                         | Service-distributor  of personal care products and supplements |       | Line of Credit,  $3,000 available (11.3%, Due 5/2010) (5)           |       | 1,000      |       | 945                 |       |
|                                                    | Senior Term Debt  (5) (11.3%, Due 5/2012) (5)           |                                                           | 3,870      |                                                                | 3,657      |       |
|                                                    |                                                         |                                                           |       | Senior Term Debt  (14.3%, Due 5/2012) (3) (5)                  |       | 4,410      |       | 4,112               |       |
|                                                         |                                                              |                                                                |            |                                                                     |            |            |            |                     |            |  |  |

 

7

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Table ofContents

 
| **Company (1)**                            | ** **                                             | **Industry**                                                    | ** ** | **Investment (2)**                                   | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------|--------------------------------------------------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------|------------|---------------------|------------|
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Northern Contours, Inc.                         |                                                   | Manufacturing-veneer  and laminate components                   |       | Senior  Subordinated Term Debt (10.0%, Due 5/2010) (5)    |       | $        | 6,562      |                | $          | 5,414 |   |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Pinnacle Treatment Centers, Inc.           |                                                   | Service-Addiction  treatment centers                            |       | Line of Credit,  $500 available (4.5%, Due 12/2009)       |       | —   |       | —              |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (10.5%, Due 12/2011) (5)                |       | 2,750    |       | 2,633               |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (10.5%, Due 12/2011) (3) (5)       |       | 7,500    |       | 7,059               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Precision Acquisition Group Holdings, Inc. |                                                   | Manufacturing-consumable  components for the aluminum industry  |       | Equipment Note  (8.5%, Due 10/2011) (5)                   |       | 1,000    |       | 988                 |       |
|                                            | Senior Term Debt  (8.5%, Due 10/2010) (5)              |                                                            | 4,250      |                                                      | 4,192      |     |
|                                            | Senior Term Debt  (11.5%, Due 10/2010) (3) (5)    |                                                            | 4,074      |                                                      | 4,023      |     |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| PROFITSystems Acquisition Co.                   |                                                   | Service-design  and develop ERP software                        |       | Line of Credit,  $350 available (4.5%, Due 7/2010)        |       | —   |       | —              |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (8.5%, Due 7/2011) (5)                  |       | 1,600    |       | 1,468               |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (10.5%, Due 7/2011) (3) (5)        |       | 2,900    |       | 2,632               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| RCS Management Holding Co.                      |                                                   | Service-healthcare  supplies                                    |       | Senior Term Debt  (8.5%, Due 1/2011) (3) (5)         |       | 2,437    |       | 2,383               |       |
|                                            | Senior Term Debt  (10.5%, Due 1/2011) (4) (5)     |                                                            | 3,060      |                                                      | 2,949      |     |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Reliable Biopharmaceutical Holdings, Inc.  |                                                   | Manufacturing-pharmaceutical  and biochemical intermediates     |       | Line of Credit,  $5,000 available (9.0%, Due 10/2010) (5) |       | 800      |       | 788                 |       |
|                                            | Mortgage Note  (9.5%, Due 10/2014) (5)                 |                                                            | 7,335      |                                                      | 7,261      |     |
|                                            | Senior Term Debt  (9.0%, Due 10/2012) (5)              |                                                            | 1,530      |                                                      | 1,507      |     |
|                                            |                                                   |                                                            |       | Senior Term Debt  (11.0%, Due 10/2012) (3) (5)       |       | 11,813   |       | 11,518              |       |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (12.0%, Due 10/2013) (5)   |       | 6,000    |       | 5,640               |       |
|                                            |                                                   |                                                            |       | Common Stock  Warrants (8)                                |       | 209      |       | 282                 |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Saunders & Associates                  |                                                   | Manufacturing-equipment  provider for frequency control devices |       | Senior Term Debt  (9.8%, Due 5/2013) (5)                  |       | 10,780   |       | 10,618              |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| SCI Cable, Inc.                            |                                                   | Service-cable,  internet, voice provider                        |       | Senior Term Debt  (9.3%, Due 10/2008) (5) (12)       |       | 2,881    |       | 576                 |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Sunburst Media - Louisiana, LLC                 |                                                   | Service-radio  station operator                                 |       | Senior Term Debt  (10.5%, Due 6/2011) (5)                 |       | 6,411    |       | 5,817               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Sunshine Media Holdings                         |                                                   | Service-publisher  regional B2B trade magazines                 |       | Senior Term Debt  (11.0%, Due 5/2012) (5)                 |       | 16,948   |       | 15,973              |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (13.5%, Due 5/2012) (3) (5)        |       | 10,700   |       | 9,978               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Thibaut Acquisition Co.                         |                                                   | Service-design  and disbribute wall covering                    |       | Line of Credit,  $1,000 available (9.0%, Due 1/2011) (5)  |       | 1,000    |       | 933                 |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (8.5%, Due 1/2011) (5)                  |       | 1,487    |       | 1,387               |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (12.0%, Due 1/2011) (3) (5)        |       | 3,000    |       | 2,745               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Tulsa Welding School                            |                                                   | Service-private  welding school                                 |       | Line of credit,  $750 available (9.5%, Due 9/2011)        |       | —   |       | —              |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (9.5%, Due 9/2013) (5)                  |       | 4,144    |       | 4,144               |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (12.8%, Due 9/2013) (5)                 |       | 7,960    |       | 7,950               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| VantaCore                                       |                                                   | Service-acquisition  of aggregate quarries                      |       | Senior  Subordinated Term Debt (12.0%, Due 8/2013) (5)    |       | 13,726   |       | 13,589              |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Viapack, Inc.                              |                                                   | Manufacturing-polyethylene  film                                |       | Senior Real  Estate Term Debt (10.0%, Due 3/2011) (5)     |       | 775      |       | 743                 |       |
|                                            |                                                   |                                                            |       | Senior Term Debt  (13.0%, Due 3/2011) (3) (5)        |       | 4,061    |       | 3,893               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Visual Edge Technology, Inc.               |                                                   | Service-office  equipment distribution                          |       | Line of credit,  $3,000 available (10.8%, Due 9/2011) (5) |       | 2,981    |       | 2,340               |       |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (15.5%, Due 8/2011) (5)    |       | 5,000    |       | 3,925               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Westlake Hardware, Inc.                    |                                                   | Retail-hardware  and variety                                    |       | Senior  Subordinated Term Debt (9.0%, Due 1/2011) (5)     |       | 15,000   |       | 14,269              |       |
|                                            |                                                   |                                                            |       | Senior  Subordinated Term Debt (10.3%, Due 1/2011) (5)    |       | 10,000   |       | 9,400               |       |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| Winchester Electronics                          |                                                   | Manufacturing-high  bandwidth connectors and cables             |       | Senior Term Debt  (5.3%, Due 5/2013) (5)                  |       | 1,147    |       | 1,136               |       |
|                                            | Senior Term Debt  (5.7%, Due 5/2013) (5)               |                                                            | 1,690      |                                                      | 1,642      |     |
|                                            | Senior  Subordinated Term Debt (14.0%, Due 6/2013) (5) |                                                            | 9,925      |                                                      | 9,478      |     |
|                                            |                                                   |                                                            |       |                                                      |       |     |       |                |       |
| *Subtotal - Non-syndicated loans*               |                                                   |                                                            |       | 298,322                                                   |       | 277,048  |       |
|                                                 |                                                        |                                                                 |            |                                                           |            |          |            |                     |            |  |  |

 

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| **Company (1)**                             | ** **                   | **Industry**                                                | ** ** | **Investment (2)**                                                     | ** **  | **Cost**   | ** **  | **Fair Value** | ** ** |
|--------------------------------------------------|------------------------------|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------|-------------|------------|-------------|---------------------|------------|
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| ***Syndicated Loans:***                          |                         |                                                        |       |                                                                        |        |       |        |                |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| GTM Holdings, Inc.                          |                         | Manufacturing-socks                                         |       | Senior  Subordinated Term Debt (11.8%, Due 4/2014) (6)                      |        | $          | 500         |                | $          | 220 |   |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Kinetek Acquisition Corp.                        |                         | Manufacturing-custom  engineered motors & controls |       | Senior Term Debt  (3.6%, Due 11/2013) (7)                                   |        | 1,438      |        | 925                 |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Puerto Rico Cable Acquisition Company, Inc. |                         | Service-telecommunications                                  |       | Senior  Subordinated Term Debt (7.8%, Due 1/2012) (6)                       |        | 7,174      |        | 5,713               |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Wesco Holdings, Inc.                        |                         | Service-aerospace  parts and distribution                   |       | Senior  Subordinated Term Debt (6.0%, Due 3/2014) (7)                       |        | 2,264      |        | 1,856               |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| WP Evenflo Group Holdings Inc.                   |                         | Manufacturing-infant  and juvenile products                 |       | Senior Term Debt  (8.0%, Due 2/2013) (6)                                    |        | 1,901      |        | 1,235               |       |
|                                             | Senior Preferred  Equity (8) |                                                        | 333        |                                                                        | —      |       |
|                                             | Junior Preferred  Equity (8) |                                                        | 111        |                                                                        | —      |       |
|                                             |                         |                                                        |       | Common Stock (8)                                                            |        | —     |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| *Subtotal - Syndicated loans*                    |                         |                                                        |       | 13,721                                                                      |        | 9,949      |        |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| **Total Non-Control/Non-Affiliate  Investments** |                         |                                                        | ** ** | **$**                                                                       | **312,043** | ** ** | **$**       | **286,997**         |       |
| * *                                         |                         |                                                        |       |                                                                        |        |       |        |                |       |
| **CONTROL INVESTMENTS**                          |                         |                                                        |       |                                                                        |        |       |        |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| BERTL, Inc.                                 |                         | Service-web-based  evaluator of digital imaging products    |       | Line of Credit,  $842 available (non-accrual, Due 10/2009) (10)(13)(15)     |        | $          | 930         |                | $          | — |   |
|                                             |                         |                                                        |       | Common Stock  (8) (15)                                                 |        | 424        |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Clinton Holdings, LLC                            |                         | Distribution-aluminum  sheets and stainless steel           |       | Senior  Subordinated Term Debt (12.0%, Due 1/2013) (5) (14)            |        | 15,500     |        | 12,013              |       |
|                                             |                         |                                                        |       | Escrow Funding  Note (12.0%, Due 1/2013) (5) (14)                      |        | 640        |        | 496                 |       |
|                                             |                         |                                                        |       | Common Stock  Warrants (8) (15)                                        |        | 109        |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Defiance Integrated Technologies, Inc.      |                         | Manufacturing-trucking  parts                               |       | Senior Term Debt  (11.0%, Due 4/2010) (3) (11)                         |        | 6,005      |        | 6,005               |       |
|                                             |                         |                                                        |       | Senior Term Debt  (11.0%, Due 4/2010) (3) (11)                         |        | 1,178      |        | 1,178               |       |
|                                             |                         |                                                        |       | Common Stock  (8) (15)                                                 |        | 1          |        | 816                 |       |
|                                             |                         |                                                        |       | Guaranty ($250)                                                             |        |       |        |                |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Lindmark Acquisition, LLC                        |                         | Service-advertising                                         |       | Senior  Subordinated Term Debt (11.3%, Due 10/2012) (15) (16)               |        | 12,000     |        | 10,410              |       |
|                                             |                         |                                                        |       | Senior  Subordinated Term Debt (13.0%, Due Upon Demand) (15) (16)           |        | 1,553      |        | 1,049               |       |
|                                             |                         |                                                        |       | Common Stock  (8) (15)                                                 |        | 1          |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| LYP Holdings Corp.                               |                         | Service-yellow  pages publishing                            |       | Line of credit,  $1,250 available (10.0%, Due 7/2010) (15)                  |        | 1,168      |        | 1,168               |       |
|                                             |                         |                                                        |       | Senior Term Debt  (12.5%, Due 2/2012) (15)                                  |        | 325        |        | 325                 |       |
|                                             |                         |                                                        |       | Line of Credit,  $3,000 available (non-accrual, Due 6/2010) (10) (15)  |        | 1,170      |        | 421                 |       |
|                                             |                         |                                                        |       | Senior Term Debt  (non-accrual, Due 6/2011) (10) (15)                  |        | 2,688      |        | —              |       |
|                                             |                         |                                                        |       | Senior Term Debt  (non-accrual, Due 6/2011) (3) (10) (15)         |        | 2,750      |        | —              |       |
|                                             |                         |                                                        |       | Common Stock  Warrants (8) (15)                                        |        | —     |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| U.S. Healthcare Communications, Inc.        |                         | Service-magazine  publisher/operator                        |       | Line of credit,  $200 available (non-accrual, Due 3/2010) (10) (15)    |        | 169        |        | 91                  |       |
|                                             |                         |                                                        |       | Line of credit,  $450 available (non-accrual, Due 3/2010) (10) (15)    |        | 450        |        | —              |       |
|                                             |                         |                                                        |       | Common Stock  (8) (15)                                                 |        | 2,470      |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| Western Directories, Inc.                   |                         | Service-directory  publisher                                |       | Line of credit,  $1,250 available (non-accrual, Due 12/2009) (10) (15) |        | 1,234      |        | —              |       |
|                                             |                         |                                                        |       | Preferred Stock  (8) (15)                                              |        | 1,584      |        | —              |       |
|                                             |                         |                                                        |       | Common Stock  (8) (15)                                                 |        | 1          |        | —              |       |
|                                             |                         |                                                        |       |                                                                        |        |       |        |                |       |
| **Total Control Investments**                    | ** **                   | ** **                                                  | ** ** | **$**                                                                       | **52,350**  | ** ** | **$**       | **33,972**          |       |
| ** **                                       | ** **                   | ** **                                                  | ** ** | ** **                                                                  | ** **  | ** ** | ** **  | ** **          |       |
| **Total Investments**                            |                         |                                                        |       |                                                                        | ** **  | **$**      | **364,393** | ** **          | **$**      | **320,969** |   |

 

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| (1)  | Certain of the  listed securities are issued by affiliate(s) of the indicated portfolio  company.                                                                                                                                                                                                                                                                 |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Percentage  represents interest rates in effect at September 30, 2009 and due date  represents the contractual maturity date.                                                                                                                                                                                                                                     |
| (3)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt.                                                                                                                                                                                                                   |
| (4)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt, however, the debt is also  junior to another Last Out Tranche.                                                                                                                                                    |
| (5)  | Fair value was  based on opinions of value submitted by Standard & Poor’s Securities  Evaluations, Inc.                                                                                                                                                                                                                                             |
| (6)  | Security valued  based on the indicative bid price on or near September 30, 2009, offered  by the respective syndication agent’s trading desk or secondary desk.                                                                                                                                                                                             |
| (7)  | Security valued  based on the transaction sale price subsequent to September 30, 2009  (see Note 12).                                                                                                                                                                                                                                                             |
| (8)  | Security is non-income  producing.                                                                                                                                                                                                                                                                                                                                     |
| (9)  | Access  Television includes a success fee with a fair value of $1.                                                                                                                                                                                                                                                                                                     |
| (10) | BERTL, CCS, U.S.  Healthcare, Western Directories and a portion of LYP Holdings are currently  past due on interest payments and are on non-accrual. BERTL’s loan matured in  October 2009 and the Company is actively working to recover amounts due  under this loan. However, there is no assurance that there will be any  recovery of amounts past due. |
| (11) | Fair value of  security estimated to be equal to cost due to recent recapitalization.                                                                                                                                                                                                                                                                                  |
| (12) | BAS  Broadcasting’s loan matured in July 2009, CCS’ loan matured in  August 2008 and SCI Cable’s loan matured in October 2008. The  Company is actively working to recover amounts due under these loans,  however, there is no assurance that there will be any recovery of amounts  past due.                                          |
| (13) | ACE Expediters’  interest and BERTL’s interest include paid in kind (“PIK”) interest. Please  refer to Note 2 “Summary of Significant Accounting Policies.”                                                                                                                                                                              |
| (14) | Subsequent to  September 30, 2009, Clinton Aluminum’s senior subordinated term debt and  escrow funding note were combined into one term note, with an interest rate  of 12.0% and maturity date of January 2013. In addition, a term loan was  entered into for $320, with an interest rate of 12.0% and maturity date of  January 2013.          |
| (15) | Fair value was  based on the total enterprise value of the portfolio company using a  liquidity waterfall approach. The Company also considered discounted cash  flow methodologies.                                                                                                                                                                                   |
| (16) | Lindmark’s loan  agreement was amended in March 2009 such that any unpaid current  interest accrues at a conditional interest rate.  The conditional  interest is not recorded until paid (see Note 2, “Summary of Significant  Accounting Policies — *Interest Income  Recognition*”).                                                  |

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIALSTATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)**

**(UNAUDITED)**

 
| ** **                                                                               | ** ** | **Three Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| INVESTMENT INCOME                                                                        |       |                                     |       |   |   |
| Interest income — Non-Control/Non-Affiliate investments                             |       | $                                        | 8,984      |   | $ | 11,661 |   |
| Interest income — Control  investments                                              |       | 693                                      |       | 20 |   |
| Interest income — Cash                                                              |       | —                                   |       | 10 |   |
| Interest income — Notes  receivable from employees (Refer to Note 4)                |       | 113                                      |       | 117 |   |
| Prepayment fees and other  income                                                        |       | 14                                       |       | — |   |
| Total investment income                                                                  |       | 9,804                                    |       | 11,808 |   |
|                                                                                     |       |                                     |       |   |   |
| EXPENSES                                                                                 |       |                                     |       |   |   |
| Interest expense                                                                         |       | 1,535                                    |       | 2,461 |   |
| Loan servicing fee (Refer  to Note 4)                                                    |       | 929                                      |       | 1,623 |   |
| Base management fee (Refer  to Note 4)                                                   |       | 721                                      |       | 434 |   |
| Incentive fee (Refer to  Note 4)                                                         |       | 375                                      |       | 1,176 |   |
| Administration fee (Refer  to Note 4)                                                    |       | 178                                      |       | 227 |   |
| Professional fees                                                                        |       | 912                                      |       | 313 |   |
| Amortization of deferred  financing fees                                                 |       | 494                                      |       | 719 |   |
| Stockholder related costs                                                                |       | 78                                       |       | 89 |   |
| Directors fees                                                                           |       | 48                                       |       | 48 |   |
| Insurance expense                                                                        |       | 68                                       |       | 57 |   |
| Other expenses                                                                           |       | 67                                       |       | 66 |   |
| Expenses before credit from  Adviser                                                     |       | 5,405                                    |       | 7,213 |   |
| Credit to base management  and incentive feesfrom Adviser  (Refer to Note 4)             |       | (29                                      | )          | (1,286 | ) |
| Total expenses net of  credit to base management and incentive fees                      |       | 5,376                                    |       | 5,927 |   |
|                                                                                     |       |                                     |       |   |   |
| NET INVESTMENT INCOME                                                                    |       | 4,428                                    |       | 5,881 |   |
|                                                                                     |       |                                     |       |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS AND BORROWINGS UNDER LINE OF CREDIT: |       |                                     |       |   |   |
| Net realized loss on  investments                                                        |       | (920                                     | )          | (1,731 | ) |
| Net unrealized appreciation  (depreciation) on investments                               |       | 2,599                                    |       | (13,253 | ) |
| Net unrealized depreciation  on borrowings under line of credit                          |       | 219                                      |       | — |   |
| Net gain (loss) on  investments and borrowings under line of credit                      |       | 1,898                                    |       | (14,984 | ) |
|                                                                                     |       |                                     |       |   |   |
| NET INCREASE (DECREASE) IN  NET ASSETS RESULTING FROM OPERATIONS                         |       | $                                        | 6,326      |   | $ | (9,103 | ) |
|                                                                                     |       |                                     |       |   |   |
| NET INCREASE (DECREASE) IN  NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:       |       |                                     |       |   |   |
| Basic and Diluted                                                                        |       | $                                        | 0.30       |   | $ | (0.43 | ) |
|                                                                                     |       |                                     |       |   |   |
| WEIGHTED AVERAGE SHARES OF  COMMON STOCK OUTSTANDING:                                    |       |                                     |       |   |   |
| Basic and Diluted                                                                        |       | 21,087,574                               |       | 21,087,574 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESECONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN NETASSETS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                      | ** ** | **Three Months Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| *Operations:*                                                   |       |                                     |       |   |   |
| Net investment income                                           |       | $                                        | 4,428      |   | $ | 5,881 |   |
| Net realized loss on investments                                |       | (920                                     | )          | (1,731 | ) |
| Net unrealized appreciation (depreciation) on  investments      |       | 2,599                                    |       | (13,253 | ) |
| Net unrealized depreciation on borrowings under line  of credit |       | 219                                      |       | — |   |
| Net increase (decrease) in net assets from operations           |       | 6,326                                    |       | (9,103 | ) |
|                                                            |       |                                     |       |   |   |
| *Capital transactions:*                                         |       |                                     |       |   |   |
| Shelf offering costs                                            |       | (39                                      | )          | (3 | ) |
| Distributions to stockholders                                   |       | (4,428                                   | )          | (8,856 | ) |
| Repayment of principal on employee notes                        |       | —                                   |       | 4 |   |
| Reclassification of principal on employee note                  |       | 514                                      |       | — |   |
| Net (decrease) in net assets from capital  transactions         |       | (3,953                                   | )          | (8,855 | ) |
|                                                            |       |                                     |       |   |   |
| Total increase (decrease) in net assets                         |       | 2,373                                    |       | (17,958 | ) |
| Net assets at beginning of year                                 |       | 249,076                                  |       | 271,748 |   |
| Net assets at end of period                                     |       | $                                        | 251,449    |   | $ | 253,790 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESECONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                                                                               | ** ** | **Three Months ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| **CASH FLOWS  FROM OPERATING ACTIVITIES**                                                                                                |       |                                     |       |   |   |
| Net increase (decrease) in  net assets resulting from operations                                                                         |       | $                                        | 6,326      |   | $ | (9,103 | ) |
| Adjustments to reconcile  net increase (decrease) in net assets resulting from operations to net cash  provided by operating activities: |       |                                     |       |   |   |
| Purchase of investments                                                                                                                  |       | (2,171                                   | )          | (8,702 | ) |
| Principal repayments on  investments                                                                                                     |       | 15,404                                   |       | 14,927 |   |
| Proceeds from sale of  investments                                                                                                       |       | 2,782                                    |       | 2,212 |   |
| Net amortization of  premiums and discounts                                                                                              |       | 45                                       |       | (49 | ) |
| Increase in investment  balance due to paid in kind interest                                                                             |       | (51                                      | )          | (17 | ) |
| Net realized loss on  investments                                                                                                        |       | 920                                      |       | 1,731 |   |
| Amortization of deferred  financing fees                                                                                                 |       | 494                                      |       | 719 |   |
| Change in net unrealized  (depreciation) appreciation on investments                                                                     |       | (2,599                                   | )          | 13,253 |   |
| Change in net unrealized  appreciation on borrowings under line of credit                                                                |       | (219                                     | )          | — |   |
| (Increase) decrease in  interest receivable                                                                                              |       | (139                                     | )          | 902 |   |
| Increase in funds due from  custodian                                                                                                    |       | (6,711                                   | )          | (2,760 | ) |
| Increase in prepaid assets                                                                                                               |       | (40                                      | )          | (15 | ) |
| Decrease in due from  affiliate                                                                                                          |       | 69                                       |       | — |   |
| Decrease (increase) in  receivables from portfolio companies                                                                             |       | 885                                      |       | (272 | ) |
| Decrease in other assets                                                                                                                 |       | 24                                       |       | 69 |   |
| Decrease in accounts  payable                                                                                                            |       | (67                                      | )          | — |   |
| Decrease in interest  payable                                                                                                            |       | (39                                      | )          | (103 | ) |
| Decrease in accrued  expenses and deferred liabilities                                                                                   |       | (112                                     | )          | (181 | ) |
| Increase in fees due to  affiliate (Refer to Note 4)                                                                                     |       | 451                                      |       | 268 |   |
| Decrease in administration  fee due to Gladstone Administration (Refer to Note 4)                                                        |       | (38                                      | )          | (20 | ) |
| Decrease in funds held in  escrow                                                                                                        |       | (145                                     | )          | (158 | ) |
| Net cash provided by  operating activities                                                                                               |       | 15,069                                   |       | 12,701 |   |
|                                                                                                                                     |       |                                     |       |   |   |
| **CASH FLOWS  FROM FINANCING ACTIVITIES:**                                                                                               |       |                                     |       |   |   |
| Shelf offering costs                                                                                                                     |       | (39                                      | )          | (3 | ) |
| Borrowings from the line of  credit                                                                                                      |       | 2,900                                    |       | 22,500 |   |
| Repayments on the line of  credit                                                                                                        |       | (12,500                                  | )          | (27,060 | ) |
| Distributions paid                                                                                                                       |       | (4,428                                   | )          | (8,856 | ) |
| Receipt of principal on  notes receivable — employees (Refer to Note 4)                                                             |       | —                                   |       | 4 |   |
| Deferred financing rebate  (fees)                                                                                                        |       | 96                                       |       | (23 | ) |
| Net cash used in financing  activities                                                                                                   |       | (13,971                                  | )          | (13,438 | ) |
|                                                                                                                                     |       |                                     |       |   |   |
| **NET  INCREASE (DECREASE) IN CASH**                                                                                                     |       | 1,098                                    |       | (737 | ) |
| **CASH,  BEGINNING OF PERIOD**                                                                                                           |       | 5,276                                    |       | 6,493 |   |
| **CASH, END  OF PERIOD**                                                                                                                 |       | $                                        | 6,374      |   | $ | 5,756 |   |
| ** **                                                                                                                               |       |                                     |       |   |   |
| **NON-CASH  FINANCING ACTIVITIES**                                                                                                       |       |                                     |       |   |   |
| Reclassification  of principal on employee note (Refer to Note 4)                                                                        |       | $                                        | 514        |   | $ | — |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESECONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**FINANCIAL HIGHLIGHTS**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)**

**(UNAUDITED)**

 
| ** **                                                          | ** ** | **Three months ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| Per Share Data (1)                                                  |       |                                     |       |   |   |
| Net asset value at  beginning of period                             |       | $                                        | 11.81      |   | $ | 12.89 |   |
| *Income  from investment operations:*                               |       |                                     |       |   |   |
| Net investment income (2)                                           |       | 0.21                                     |       | 0.28 |   |
| Net realized loss on  investments (2)                               |       | (0.04                                    | )          | (0.08 | ) |
| Net unrealized appreciation  (depreciation) on investments (2)      |       | 0.12                                     |       | (0.63 | ) |
| Net unrealized depreciation  on borrowings under line of credit (2) |       | 0.01                                     |       | — |   |
| Total from investment  operations                                   |       | 0.30                                     |       | (0.43 | ) |
|                                                                |       |                                     |       |   |   |
| Distributions to  stockholders (3)                                  |       | (0.21                                    | )          | (0.42 | ) |
| Reclassification  of principal on employee note (3)                 |       | 0.02                                     |       | — |   |
| Net asset value at end of  period                                   |       | $                                        | 11.92      |   | $ | 12.04 |   |
|                                                                |       |                                     |       |   |   |
| Per share market value at  beginning of period                      |       | $                                        | 8.93       |   | $ | 15.24 |   |
| Per share market value at  end of period                            |       | $                                        | 7.69       |   | $ | 8.09 |   |
| Total return (4)(5)                                                 |       | (11.58                                   | )%         | (44.09 | )% |
| Shares outstanding at end  of period                                |       | 21,087,574                               |       | 21,087,574 |   |
|                                                                |       |                                     |       |   |   |
| Statement of Assets and  Liabilities Data:                          |       |                                     |       |   |   |
| Net assets at end of period                                         |       | $                                        | 251,449    |   | $ | 253,790 |   |
| Average net assets (6)                                              |       | $                                        | 248,874    |   | $ | 262,001 |   |
| Senior Securities Data:                                             |       |                                     |       |   |   |
| Borrowings under line of  credit                                    |       | $                                        | 73,531     |   | $ | 146,470 |   |
| Asset coverage ratio (7)(8)                                         |       | 442                                      | %          | 273 | % |
| Asset coverage per unit (8)                                         |       | $                                        | 4,420      |   | $ | 2,733 |   |
| Ratios/Supplemental Data:                                           |       |                                     |       |   |   |
| Ratio of expenses to  average net assets-annualized (9)             |       | 8.69                                     | %          | 11.01 | % |
| Ratio of net expenses to  average net assets-annualized (10)        |       | 8.64                                     | %          | 9.05 | % |
| Ratio of net investment  income to average net assets-annualized    |       | 7.12                                     | %          | 8.98 | % |

 

----

| (1)  |   | Based on actual shares outstanding at the end of the corresponding  period.                                                                                                                                                                                                                                                                                                                                                                                                            |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Based on weighted average basic per share data.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (3)  |   | Distributions are determined based on taxable income calculated in  accordance with income tax regulations which may differ from amounts  determined under accounting principles generally accepted in the United  States of America.                                                                                                                                                                                                                                                  |
| (4)  |   | Total return equals the change in the ending market value of the  Company’s common stock from the beginning of the period taking into account  distributions reinvested in accordance with the terms of the Company’s  dividend reinvestment plan. Total return does not take into account  distributions that may be characterized as a return of capital. For further  information on the estimated character of the Company’s distributions please  refer to Note 8. |
| (5)  |   | Amounts were not annualized.                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (6)  |   | Average net assets are computed using the average of the balance of  net assets at the end of each month of the reporting period.                                                                                                                                                                                                                                                                                                                                                      |
| (7)  |   | As a business development company, the Company is generally required  to maintain a ratio of at least 200% of total assets, less all liabilities  and indebtedness not represented by senior securities, to total borrowings.                                                                                                                                                                                                                                                          |
| (8)  |   | Asset coverage ratio is the ratio of the carrying value of the  Company’s total consolidated assets, less all liabilities and indebtedness  not represented by senior securities, to the aggregate amount of senior  securities representing indebtedness. Asset coverage per unit is the asset  coverage ratio expressed in terms of dollar amounts per $1 thousand of  indebtedness.                                                                                            |
| (9)  |   | Ratio of expenses to average net assets is computed using expenses  before credits from Adviser to the base management and incentive fees and  including income tax expense.                                                                                                                                                                                                                                                                                                           |
| (10) |   | Ratio of net expenses to average net assets is  computed using total expenses net of credits from Adviser to the base  management and incentive fees and including income tax expense.                                                                                                                                                                                                                                                                                                 |

 

*THE ACCOMPANYING NOTESARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2009**

**(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISEINDICATED)**

**(UNAUDITED)**

 

**NOTE 1.  ORGANIZATION**

 

GladstoneCapital Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Maryland on May 30, 2001.  The Company is a closed-end, non-diversifiedmanagement investment company that has elected to be treated as a businessdevelopment company (“BDC”) under the Investment Company Act of 1940, asamended (the “1940 Act”).  In addition,the Company has elected to be treated for tax purposes as a regulatedinvestment company (“RIC”) under the Internal Revenue Code of 1986, as amended(the “Code”).  The Company’s investmentobjective is to achieve a high level of current income by investing in debtsecurities, consisting primarily of senior notes, senior subordinated notes andjunior subordinated notes, of established private businesses that aresubstantially owned by leveraged buyout funds, individual investors or arefamily-owned businesses, with a particular focus on senior notes. In addition,the Company may acquire from others existing loans that meet this profile.

 

GladstoneBusiness Loan, LLC (“Business Loan”), a wholly-owned subsidiary of the Company,was established on February 3, 2003 for the purpose of holding the Company’sportfolio of loan investments.  GladstoneCapital Advisers, Inc. is also a wholly-owned subsidiary of the Company,which was established on December 30, 2003.

 

GladstoneSBIC, LP (“Gladstone SBIC”) and Gladstone SBIC GP, LLC, the general partner ofGladstone SBIC, were established on December 4, 2008 as wholly-ownedsubsidiaries of the Company for the purpose of applying for and holding alicense to enable the Company, through Gladstone SBIC, to make investments inaccordance with the United States Small Business Administration guidelines for smallbusiness investment companies.

 

GladstoneFinancial Corporation (“Gladstone Financial”), a wholly-owned subsidiary of theCompany, was established on November 21, 2006 for the purpose of holding alicense to operate as a Specialized Small Business Investment Company.  Gladstone Financial (previously known asGladstone SSBIC Corporation) acquired this license in February 2007.  This will enable the Company, through thissubsidiary, to make investments in accordance with the United States SmallBusiness Administration guidelines for specialized small business investmentcompanies.

 

Thefinancial statements of the subsidiaries are consolidated with those of theCompany.

 

TheCompany is externally managed by Gladstone Management Corporation (the “Adviser”),an unconsolidated affiliate of the Company.

 

**NOTE 2.  SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

*Unaudited Interim Financial Statements*

 

Interimfinancial statements of the Company are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and pursuant to the requirements for reporting onForm 10-Q and Article 10 of Regulation S-X.  Accordingly, certain disclosures accompanyingannual financial statements prepared in accordance with GAAP are omitted.  In the opinion of the Company’s management,all adjustments, consisting solely of normal recurring accruals, necessary forthe fair 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-Kfor the fiscal year ended September 30, 2009, as filed with the Securitiesand Exchange Commission (the “SEC”) on November 23, 2009.

 

Theyear-end condensed balance sheet data was derived from audited financialstatements, but does not include all disclosures required by GAAP.

 

*InvestmentValuation Policy*

 

The Companycarries its investments at market value to the extent that market quotationsare readily available and reliable, and otherwise at fair value, as determinedin good faith by its Board of Directors. In determining the fair value of the Company’s investments, the Adviserhas established an investment valuation policy (the “Policy”).  The Policy is approved by the Company’s 

 

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Board of Directorsand each quarter the Board of Directors reviews whether the Adviser has appliedthe Policy consistently and votes whether or not to accept the recommendedvaluation of the Company’s investment portfolio.

 

The Company uses generally accepted valuation techniques to value itsportfolio unless the Company has specific information about the value of aninvestment to determine otherwise. From time to time the Company may accept anappraisal of a business in which the Company holds securities. These appraisalsare expensive and occur infrequently but provide a third-party valuationopinion that may differ in results, techniques and scopes used to value theCompany’s investments.  When thesespecific third-party appraisals are engaged or accepted, the Company usesestimates of value provided by such appraisals and its own assumptionsincluding estimated remaining life, current market yield and interest ratespreads of similar securities as of the measurement date to value theinvestment the Company has in that business.

 

The Policy, whichis summarized below, applies to publicly-traded securities, securities forwhich a limited market exists and securities for which no market exists.

 

**Publicly-tradedsecurities:** TheCompany determines the value of publicly-traded securities based on the closingprice for the security on the exchange or securities market on which it islisted and primarily traded on the valuation date.  To the extent that the Company ownsrestricted securities that are not freely tradable, but for which a publicmarket otherwise exists, the Company will use the market value of that securityadjusted for any decrease in value resulting from the restrictive feature.

 

**Securitiesfor which a limited market exists:** The Company values securities that are not traded onan established secondary securities market, but for which a limited market forthe security exists, such as certain participations in, or assignments of,syndicated loans, at the quoted bid price. In valuing these assets, the Company assesses trading activity in anasset class and evaluates variances in prices and other market insights todetermine if any available quote prices are reliable.  If the Company concludes that quotes based onactive markets or trading activity may be relied upon, firm bid prices arerequested; however, if a firm bid price is unavailable, the Company bases thevalue of the security upon the indicative bid price offered by the respectiveoriginating syndication agent’s trading desk, or secondary desk, on or near thevaluation date. To the extent that the Company uses the indicative bid price asa basis for valuing the security, the Adviser may take further steps toconsider additional information to validate that price in accordance with thePolicy.

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, the Company will value its syndicated loans using estimated netpresent values of the future cash flows or discounted cash flows (“DCF”). Theuse of a DCF methodology follows that prescribed by the Financial AccountingStandards Board (“FASB”) AccountingStandards Codification (“ASC”) 820,“Fair Value Measurements and Disclosures,” which provides guidance onthe use of a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in ASC820 is the use of valuing investments based on DCF.  For the purposes of using DCF to provide fairvalue estimates, the Company considers multiple inputs such as a risk-adjusteddiscount rate that incorporates adjustments that market participants would makeboth for nonperformance and liquidity risks. As such, the Company develops a modified discount rate approach thatincorporates risk premiums including, among others, increased probability ofdefault, or higher loss given default, or increased liquidity risk. The DCFvaluations applied to the syndicated loans provide an estimate of what theCompany believes a market participant would pay to purchase a syndicated loanin an active market, thereby establishing a fair value.  The Company will apply the DCF methodology inilliquid markets until quoted prices are available or are deemed reliable basedon trading activity.

 

As of December 31,2009, the Company assessed trading activity in its syndicated loan assets anddetermined that there continued to be market liquidity and a functioningsecondary market for these assets.  Thus,firm bid prices or indicative bids were used to fair value the Company’sremaining syndicated loans as of December 31, 2009.  However, for the syndicated loan salecompleted after December 31, 2009, the Company used the sales price tovalue such syndicated loan.

 

**Securitiesfor which no market exists:** The valuation methodology for securities for which nomarket exists falls into three categories: (1) portfolio investmentscomprised solely of debt securities; (2) portfolio investments incontrolled companies comprised of a bundle of securities, which can includedebt and equity securities; and (3) portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities.

 

**(1)****        ****Portfolio investments comprisedsolely of debt securities:** Debt securities that are not publicly-traded on anestablished securities market, or for which a limited market does not exist (“Non-PublicDebt Securities”), and that are issued by portfolio companies where the Companyhas no equity or equity-like securities, are fair valued in accordance with theterms of the Policy, which utilizes opinions of value submitted to the Companyby Standard & Poor’s Securities Evaluations, Inc. (“SPSE”). TheCompany may also submit paid in kind (“PIK”) interest to SPSE for theirevaluation when it is determined the PIK interest is likely to be received.

 

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**(2)****        ****Portfolio investments in controlledcompanies comprised of a bundle of investments, which can include debt andequity securities:**The fair value of these investments is determined based on the total enterprisevalue of the portfolio company, or issuer, utilizing a liquidity waterfallapproach, for the Company’s Non-Public Debt Securities and equity orequity-like securities (e.g. preferred equity, equity, or other equity-likesecurities) that are purchased together as part of a package, where the Companyhas control or could gain control through an option or warrant security, boththe debt and equity securities of the portfolio investment would exit in themergers and acquisition market as the principal market, generally through asale or recapitalization of the portfolio company. In accordance with ASC820-10, the Company applies the in-use premise of value which assumes the debtand equity securities are sold together. Under this liquidity waterfallapproach, the Company first calculates the total enterprise value of the issuerby incorporating some or all of the following factors to determine the totalenterprise value of the issuer:

 

·        the issuer’s ability to make payments;

·        the earnings of the issuer;

·        recent sales to third parties of similar securities;

·        the comparison to publicly traded securities; and

·        DCF or other pertinent factors.

 

In gathering the sales to third parties of similar securities, theCompany may reference industry statistics and use outside experts. Once theCompany has estimated the total enterprise value of the issuer, the Companywill subtract the value of all the debt securities of the issuer, which are valuedat the contractual principal balance. Fair values of these debt securities arediscounted for any shortfall of total enterprise value over the total debtoutstanding for the issuer. Once the values for all outstanding seniorsecurities (which include the debt securities) have been subtracted from thetotal enterprise value of the issuer, the remaining amount, if any, is used todetermine the value of the issuer’s equity or equity like securities.  If, in the Adviser’s judgment, the liquiditywaterfall approach does not accurately reflect the value of the debt component,the Adviser may recommend that the Company use a valuation by SPSE, or if thatis unavailable, a DCF valuation technique.

 

**(3)****        ****Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities:**The Company values Non-Public Debt Securities that arepurchased together with equity and equity-like securities from the sameportfolio company, or issuer, for which the Company does not control or cannotgain control as of the measurement date, using a hypothetical secondary marketas the Company’s principal market. In accordance with ASC 820-10, the Companydetermines its fair value of these debt securities of non-control investmentsassuming the sale of an individual debt security using the in-exchange premiseof value. As such, the Company estimates the fair value of the debt componentusing estimates of value provided by SPSE and its own assumptions in theabsence of observable market data, including synthetic credit ratings,estimated remaining life, current market yield and interest rate spreads ofsimilar securities as of the measurement date. For equity or equity-likesecurities of investments for which the Company does not control or cannot gaincontrol as of the measurement date, the Company estimates the fair value of theequity using the in-exchange premise of value based on factors such as theoverall value of the issuer, the relative fair value of other units of account includingdebt, or other relative value approaches. Consideration also is given tocapital structure and other contractual obligations that may impact the fairvalue of the equity. Further, the Company may utilize comparable values ofsimilar companies, recent investments and indices with similar structures andrisk characteristics or its own assumptions in the absence of other observablemarket data and may also employ DCF valuation techniques.

 

Due to the uncertainty inherent in the valuation process, such estimatesof fair value may differ significantly from the values that would have beenobtained had a ready market for the securities existed, and the differencescould be material. Additionally, changes in the market environment and otherevents that may occur over the life of the investments may cause the gains orlosses ultimately realized on these investments to be different than thevaluations currently assigned. There is no single standard for determining fairvalue in good faith, as fair value depends upon circumstances of eachindividual case. In general, fair value is the amount that the Company mightreasonably expect to receive upon the current sale of the security in anarms-length transaction in the security’s principal market.

 

Refer to Note 3 foradditional information regarding fair value measurements under ASC 820-10.

 

*InterestIncome Recognition*

 

Interest income, adjusted for amortization of premiums and acquisitioncosts and for the accretion of discounts, is recorded on the accrual basis tothe extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days ormore past due or if the Company’s qualitative assessment indicates that thedebtor is unable to service its debt or other obligations, the Company will placethe loan on non-accrual status and cease recognizing interest income on thatloan until the borrower has demonstrated the ability 

 

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and intent to paycontractual amounts due.  However, theCompany remains contractually entitled to this interest.  At December 31,2009, two Non-Control/Non-Affiliate investments and four Control investmentswere on non-accrual with an aggregate cost basis of approximately $13,001, or 3.7%of the cost basis of all loans in the Company’s portfolio.  At September 30, 2009, oneNon-Control/Non-Affiliate investment and four Control investments were onnon-accrual with an aggregate cost basis of approximately $10,022, or 2.8% ofthe cost basis of all loans in the Company’s portfolio.  Conditional interest, or a success fee, isrecorded when earned or upon full repayment of a loan investment.

 

*Paid in Kind Interest*

 

TheCompany has two loans in its portfolio which contain PIK provisions. The PIKinterest, computed at the contractual rate specified in each loan agreement, isadded to the principal balance of the loan and recorded as income. To maintainthe Company’s status as a RIC, this non-cash source of income must be paid outto stockholders in the form of distributions, even though the Company has notyet collected the cash.   For the threemonths ended December 31, 2009 and 2008, the Company recorded PIK incomeof $51 and $17, respectively.

 

*Recent Accounting Pronouncements*

 

InAugust 2009, FASB issued Accounting Standard Update (“ASU”) No. 2009-05,“Fair Value Measurements and Disclosures: Measuring Liabilities at Fair Value.”  The update provides clarification to ASC 820for the valuation techniques required to measure the fair value ofliabilities.  ASU No. 2009-05 alsoprovides clarification around required inputs to the fair value measurement ofa liability and definition of a Level 1 liability.  ASU No. 2009-05 is effective for interimand annual periods beginning after August 28, 2009.  The Company adopted ASU No. 2009-05beginning with the quarter ended December 31, 2009.  The adoption of this standard did not have amaterial effect on the Company’s financial position and results of operations.

 

In September 2009, the FASB issued ASU No. 2009-12,“Measuring Fair Value Measurements and Disclosures: Investments in CertainEntities That Calculate Net Asset Value per Share (or Its Equivalent),” thatprovides additional guidance on how companies should estimate the fair value ofcertain alternative investments, such as hedge funds, private equity funds andventure capital funds. The fair value of such investments can now be determinedusing net asset value (“NAV”) as a practical expedient, unless it is probablethat the investment will not be sold at a price equal to NAV. In thosesituations, the practical expedient cannot be used and disclosure of theremaining actions necessary to complete the sale will be required.  New disclosures of the attributes of allinvestments within the scope of the new guidance is required, regardless ofwhether an entity used the practical expedient to measure the fair value of anyof its investments.  ASU No. 2009-12is effective for the first annual or interim reporting period ending after December 15,2009, with early application permitted. The Company determined that theadoption of this standard did not have a material effect on its financialposition and results of operations as of and for the three months ended December 31,2009.

 

In December 2009,FASB issued ASU No. 2009-17, “Consolidations: Improvements to FinancialReporting by Enterprises Involved with Variable Interest Entities,” that amendsthe FASB ASC for the issuance of FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R).”  The amendments in this ASU replace thequantitative-based risks and rewards calculation for determining whichreporting entity, if any, has a controlling financial interest in a variableinterest entity with an approach focused on identifying which reporting entityhas the power to direct the activities of a variable interest entity that mostsignificantly impact such entity’s economic performance and (1) theobligation to absorb losses of such entity or (2) the right to receivebenefits from such entity. An approach that is expected to be primarilyqualitative will be more effective for identifying which reporting entity has acontrolling financial interest in a variable interest entity. The amendments inASU No. 2009-17 also require additional disclosures about a reportingentity’s involvement in variable interest entities, which will enhance theinformation provided to users of financial statements.  ASU No. 2009-17 is effective for annualperiods beginning after November 15, 2009. The Company does not believe the adoption of this standard will have amaterial impact on its financial position and results of operations.

 

In January 2010,FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures,” thatrequires reporting entities to make new disclosures about recurring ornonrecurring fair-value measurements including significant transfers into andout of Level 1 and Level 2 fair-value measurements and information onpurchases, sales, issuances, and settlements on a gross basis in thereconciliation of Level 3 fair-value measurements.  The FASB also clarified existing fair-valuemeasurement disclosure guidance about the level of disaggregation, inputs, andvaluation techniques. The new and revised disclosures are required to beimplemented in fiscal years beginning after December 15, 2009 and December 15,2010.  The Company is currentlyevaluating the impact of adopting this standard on its financial position andresults of operations.

 

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**NOTE 3. INVESTMENTS**

 

The Companyadopted guidance for fair value measurements on October 1, 2008.  In part, this guidance defines fair value,establishes a framework for measuring fair value and expands disclosures aboutassets and liabilities measured at fair value. The guidance provides aconsistent definition of fair value that focuses on exit price in theprincipal, or most advantageous, market and prioritizes, within a measurementof fair value, the use of market-based inputs over entity-specific inputs. Theguidance also establishes the following three-level hierarchy for fair valuemeasurements based upon the transparency of inputs to the valuation of an assetor liability as of the measurement date.

 
| · | *Level  1* — inputs  to the valuation methodology are quoted prices (unadjusted) for identical  assets or liabilities in active markets;                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| · | *Level  2***— inputs to the valuation methodology include quoted prices for  similar assets and liabilities in active markets, and inputs that are  observable for the asset or liability, either directly or indirectly, for  substantially the full term of the financial instrument. Level 2 inputs are in  those markets for which there are few transactions, the prices are not  current, little public information exists or instances where prices vary  substantially over time or among brokered market makers; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| · | *Level  3*— inputs  to the valuation methodology are unobservable and significant to the fair  value measurement. Unobservable inputs are those inputs that reflect the  Company’s own assumptions that market participants would use to price the  asset or liability based upon the best available information.                                                                                                                                                                                                        |

 

At December 31,2009, all of the Company’s assets were valued using Level 3 inputs.

 

The followingtable presents the financial instruments carried at fair value as of December 31,2009 and September 30, 2009, by caption on the accompanying condensedconsolidated statements of assets and liabilities for each of the three levelsof hierarchy established by the guidance:

 
| ** **                      | ** ** | **As of December 31, 2009**                 | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statements of** | ** ** |
| ** **                      | ** ** | **Level 1**                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Senior Term Debt                |       | $                                                | —     |   | $ | — |   | $ | 198,577 |   | $ | 198,577 |   |
| Senior Subordinated  Term Debt  |       | —                                           |       | — |   | 106,609 |   | 106,609 |   |
| Preferred Equity  Securities    |       | —                                           |       | — |   | — |   | — |   |
| Common Equity Securities        |       | —                                           |       | — |   | 1,452 |   | 1,452 |   |
| Total investments at fair value |       | $                                                | —     |   | $ | — |   | $ | 306,638 |   | $ | 306,638 |   |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **As of September 30, 2009** | ** ** |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statements of** | ** ** |
| ** **                      | ** ** | **Level 1**                                 | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Senior Term Debt                |       | $                                                | —     |   | $ | — |   | $ | 212,290 |   | $ | 212,290 |   |
| Senior Subordinated  Term Debt  |       | —                                           |       | — |   | 105,794 |   | 105,794 |   |
| Preferred Equity  Securities    |       | —                                           |       | — |   | — |   | — |   |
| Common Equity  Securities       |       | —                                           |       | — |   | 2,885 |   | 2,885 |   |
| Total investments at fair value |       | $                                                | —     |   | $ | — |   | $ | 320,969 |   | $ | 320,969 |   |

 

*Changesin Level 3 Fair Value Measurements*

 

The followingtable provides a roll-forward in the changes in fair value during thethree-month period from September 30, 2009 to December 31, 2009, andfor the three-month period from  September 30,2008 to December 31, 2008, for all investments for which the Companydetermines fair value using unobservable (Level 3) factors. When adetermination is made to classify a financial instrument within Level 3 of thevaluation hierarchy, the determination is based upon the significance of theunobservable factors to the overall fair value measurement. However, Level 3financial instruments typically include, in addition to the unobservable orLevel 3 components, observable components (that is, components that areactively quoted and can be validated by external sources). Accordingly, thelosses in the table below include changes in fair value due in part toobservable factors that are part of the valuation methodology.

 

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**Fairvalue measurements using unobservable data inputs (Level 3)**

 
| ** **                                                | ** ** | **Non-Control/**  | ** ** | ** **      | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                | ** ** | **Non-Affiliate** | ** ** | **Control**     | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | **Investments**   | ** ** | **Investments** | ** ** | **Total**  | ** ** |
| **Three months ended  December 31, 2009:**           |       |              |       |            |       |       |       |
| Fair value at September 30, 2009                     |       | $                 | 286,997    |            | $          | 33,972     |       | $ | 320,969 |   |
| Realized losses (a)                                       |       | (920              | )          | —          |       | (920       | )          |
| Reversal of prior period depreciation on realization  (b) |       | 1,406             |       | —          |       | 1,406      |       |
| Unrealized appreciation (depreciation) (b)                |       | 2,193             |       | (1,000          | )          | 1,193      |       |
| New investments, repayments, and settlements, net  (c)    |       | (17,296           | )          | 1,286           |       | (16,010    | )          |
| Transfers in (out) of Level 3                             |       | —            |       | —          |       | —     |       |
| Fair value as of December 31, 2009                   |       | $                 | 272,380    |            | $          | 34,258     |       | $ | 306,638 |   |
| ** **                                                |       |              |       |            |       |       |       |
| **Three months ended  December 31, 2008:**           |       |              |       |            |       |       |       |
| Fair value at September 30, 2008                     |       | $                 | 407,153    |            | $          | 780        |       | $ | 407,933 |   |
| Realized losses (a)                                       |       | (1,731            | )          | —          |       | (1,731     | )          |
| Reversal of prior period depreciation on realization  (b) |       | 1,185             |       | —          |       | 1,185      |       |
| Unrealized depreciation (b)                               |       | (13,626           | )          | (812            | )          | (14,438    | )          |
| New investments, repayments and settlements, net (c)      |       | (8,969            | )          | 598             |       | (8,371     | )          |
| Transfers in (out) of Level 3                             |       | —            |       | —          |       | —     |       |
| Fair value as of December 31, 2008                   |       | $                 | 384,012    |            | $          | 566        |       | $ | 384,578 |   |

 
| ** **                                                | ** ** | **Senior** | ** ** | **Senior**       | ** ** | **Preferred**  | ** ** | **Common**     | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|------------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                                | ** ** | **Term**   | ** ** | **Subordinated** | ** ** | **Equity**     | ** ** | **Equity**     | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | **Debt**   | ** ** | **Term Debt**    | ** ** | **Securities** | ** ** | **Securities** | ** ** | **Total**  | ** ** |
| **Three  months ended December 31, 2009:**           |       |       |       |             |       |           |       |           |       |       |       |
| Fair value at  September 30, 2009                    |       | $          | 212,290    |             | $          | 105,794        |       | $              | —     |       | $          | 2,885 |   | $ | 320,969 |   |
| Realized losses (a)                                       |       | (513       | )          | (407             | )          | —         |       | —         |       | (920       | )          |
| Reversal of prior period  depreciation on realization (b) |       | 999        |       | 407              |       | —         |       | —         |       | 1,406      |       |
| Unrealized appreciation  (depreciation) (b)               |       | (19        | )          | 1,829            |       | —         |       | (617           | )          | 1,193      |       |
| New investments,  repayments, and settlements, net (c)    |       | (14,180    | )          | (1,014           | )          | —         |       | (816           | )          | (16,010    | )          |
| Transfers in (out) of Level  3                            |       | —     |       | —           |       | —         |       | —         |       | —     |       |
| Fair value as of  December 31, 2009                  |       | $          | 198,577    |             | $          | 106,609        |       | $              | —     |       | $          | 1,452 |   | $ | 306,638 |   |
| ** **                                                |       |       |       |             |       |           |       |           |       |       |       |
| **Three  months ended December 31, 2008:**           |       |       |       |             |       |           |       |           |       |       |       |
| Fair value at  September 30, 2008                    |       | $          | 265,297    |             | $          | 140,676        |       | $              | —     |       | $          | 1,960 |   | $ | 407,933 |   |
| Realized losses (a)                                       |       | (1,758     | )          | 27               |       | —         |       | —         |       | (1,731     | )          |
| Reversal of prior period  depreciation on realization (b) |       | 1,185      |       | —           |       | —         |       | —         |       | 1,185      |       |
| Unrealized depreciation (b)                               |       | (8,891     | )          | (5,586           | )          | —         |       | 38             |       | (14,438    | )          |
| New investments, repayments  and settlements, net (c)     |       | (7,948     | )          | (423             | )          | —         |       | —         |       | (8,371     | )          |
| Transfers in (out) of Level  3                            |       | —     |       | —           |       | —         |       | —         |       | —     |       |
| Fair value as of  December 31, 2008                  |       | $          | 247,886    |             | $          | 134,694        |       | $              | —     |       | $          | 1,998 |   | $ | 384,578 |   |

 

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| (a) |   | Included in net  realized loss on investments on the accompanying condensed consolidated  statements of operations for the three months ended December 31, 2009  and 2008.                                                                                |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) |   | Included in  unrealized appreciation (depreciation) on investments on the accompanying  condensed consolidated statements of operations for the three months ended  December 31, 2009 and 2008.                                                           |
| (c) |   | Includes  increases in the cost basis of investments resulting from new portfolio  investments, the amortization of discounts, premiums and closing fees as well  as decreases in the cost basis of investments resulting from principal  repayments or sales. |

 

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*Non-Control/Non-AffiliateInvestments*

 

At December 31,2009 and September 30, 2009, the Company held Non-Control/Non-Affiliateinvestments in the aggregate of approximately $272,380 and $286,997, at fairvalue, respectively.

 

*ControlInvestments*

 

At December 31,2009 and September 30, 2009, the Company held Control investments in theaggregate of approximately $34,258 and $33,972, at fair value,respectively.  At December 31, 2009,the Control investments were comprised of BERTL, Inc. (“BERTL”), ClintonHoldings, LLC (“Clinton”), Defiance Integrated Technologies, Inc. (“Defiance”),Lindmark Acquisition, LLC (“Lindmark”), LYP Holdings Corp. (“LYP Holdings”),U.S. Healthcare Communications, Inc. (“U.S. Healthcare”) and WesternDirectories, Inc. (“Western Directories”).

 

·                  *BERTL:*The Company originally purchased a pastdue debt instrument in MCA Communications, LLC and the Company accepted a deedin lieu of foreclosure in satisfaction of BERTL’s obligations under the debtinstrument on September 28, 2007. BERTL is a web-based evaluator of digital imaging products.

 

·                  *Clinton:*  In September 2009, the Company tookcontrol of certain Clinton entities by exercising contractual rights under theinvestment documents.  Clinton is a distributor of aluminum sheets andstainless steel.

 

·                  *Defiance:*In July 2009, the Company acquired from the previous owner certain assetsof Defiance Acquisition Corp., consisting of tangible and intangible personalproperty.  The Company acquired these assets through a newly formedsubsidiary, Defiance, and intends to continue the business under itscontrol.  Defiance is a manufacturer of trucking parts.

 

·                  *Lindmark:* On March 18, 2009, the Companyacquired from the previous owner certain assets of Lindmark OutdoorAdvertising, LLC, consisting of all tangible and intangible personalproperty.  The Company acquired theseassets through a newly formed subsidiary, Lindmark, and intends to continue thebusiness under its control.  Lindmark isa billboard advertising company.

 

·                  *LYP Holdings:*On July 2, 2008, the Companyacquired from the previous owner certain assets of LocalTel, Inc.,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, LYP Holdings, and intends to continue the businessunder its control.  LYP Holdings is apublisher of community yellow page directories.

 

·                  *U.S. Healthcare:* The Company offered at public salecertain assets of U.S. Healthcare Communications, LLC on January 30, 2008,consisting generally of all fixtures of tangible and intangible personalproperty.  The Company acquired theseassets in the sale through a newly formed subsidiary, U.S. Healthcare, andintends to continue the business under its control.  U.S. Healthcare is a trade magazine operator.

 

·                  *Western Directories:* On August 27, 2008, the Companyacquired from the previous owner certain assets of West Coast Yellow Pages, Inc.,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, Western Directories, and intends to continue thebusiness under its control.  WesternDirectories is a publisher of community yellow page directories.

 

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*InvestmentConcentrations*

 

At December 31, 2009, the Company had aggregate investments in 46portfolio companies and approximately 64.8% of the aggregate fair value of suchinvestments was senior term debt, approximately 34.8% was senior subordinatedterm debt, no investments were in junior subordinated debt and approximately0.4% was in equity securities.  Thefollowing table outlines the Company’s investments by type at December 31,2009 and September 30, 2009:

 
| ** **                    | ** ** | **December 31, 2009** | ** ** | **September 30, 2009** | ** ** |
|-------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **Cost**                   | ** ** | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior Term Debt              |       | $                          | 224,663    |                        | $          | 198,577 |   | $ | 240,172 |   | $ | 212,290 |   |
| Senior Subordinated Term Debt |       | 117,323                    |       | 106,609                     |       | 118,743 |   | 105,794 |   |
| Preferred Equity Securities   |       | 2,028                      |       | —                      |       | 2,028 |   | — |   |
| Common Equity Securities      |       | 3,450                      |       | 1,452                       |       | 3,450 |   | 2,885 |   |
|                          |       |                       |       |                        |       |   |   |   |   |
| Total Investments             |       | $                          | 347,464    |                        | $          | 306,638 |   | $ | 364,393 |   | $ | 320,969 |   |

 

Investmentsat fair value consisted of the following industry classifications as of December 31,2009 and September 30, 2009:

 
| ** **                                                          | ** ** | **December 31, 2009** | ** ** | **September 30, 2009** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                                                          | ** ** | ** **                 | ** ** | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                                         | ** ** | **Fair Value**             | ** ** | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace & Defense                                        |       | $                          | —     |                        | —     |   | — |   | $ | 1,857 |   | 0.6 | % | 0.7 | % |
| Automobile                                                          |       | 7,355                      |       | 2.4                         | %          | 2.9 | % | 7,999 |   | 2.5 | % | 3.2 | % |
| Broadcast (TV & Radio)                                     |       | 43,192                     |       | 14.1                        | %          | 17.2 | % | 43,403 |   | 13.5 | % | 17.4 | % |
| Buildings & Real Estate                                    |       | 13,015                     |       | 4.3                         | %          | 5.2 | % | 12,882 |   | 4.0 | % | 5.2 | % |
| Cargo Transport                                                     |       | 5,462                      |       | 1.8                         | %          | 2.2 | % | 5,427 |   | 1.7 | % | 2.2 | % |
| Chemicals, Plastics & Rubber                               |       | 15,813                     |       | 5.2                         | %          | 6.3 | % | 15,884 |   | 4.9 | % | 6.4 | % |
| Diversified/Conglomerate Manufacturing                              |       | 1,573                      |       | 0.5                         | %          | 0.6 | % | 1,236 |   | 0.4 | % | 0.5 | % |
| Diversified Natural Resources, Precious  Metals & Minerals |       | 13,590                     |       | 4.4                         | %          | 5.4 | % | 13,589 |   | 4.2 | % | 5.5 | % |
| Electronics                                                         |       | 27,092                     |       | 8.8                         | %          | 10.8 | % | 27,899 |   | 8.7 | % | 11.2 | % |
| Farming & Agriculture                                      |       | 8,982                      |       | 2.9                         | %          | 3.6 | % | 9,309 |   | 2.9 | % | 3.7 | % |
| Healthcare, Education & Childcare                          |       | 45,817                     |       | 14.9                        | %          | 18.2 | % | 58,054 |   | 18.1 | % | 23.3 | % |
| Home & Office Furnishings                                  |       | 16,825                     |       | 5.5                         | %          | 6.7 | % | 16,744 |   | 5.2 | % | 6.7 | % |
| Leisure, Amusement, Movies & Entertainment                 |       | 5,037                      |       | 1.6                         | %          | 2.0 | % | 5,091 |   | 1.6 | % | 2.0 | % |
| Machinery                                                           |       | 8,926                      |       | 2.9                         | %          | 3.5 | % | 9,202 |   | 2.9 | % | 3.7 | % |
| Mining, Steel, Iron & Non-Precious Metals                  |       | 22,969                     |       | 7.5                         | %          | 9.1 | % | 21,926 |   | 6.8 | % | 8.8 | % |
| Personal & Non-durable Consumer Products                   |       | 8,586                      |       | 2.8                         | %          | 3.4 | % | 8,714 |   | 2.7 | % | 3.5 | % |
| Printing & Publishing                                      |       | 37,854                     |       | 12.4                        | %          | 15.1 | % | 37,864 |   | 11.8 | % | 15.2 | % |
| Retail Stores                                                       |       | 24,213                     |       | 7.9                         | %          | 9.6 | % | 23,669 |   | 7.4 | % | 9.5 | % |
| Textiles & Leather                                         |       | 337                        |       | 0.1                         | %          | 0.1 | % | 220 |   | 0.1 | % | 0.1 | % |
| **Total**                                                           |       | $                          | 306,638    |                        | 100.0      | % |   |   | $ | 320,969 |   | 100.0 | % |   |   |

 

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Theinvestments at fair value were included in the following geographic regions ofthe United States at December 31, 2009 and September 30, 2009:

 
| ** **             | ** ** | **December 31, 2009** | ** ** | **September 30, 2009**  | ** ** |
|------------------------|------------|----------------------------|------------|------------------------------|------------|
| ** **             | ** ** | ** **                 | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**             | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** | **Fair Value** | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** |
| Midwest                |       | $                          | 160,523    |                         | 52.4       | % | 63.8 | % | $ | 172,263 |   | 53.7 | % | 69.2 | % |
| West                   |       | 62,970                     |       | 20.5                         | %          | 25.0 | % | 65,678 |   | 20.5 | % | 26.4 | % |
| Southeast              |       | 34,626                     |       | 11.3                         | %          | 13.8 | % | 34,708 |   | 10.8 | % | 13.9 | % |
| Mid-Atlantic           |       | 28,633                     |       | 9.3                          | %          | 11.4 | % | 28,437 |   | 8.8 | % | 11.4 | % |
| Northeast              |       | 13,887                     |       | 4.5                          | %          | 5.5 | % | 14,170 |   | 4.4 | % | 5.7 | % |
| U.S. Territory         |       | 5,999                      |       | 2.0                          | %          | 2.4 | % | 5,713 |   | 1.8 | % | 2.3 | % |
|                   |       | $                          | 306,638    |                         | 100.0      | % |   |   | $ | 320,969 |   | 100.0 | % |   |   |

 

Thegeographic region indicates the location of the headquarters for the Company’sportfolio companies.  A portfolio companymay have a number of other business locations in other geographic regions.

 

*InvestmentPrincipal Repayments*

 

The followingtable summarizes the contractual principal repayment and maturity of theCompany’s investment portfolio by fiscal year, assuming no voluntaryprepayments:

 
| ** **                                               | ** ** | ** **                                                                           | ** ** | **Amount** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the remaining nine months ending  September 30: |       | 2010                                                                                 |       | $          | 36,599     |   |
| For the fiscal year ending September 30:            |       | 2011                                                                                 |       | 92,485     |       |
|                                                     |       | 2012                                                                                 |       | 72,816     |       |
|                                                     |       | 2013                                                                                 |       | 121,017    |       |
|                                                     |       | 2014                                                                                 |       | 11,773     |       |
|                                                     |       | 2015                                                                                 |       | 6,851      |       |
| ** **                                               | ** ** | **Total  Contractual Repayments**                                                    |       | 341,541    |       |
|                                                     |       | Investments in  equity securities                                                    |       | 5,478      |       |
| ** **                                               |       | Unamortized premiums, discounts and investment  acquisition costs on debt securities |       | 445        |       |
| ** **                                               | ** ** | **Total**                                                                            |       | $          | 347,464    |   |

 

**NOTE 4. RELATED PARTY TRANSACTIONS**

 

*Loans to Employees*

 

TheCompany provided loans to employees of the Adviser, who at the time of theloans were joint employees of the Company and either the Adviser or the Company’sprevious investment adviser, Gladstone Capital Advisers, Inc., for theexercise of options under the Amended and Restated 2001 Equity Incentive Plan,which has since been terminated and is no longer in operation.  The loans require the quarterly payment ofinterest at the market rate in effect at the date of issue, have varying termsnot exceeding ten years and have been recorded as a reduction of netassets.  The loans are evidenced by fullrecourse notes that are due upon maturity or 60 days following termination ofemployment, and the shares of common stock purchased with the proceeds of theloan are posted as collateral.  No newloans were issued during the three months ended December 31, 2009 or December 31,2008.  The Company received $0 and $4 ofprincipal repayments during the three months ended December 31, 2009 and December 31,2008, respectively.  The Companyrecognized interest income from all employee stock option loans of $113 and$117 for the three months ended December 31, 2009 and 2008, respectively.

 

Duringthe three months ended December 31, 2009, $514 of an employee stock optionloan to a former employee of the Adviser was transferred from notes receivable —employees to other assets in connection with the termination of her employmentwith the Adviser and the later amendment of the loan.  The intereston the loan from the time the employee stopped working for the Adviser isincluded in other income on the condensed consolidated statement of operations.

 

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*Investment Advisory and Management Agreement*

 

TheCompany is externally managed by the Adviser, which is controlled by itschairman and chief executive officer, under a contractual investment advisoryagreement.  On October 1, 2006, theCompany entered into the investment advisory agreement (the “Advisory Agreement”).  Under the Advisory Agreement, the Company paysthe Adviser an annual base management fee of 2% of its average gross assets,which is defined as total assets less uninvested cash and cash equivalentsresulting from borrowings calculated as of the end of the two most recentlycompleted fiscal quarters.  The AdvisoryAgreement also includes a two-part incentive fee.

 

Thefollowing tables summarize the management fees, incentive fees and associatedcredits reflected in the accompanying condensed consolidated statement ofoperations:

 
| ** **                                                                                                         | ** ** | **Three months ended**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                         | ** ** | **December 31,********2009** | ** ** | **December 31,  2008** | ** ** |
| Base management fee (1)                                                                                            |       | $                                 | 721        |   | $ | 434 |   |
| Credit for fees received by  Adviser from the portfolio companies                                                  |       | —                            |       | (5 | ) |
| Fee reduction for the  voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans to 0.5%  per annum (2) |       | (7                                | )          | (105 | ) |
| Net base management fee                                                                                            |       | $                                 | 714        |   | $ | 324 |   |
|                                                                                                               |       |                              |       |   |   |
| Incentive fee                                                                                                      |       | $                                 | 375        |   | $ | 1,176 |   |
| Credit from voluntary,  irrevocable waiver issued by Adviser’s board of directors                             |       | (22                               | )          | (1,176 | ) |
| Net incentive fee                                                                                                  |       | $                                 | 353        |   | $ | — |   |
|                                                                                                               |       |                              |       |   |   |
| Credit for fees received by  Adviser from the portfolio companies                                                  |       | $                                 | —     |   | $ | (5 | ) |
| Fee reduction for the  voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans to 0.5%  per annum     |       | (7                                | )          | (105 | ) |
| Incentive fee credit                                                                                               |       | (22                               | )          | (1,176 | ) |
| Credit to base management and  incentive fees from Adviser                                                         |       | $                                 | (29        | ) | $ | (1,286 | ) |

 

----

(1)         Base management fee is net of loan servicing fees perthe terms of the Advisory Agreement.

(2)         The board of our Adviser voluntarily, irrevocably andunconditionally waived, for the three months ended December 31, 2009 and2008, the annual 2.0% base management fee to 0.5% for senior syndicated loanparticipations.  Fees waived cannot berecouped by the Adviser in the future.

 

Overall,the base management fee due to the Adviser cannot exceed 2% of total assets (asreduced by cash and cash equivalents pledged to creditors) during any givenfiscal year.  Amounts included in Due toAdviser in the accompanying condensed consolidated statements of assets andliabilities were as follows:

 
| ** **                             | ** ** | **December 31,********2009** | ** ** | **September 30, 2009** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
| Unpaid base management fee  to Adviser |       | $                                 | 714        |                        | $          | 617 |   |
| Unpaid incentive fee to  Adviser       |       | 353                               |       | —                      |       |
| Unpaid loan servicing fees  to Adviser |       | 218                               |       | 217                         |       |
| Total Due to Adviser                   |       | $                                 | 1,285      |                        | $          | 834 |   |

 

Asof December 31, 2009 and September 30, 2009, Due from Adviser totaled$0 and $69, respectively, which included reimbursements for non-recurring costsincurred on behalf of the portfolio companies.

 

*Loan Servicing and Portfolio Company Fees*

 

TheAdviser also services the loans held by Business Loan, in return for which itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser have been and continue to be treated asreductions directly against the 2% base management fee under the AdvisoryAgreement.  For the three months ended December 31,2009 and 2008, these loan servicing fees totaled $929 and $1,623, respectively,all of which were deducted against the 2% base management fee in order toderive the base management fee, 

 

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whichis presented as the line item Base management fee in the accompanying condensedconsolidated statements of operations. As of December 31, 2009 and September 30, 2009, the Companyowed $218 and $217, respectively, of unpaid loan servicing fees to the Adviser,which are recorded in Fees due to Adviser in the accompanying condensedconsolidated statements of assets and liabilities.

 

*Administration Agreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),an affiliate of the Adviser.  Under the Administration Agreement, theCompany pays separately for administrative services.  The Administration Agreement provides forpayments equal to the Company’s allocable portion of the Administrator’soverhead expenses in performing its obligations under the AdministrationAgreement, including, but not limited to, rent for employees of theAdministrator, and the allocable portion of salaries and benefits expenses ofthe Company’s chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. For the three months ended December 31, 2009 and 2008, the Companyrecorded administration fees of $178 and $227, respectively.  As of December 31, 2009 and September 30,2009, the Company owed $178 and $216, respectively, of unpaid administrationfees to the Adviser, which is recorded in the Fee due to Administrator in theaccompanying condensed consolidated statements of assets and liabilities.

 

**NOTE 5. LINE OF CREDIT**

 

On May 15,2009, the Company, through Business Loan, entered into a third amended andrestated credit agreement which currently provides for a $102,000 revolvingline of credit arranged by Key Equipment Finance Inc. “(KEF”) as administrativeagent, replacing Deutsche Bank, A.G. as administrative agent (the “KEF Facility”).  Branch Banking and Trust Company (“BB&T”)also joined the KEF Facility as a committed lender.  Advances under the KEF Facility willgenerally bear interest at the 30-day LIBOR or the commercial paper rate(subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of0.75% per annum on undrawn amounts.  Asof December 31, 2009, there was a cost basis of approximately $73,400 ofborrowings outstanding under the KEF Facility at an average interest rate of7.30%, and the remaining borrowing capacity under the KEF Facility was$28,600.  Available borrowings aresubject to various constraints imposed under the KEF Facility, based on theaggregate loan balance pledged by Business Loan. Interest is payable monthlyduring the term of the KEF Facility.  TheKEF Facility matures on May 14, 2010 and, if the facility is not renewedor extended by this date, all principal and interest will be due and payablewithin one year of maturity.  Inaddition, after May 14, 2010, if the KEF Facility is not renewed, allprincipal collections from the Company’s loans are required to be used to payoutstanding principal on the KEF Facility.

 

Duringthe three months ended December 31, 2009, the Company reduced the size ofthe KEF Facility by $25,000, from $127,000 to $102,000.  Without theaddition of other committed lenders, the KEF Facility provides a totalcommitment of $102,000 from January 1, 2010 to May 11, 2010 and$77,000 thereafter.

 

TheKEF Facility contains covenants that require Business Loan to maintain itsstatus as a separate entity, prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions),and restrict material changes to the Company’s credit and collectionpolicies.  The facility also limitspayments of distributions.  As of December 31,2009, Business Loan was in compliance with all of the facility covenants.

 

The Companyapplied ASC 825, “Financial Instruments,”specifically for the KEF Facility, which was consistent with itsapplication of ASC 820 to its investments. ASC 825 requires thatthe Company apply a fair value methodology to the KEF Facility. The Companyestimated the fair value of the KEF Facility using estimates of value providedby an independent third party and its own assumptions in the absence ofobservable market data, including estimated remaining life, current marketyield and interest rate spreads of similar securities as of the measurementdate.  The Company also considered itsown credit risk.  The following tablepresents the KEF Facility carried at fair value as of December 31, 2009and September 30, 2009, by caption on the accompanying consolidatedstatements of assets and liabilities for each of the three levels of hierarchyestablished by ASC 820-10:

** **
| ** **                      | ** ** | **As of December 31, 2009** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                                | —     |   | $ | — |   | $ | 73,531 |   | $ | 73,531 |   |
| Total                           |       | $                                | —     |   | $ | — |   | $ | 73,531 |   | $ | 73,531 |   |

 

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| ** **                      | ** ** | **As of September 30, 2009** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |
| Total                           |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |

 

*Changesin Level 3 Fair Value Measurements*

 

The followingtable provides a roll-forward in the changes in fair value during thethree-month period from September 30, 2009 to December 31, 2009, forthe KEF Facility for which the Company determines fair value using unobservable(Level 3) factors. When a determination is made to classify a financialinstrument within Level 3 of the valuation hierarchy, the determination isbased upon the significance of the unobservable factors to the overall fair valuemeasurement. However, Level 3 financial instruments typically include, inaddition to the unobservable or Level 3 components, observable components (thatis, components that are actively quoted and can be validated by externalsources). Accordingly, the losses in the table below include changes in fairvalue due in part to observable factors that are part of the valuationmethodology.

 

**Fairvalue measurements using unobservable data inputs (Level 3)**

 
| ** **                                      | ** ** | **Borrowings  under line  of credit** | ** ** |   |   |
|-------------------------------------------------|------------|---------------------------------------|------------|--------|--------|
| **Three months ended  December 31, 2009:** |       |                                  |       |   |   |
| Fair value at September 30, 2009           |       | $                                     | 83,350     |   |   |   |
| Unrealized depreciation (a)                     |       | (219                                  | )          |   |   |
| Net borrowings (b)                              |       | (9,600                                | )          |   |   |
| Transfers in (out) of Level 3                   |       | —                                |       |   |   |
| Fair value as of December 31, 2009         |       | $                                     | 73,531     |   |   |   |

 

----

(a)          Included in unrealized depreciation onborrowings under line of credit on the accompanying condensed consolidatedstatements of operations for the three months ended December 31, 2009.

(b)         Includes borrowings and principalrepayments on the line of credit.

 

**NOTE 6. COMMON STOCK TRANSACTIONS**

 

Transactionsin common stock were as follows:

 
| ** **                         | ** ** | **Shares** | ** ** | **Total Value** | ** ** |
|------------------------------------|------------|------------|------------|-----------------|------------|
| Balance at September 30, 2009 |       | 21,087,574 |       | $               | 328,224    |   |
| Shelf offering costs               |       | —     |       | (39             | )          |
| Balance at December 31, 2009  |       | 21,087,574 |       | $               | 328,185    |   |

 

**NOTE 7. NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROMOPERATIONS PER COMMON SHARE**

 

Thefollowing table sets forth the computation of basic and diluted net increase(decrease) in net assets resulting from operations per common share for thethree months ended December 31, 2009 and 2008:

 
| ** **                                                                                                 | ** ** | **Three months ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| Numerator for basic and diluted net increase  (decrease) in net assets resulting from operations per share |       | $                                        | 6,326      |   | $ | (9,103 | ) |
|                                                                                                       |       |                                     |       |   |   |
| Denominator for basic and diluted shares                                                                   |       | 21,087,574                               |       | 21,087,574 |   |
| Basic and diluted net increase (decrease) in net  assets resulting from operations per common share        |       | $                                        | 0.30       |   | $ | (0.43 | ) |

 

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**NOTE 8. DISTRIBUTIONS**

 

Thefollowing table lists the per share distributions paid for the three monthsended December 31, 2009 and 2008:

 
| **Fiscal Year** | ** ** | **Record Date**         | ** ** | **Payment Date**        | ** ** | **Distribution  per Share** | ** ** |
|-----------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|
| 2010            |       | October 22,  2009  |       | October 30,  2009  |       | $                           | 0.07       |   |
|            |       | November 19,  2009 |       | November 30,  2009 |       | $                           | 0.07       |   |
|            |       | December 22,  2009 |       | December 31,  2009 |       | $                           | 0.07       |   |
|            |       |                    |       | Total                   |       | $                           | 0.21       |   |
|            |       |                    |       |                    |       |                        |       |
| 2009            |       | October 23,  2008  |       | October 31,  2008  |       | $                           | 0.14       |   |
|            |       | November 19,  2008 |       | November 28,  2008 |       | $                           | 0.14       |   |
|            |       | December 22,  2008 |       | December 31,  2008 |       | $                           | 0.14       |   |
|            |       |                    |       | Total                   |       | $                           | 0.42       |   |

 

Aggregate distributions declared and paid for the three months ended December 31,2009 and 2008 were approximately $4,428 and $8,856, respectively.  All distributions were declared based onestimates of net investment income for the respective fiscal years, and some ofthe distributions include a return of capital.

 

Thetiming and characterization of certain income and capital gains distributionsare determined annually in accordance with federal tax regulations which maydiffer from GAAP. These differences primarily relate to items recognized asincome for financial statement purposes and realized gains for tax purposes. Asa result, net investment income and net realized gain (loss) on investment transactionsfor a reporting period may differ significantly from distributions during suchperiod. Accordingly, the Company may periodically make reclassifications amongcertain of its capital accounts without impacting the net asset value of theCompany.

 

**NOTE 9. COMMITMENTS AND CONTINGENCIES**

 

AtDecember 31, 2009, the Company was not party to any signed term sheets forpotential investments.  The Company hadone guaranty totaling $250, which relates to Defiance Integrated Technologies, Inc.,for which the Company considers the credit risk to be remote.  The Company reports off-balance sheetguarantees on its condensed consolidated schedule of investments, as requiredby the 1940 Act.

 

**NOTE 10. SUBSEQUENT EVENTS**

 

The Company evaluated all events that occurred subsequent to December 31,2009 through the date of the filing of this Form 10-Q on February 1,2010.

 

*Distributions*

 

In January 2010,the Company’s Board of Directors declared the following monthly cashdistributions:

 
| **Record Date**        | ** ** | **Payment Date**        | ** ** | **Distribution  per Share** | ** ** |
|------------------------|------------|-------------------------|------------|-----------------------------|------------|
| January 21, 2010  |       | January 29,  2010  |       | $                           | 0.070      |   |
| February 18, 2010 |       | February 26,  2010 |       | $                           | 0.070      |   |
| March 23, 2010    |       | March 31,  2010    |       | $                           | 0.070      |   |

 

*InvestmentActivity*

 

Subsequent to December 31,2009, the Company extended approximately $2,727 of revolver draws andadditional investments to existing portfolio companies.  The Company also received approximately $6,779from scheduled and unscheduled loan repayments and a syndicated loan sale.  This included $4,000 payoff from ActivStyle’ssenior term debt.  In addition, theCompany entered into an agreement to sell the GTM Holdings syndicated loan thatwas held in its portfolio of investments at December 31, 2009 to aninvestor in the syndicated loan market. The loan had a cost of approximately $500 and fair value of $337.  This loan is included in the Company’scondensed consolidated assets as of December 31, 2009 and the loan wasvalued at the sales price.

 

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*RegistrationStatement*

 

On October 20,2009, the Company filed a registration statement on Form N-2 with the SECthat was amended on December 9, 2009. The SEC declared the registration statement effective on January 28,2010 and such registration statement will permit the Company to issue, throughone or more transactions, up to an aggregate of $300,000 in securities,consisting of common stock, senior common stock, preferred stock, subscriptionrights, debt securities and warrants to purchase common stock, or a combinationof these securities.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OFOPERATIONS (dollar amounts in thousands, except per share data or unless otherwiseindicated)**

 

**All statements contained herein, other than historical facts,may constitute “forward-looking statements.” These statements may relate to,among other things, future events or our future performance or financialcondition. In some cases, you can identify forward-looking statements byterminology such as “estimate,” “may,” “might,” “believe,” “will,” “provided,” “anticipate,”“future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,”“seek,” “possible,” “potential,” “likely” or the negative of such terms orcomparable terminology. These forward-looking statements involve known andunknown risks, uncertainties and other factors that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by such forward-looking statements. Wecaution readers not to place undue reliance on any such forward-lookingstatements. 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 condensed consolidated financial statements andthe notes thereto contained elsewhere in this report and our annual report on Form 10-Kfor the fiscal year ended September 30, 2009.**

 

**OVERVIEW**

 

**General**

 

We were incorporated under the General Corporation Laws of the State ofMaryland on May 30, 2001. Our investment objective is to achieve a highlevel of current income by investing in debt securities, consisting primarilyof senior notes, senior subordinated notes and junior subordinated notes, ofestablished private businesses that are substantially owned by leveraged buyoutfunds, individual investors or are family-owned businesses, with a particularfocus on senior notes. In addition, we may acquire from others existing loansthat meet this profile. We also seek to provide our stockholders with long-termcapital growth through the appreciation in the value of warrants or otherequity instruments that we may receive when we make loans. We operate as aclosed-end, non-diversified management investment company, and have elected tobe treated as a business development company under the Investment Company Actof 1940, as amended (the “1940 Act”).  Inaddition, for tax purposes we have elected to be treated as a regulatedinvestment company (“RIC”) under the Internal Revenue Code of 1986, as amended(the “Code”).

 

We seek to invest in small and medium-sized private U.S. businessesthat meet certain criteria, including some but not all of the following: thepotential for growth in cash flow, adequate assets for loan collateral,experienced management teams with a significant ownership interest in theborrower, profitable operations based on the borrower’s cash flow, reasonablecapitalization of the borrower (usually by leveraged buyout funds or venturecapital funds) and the potential to realize appreciation and gain liquidity inour equity position, if any. We anticipate that liquidity in our equityposition will be achieved through a merger or acquisition of the borrower, apublic offering of the borrower’s stock or by exercising our right to requirethe borrower to repurchase our warrants, though there can be no assurance thatwe will always have these rights. We lend to borrowers that need funds tofinance growth, restructure their balance sheets or effect a change of control.

 

**BusinessEnvironment**

 

The currenteconomic conditions generally and the disruptions in the capital markets inparticular have decreased liquidity and increased our cost of debt and equitycapital, where available. The longer these conditions persist, the greater theprobability that these factors could continue to increase our cost andsignificantly limit our access to debt and equity capital, and thus have anadverse effect on our operations and financial results. Many of the companiesin which we have made or will make investments may also be susceptible to theeconomic downturn, which may affect the ability of one or more of our portfoliocompanies to repay our loans or engage in a liquidity event, such as a sale, recapitalizationor initial public offering. An economic downturn could also disproportionatelyimpact some of the industries in which we invest, causing us to be morevulnerable to losses in our portfolio. Therefore, the number of ournon-performing assets are likely to increase and the fair market value of ourportfolio is likely to decrease during these periods.  We do not know when market conditions willstabilize, if adverse conditions will intensify or the full extent to which thedisruptions will affect us.  If marketinstability persists or intensifies, we may experience difficulty in raisingcapital.

 

Challenges in thecurrent market are intensified for us by certain regulatory limitations underthe Code and the 1940 Act, as well as contractual restrictions under theagreement governing our credit facility that further constrain our ability toaccess the capital markets.  To maintainour qualification as a RIC, we must satisfy, among other requirements, anannual distribution requirement to pay out at least 90% of our ordinary incomeand short-term capital gains to our stockholders on an annual basis.  Because we are required to 

 

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distribute ourincome in this manner, and because the illiquidity of many of our investmentsmakes it difficult for us to finance new investments through the sale ofcurrent investments, our ability to make new investments is highly dependentupon external financing.  Our externalfinancing sources include the issuance of equity securities, debt securities orother leverage such as borrowings under our line of credit.  Our ability to seek external debt financing,to the extent that it is available under current market conditions, is furthersubject to the asset coverage limitations of the 1940 Act, which require us tohave at least a 200% asset coverage ratio, meaning generally that for everydollar of debt, we must have two dollars of assets.

 

Recent marketconditions have also affected the trading price of our common stock and thusour ability to finance new investments through the issuance of equity.  On January 29, 2010, the closing marketprice of our common stock was $7.38, which price represented a 38% discount toour December 31, 2009 net asset value (“NAV”) per share.  When our stock is trading below NAV, as ithas consistently traded subsequent to September 30, 2008, our ability toissue equity is constrained by provisions of the 1940 Act which generallyprohibit the issuance and sale of our common stock below NAV per share withoutstockholder approval other than through sales to our then-existing stockholderspursuant to a rights offering.  At ourannual meeting of stockholders held on February 19, 2009, stockholdersapproved a proposal which authorizes us to sell shares of our common stock at aprice below our then current NAV per share for a period of one year from thedate of approval, provided that our Board of Directors makes certaindeterminations prior to any such sale. At the upcoming annual stockholdersmeeting scheduled for February 18, 2010, our stockholders will be asked tovote in favor of renewing this proposal for another year.

 

The recession mayalso continue to decrease the value of collateral securing some of our loans,as well as the value of our equity investments, which has impacted and maycontinue to impact our ability to borrow under our credit facility.  For the three months ended December 31,2009, we recorded net unrealized appreciation on our portfolio of investmentsof $2,599.  We may see decreases in thevalue of our portfolio, which will further limit our ability to borrow underour current credit facility. Additionally, our credit facility contains covenants regarding themaintenance of certain minimum net worth requirements which are affected by thedecrease in value of our portfolio. Failure to meet these requirements would result in a default which, ifwe are unable to obtain a waiver from our lenders, would result in theacceleration of our repayment obligations under our credit facility.  As of December 31, 2009, we were incompliance with all of the facility covenants.

 

We expect that,given these regulatory and contractual constraints in combination with currentmarket conditions, debt and equity capital may be costly or difficult for us toaccess for some time.  For so long asthis is the case, we will continue to focus our near-term strategy primarily onretaining capital and building the value of our existing portfolio companies toincrease the likelihood of maintaining potential future returns.  We will also, where prudent and possible,continue to consider the sale of lower-yielding investments.  This has resulted, and may continue to result,in significantly reduced investment activity, as our ability to make newinvestments under these conditions is largely dependent on availability ofproceeds from the sale or exit of existing portfolio investments, which eventsmay be beyond our control.  As capitalconstraints improve, we intend to continue our strategy of making conservativeinvestments in businesses that we believe will weather the current economy andthat are likely to produce attractive long-term returns for our stockholders.

 

**SyndicatedLoan Valuations**

 

In monitoring the market activity during the quarter ended December 31,2009, we noted markets conditions indicating continued liquidity and a betterfunctioning secondary market for syndicated loans.  Therefore, in accordance with ASC 820, andfollowing our valuation procedures which specify the use of third-partyindicative bid quotes for valuing syndicated loans where there is a liquidpublic market for those loans and market pricing quotes are readily available,a third-party bid quote was used to value the remaining syndicated loans notsold during the quarter ended December 31, 2009.  In January 2010, we sold the GTMHoldings syndicated loan.  This loan isincluded in our consolidated assets as of December 31, 2009 and was valuedas of December 31, 2009 at the respective sale price.  The sale price was deemed to be an accuratereflection of the fair value as of December 31, 2009.

 

**InvestmentHighlights**

 

*Purchases:* During the three months ended December 31,2009, we extended $180 of investments to a new portfolio company and $1,991 ofinvestments to existing portfolio companies through revolver draws or theadditions of new term notes, for total investments of $2,171.

 

*Repayments:* During the three months ended December 31,2009, one borrower made an unscheduled payoff of $12,104, one borrower made anunscheduled partial payoff of $950, and we experienced contractualamortization, revolver repayments and some principal payments received ahead ofschedule for an aggregate of $2,350, for total principal repayments of $15,404.

 

*Sales:* During the three months ended December 31,2009, we sold two syndicated loans (which resulted in our exit from twoportfolio companies) for an aggregate of $2,782 in net proceeds.

 

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Since our initialpublic offering in August 2001, we have made 262 different loans to, orinvestments in, 127 companies for a total of approximately $952,633, beforegiving effect to principal repayments on investments and divestitures.

 

**FinancingHighlights**

 

On May 15,2009, through our wholly-owned subsidiary, Gladstone Business Loan, LLC (“BusinessLoan”), we entered into a third amended and restated credit agreement whichinitially provided for a $127,000 revolving line of credit( the “KEF Facility”).  During the three months ended December 31,2009, we reduced the size of the KEF Facility by $25,000 from $127,000 to$102,000.  Under the KEF Facility, thefirst $50,000 of commitment reductions are applied against Key EquipmentFinance Inc.’s “(KEF’s”) commitment. Therefore, the entire $25,000 was subtracted from KEF’s commitment,reducing it from $100,000 to $75,000 and leaving Branch Banking and TrustCompany’s (“BB&T’s”) commitment unchanged at $27,000.  As a result of the manner in which ourborrowing base is calculated under the KEF Facility, the reduction did notaffect our availability under the KEF Facility.

 

During the threemonths ended December 31, 2009, we applied Financial Accounting StandardsBoard (“FASB”) Accounting StandardsCodification (“ASC”) 825, “Financial Instruments,” specifically to ourKEF Facility, which requires us to apply a fair value methodology to the KEF Facilityas of December 31, 2009.  The KEFFacility was fair valued at $73,531 as of December 31, 2009, and theoutstanding balance was $73,400.

 

**RegistrationStatement**

 

On October 20,2009, we filed a registration statement on Form N-2 with the Securities andExchange Commission (the “SEC”) that was amended on December 9, 2009.  The SEC declared the registration statementeffective on January 28, 2010 and such registration statement will permitus to issue, through one or more transactions, up to an aggregate of $300,000in securities, consisting of common stock, senior common stock, preferredstock, subscription rights, debt securities and warrants to purchase commonstock, or a combination of these securities.

 

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**RESULTS OF OPERATIONS**

 

***Comparison of the Three Months Ended December 31,2009 to the Three Months Ended December 31, 2008***

 

*A comparison of our operatingresults for the three months ended December 31, 2009 and 2008 is shownbelow:*

** **
| ** **                                                                     | ** ** | **For the  three months ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                                          | ** ** | **2008** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| INVESTMENT INCOME                                                              |       |                                              |       |   |   |   |   |   |   |
| Interest income – non  control/non affiliate investments                  |       | $                                                 | 8,984      |   | $ | 11,661 |   | $ | (2,677 | ) | (23.0 | )% |
| Interest income – control  investments                                    |       | 693                                               |       | 20 |   | 673 |   | 3,365.0 | % |
| Interest income – cash                                                    |       | —                                            |       | 10 |   | (10 | ) | (100.0 | )% |
| Interest income – notes  receivable from employees                        |       | 113                                               |       | 117 |   | (4 | ) | (3.4 | )% |
| Prepayment fees and other  income                                              |       | 14                                                |       | — |   | 14 |   | — |   |
| Total investment income                                                        |       | 9,804                                             |       | 11,808 |   | (2,004 | ) | (17.0 | )% |
|                                                                           |       |                                              |       |   |   |   |   |   |   |
| EXPENSES                                                                       |       |                                              |       |   |   |   |   |   |   |
| Interest expense                                                               |       | 1,535                                             |       | 2,461 |   | (926 | ) | (37.6 | )% |
| Loan servicing fee                                                             |       | 929                                               |       | 1,623 |   | (694 | ) | (42.8 | )% |
| Base management fee                                                            |       | 721                                               |       | 434 |   | 287 |   | 66.1 | % |
| Incentive fee                                                                  |       | 375                                               |       | 1,176 |   | (801 | ) | (68.1 | )% |
| Administration fee                                                             |       | 178                                               |       | 227 |   | (49 | ) | (21.6 | )% |
| Professional fees                                                              |       | 912                                               |       | 313 |   | 599 |   | 191.4 | % |
| Amortization of deferred  financing fees                                       |       | 494                                               |       | 719 |   | (225 | ) | (31.3 | )% |
| Stockholder related costs                                                      |       | 78                                                |       | 89 |   | (11 | ) | (12.4 | )% |
| Directors’ fees                                                           |       | 48                                                |       | 48 |   | — |   | — |   |
| Insurance expense                                                              |       | 68                                                |       | 57 |   | 11 |   | 19.3 | % |
| Other expenses                                                                 |       | 67                                                |       | 66 |   | 1 |   | 1.5 | % |
| Expenses before credit from  Adviser                                           |       | 5,405                                             |       | 7,213 |   | (1,808 | ) | (25.1 | )% |
| Credit to base management  and incentive fees from Adviser                     |       | (29                                               | )          | (1,286 | ) | 1,257 |   | (97.7 | )% |
| Total expenses net of  credit to base management and incentive fees            |       | 5,376                                             |       | 5,927 |   | (551 | ) | (9.3 | )% |
|                                                                           |       |                                              |       |   |   |   |   |   |   |
| NET INVESTMENT INCOME                                                          |       | 4,428                                             |       | 5,881 |   | (1,453 | ) | (24.7 | )% |
|                                                                           |       |                                              |       |   |   |   |   |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS,                           |       |                                              |       |   |   |   |   |   |   |
| DERIVATIVE AND BORROWINGS  UNDER LINE OF CREDIT:                               |       |                                              |       |   |   |   |   |   |   |
| Net realized loss on  investments                                              |       | (920                                              | )          | (1,731 | ) | 811 |   | (46.9 | )% |
| Net unrealized appreciation  (depreciation) on investments                     |       | 2,599                                             |       | (13,253 | ) | 15,852 |   | (119.6 | )% |
| Net unrealized depreciation  on borrowings under line of credit                |       | 219                                               |       | — |   | 219 |   | — |   |
| Net gain (loss) on  investments, derivative and borrowingsunder line of credit |       | 1,898                                             |       | (14,984 | ) | 16,882 |   | (112.7 | )% |
|                                                                           |       |                                              |       |   |   |   |   |   |   |
| NET INCREASE (DECREASE) IN  NET ASSETS RESULTING FROM OPERATIONS               |       | $                                                 | 6,326      |   | $ | (9,103 | ) | $ | 15,429 |   | (169.5 | )% |

 

**Investment Income**

 

Investment incomefor the three months ended December 31, 2009 was $9,804, as compared to$11,808 for the three months ended December 31, 2008.  Interest income from our aggregate investmentportfolio decreased for the three months ended December 31, 2009, ascompared to the prior year period.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsdecreased primarily due to the overall reduction in the cost basis of ourinvestments, resulting from the exit of loans subsequent to December 31,2008 partially offset by an increase in the weighted average yield on ourportfolio.  The annualized weightedaverage yield on our portfolio, excluding cash and cash equivalents, was 10.6%for the three months ended December 31, 2009 as compared to 9.8% for theprior year period.  During the threemonths ended December 31, 2009, five investments were on non-accrual, foran aggregate of approximately $10,056 at cost, or 2.9% of the aggregate cost ofour investment portfolio, and during the prior year period, three investmentswere on non-accrual, for an aggregate of approximately $9,227 at cost, or 2.0%of the aggregate cost of our investment portfolio.

 

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Interest incomefrom Non-Control/Non-Affiliate investments decreased for the three months endedDecember 31, 2009, as compared to the prior year period. The decrease wasprimarily attributable to an overall decrease in the aggregateNon-Control/Non-Affiliate investments held at December 31, 2009 comparedto the prior year period.  In addition,we reversed previously recorded interest of approximately $508 during the threemonths ended December 31, 2009.  Thesuccess fees earned during the three months ended December 31, 2009 and December 31,2008, included in interest income, were $538 and $0, respectively.   Success fees earned during the three monthsended December 31, 2009 resulted from a refinancing by Tulsa Welding andan amendment to senior term debt issued to Doe & Ingalls.

 

Interest incomefrom Control investments increased for the three months ended December 31,2009, as compared to the prior year period. The increase was attributable to three additional Control investmentsheld during the quarter ended December 31, 2009, which were converted fromNon-Control/Non-Affiliate investments, as compared to the prior yearperiod.  In addition, we reversedpreviously recorded interest of approximately $75 during the three months endedDecember 31, 2009.

 

The followingtable lists the interest income from investments for the five largest portfoliocompanies during the respective periods:

 

**Three months ended December 31,2009**

 

| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Westlake Hardware         |       | $                    | 924        |            | 9.5        | % |
| Sunshine Media            |       | 846                  |       | 8.7             | %          |
| Reliable Biopharma        |       | 759                  |       | 7.8             | %          |
| Tulsa Welding             |       | 541                  |       | 5.6             | %          |
| Clinton Aluminum          |       | 522                  |       | 5.4             | %          |
| **Subtotal**              | ** ** | **$**                | **3,592**  | ** **      | **37.0**   | **%** |
| Other companies           |       | 6,085                |       | 63.0            | %          |
| **Total interest income** | ** ** | **$**                | **9,677**  | ** **      | **100.0**  | **%** |

 

**Threemonths ended December 31, 2008**

 

| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine Media            |       | $                    | 843        |            | 7.2        | % |
| Reliable Biopharma        |       | 772                  |       | 6.6             | %          |
| Westlake Hardware         |       | 616                  |       | 5.3             | %          |
| Clinton Aluminum          |       | 475                  |       | 4.1             | %          |
| VantaCore                 |       | 441                  |       | 3.8             | %          |
| **Subtotal**              | ** ** | **$**                | **3,147**  | ** **      | **27.0**   | **%** |
| Other companies           |       | 8,534                |       | 73.0            | %          |
| **Total interest income** | ** ** | **$**                | **11,681** | ** **      | **100.0**  | **%** |

 

Interest incomefrom invested cash for the three months ended December 31, 2009 and 2008was nominal.  Interest income is based onthe amount of cash held in interest bearing accounts and the interest earned onour custodial account prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, decreased slightly for the three months ended December 31, 2009as compared to the prior year period due to the reduction of employee loansduring the current period.

 

Prepayment feesand other income increased for the three months ended December 31, 2009 ascompared to the prior year period.  Theincome for the current period consisted of prepayment penalty fees receivedupon unscheduled principal repayments as well as interest from stock optionloans of former employees.

 

**OperatingExpenses**

 

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary andirrevocable waivers applied to the base management and incentive fees,decreased for the three months ended December 31, 2009, as compared to theprior year period.  This reduction wasprimarily due to a decrease in interest expense and the amortization ofdeferred financing fees incurred in connection with the KEF Facility, as wellas a decrease in incentive fees, which were offset by a reduction in the Adviser’svoluntary credit to the incentive fee and an increase in professional fees.

 

Interest expensedecreased for the three months ended December 31, 2009 as compared to theprior year period due primarily to decreased borrowings under our line ofcredit during the three months ended December 31, 2009 as well as a lowerweighted average annual interest cost, which is determined by using the annualstated interest rate plus commitment and other fees, plus the amortization ofdeferred financing fees divided by the weighted average debt outstanding.

 

Loan servicingfees decreased for the three months ended December 31, 2009 as compared tothe prior year period.  These fees areincurred in connection with a loan servicing agreement between Business Loanand our Adviser, which is based on the size of our investment portfolio.  The decrease was primarily due to thereduction in the size of our investment portfolio, in particular the loans inour borrowing base. Due to voluntary, irrevocable and unconditional waivers appliedduring these periods, senior syndicated loans incurred a 0.5% annual fee,whereas proprietary loans incurred a 1.5% annual fee.  All of these fees were offset against theamount of the base management fee due to our Adviser.

 

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Base managementfee (which is net of loan servicing fees) increased for the three months ended December 31,2009 as compared to the prior year period. However, the gross management fee (consisting of the loan servicing feesplus the base management fee) decreased from the prior year period as shownbelow:

 

| ** **           | ** ** | **Three months ended**     | ** ** |
|----------------------|------------|----------------------------|------------|
| ** **           | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
| Loan servicing fee   |       | $                          | 929        |   | $ | 1,623 |   |
| Base management fee  |       | 720                        |       | 434 |   |
| Gross management fee |       | $                          | 1,649      |   | $ | 2,057 |   |

 

Gross managementfee decreased due to fewer total assets held during the three months ended December 31,2009.  Furthermore, due to theliquidation of the majority of our syndicated loans, the credit receivedagainst the gross base management fee for investments in syndicated loans hasalso been reduced.  The base managementfee is computed quarterly as described under *“InvestmentAdvisory and Management Agreement”* in Note 4 of the notes to theconsolidated financial statements in our Annual Report on Form 10-K asfiled with the SEC on November 23, 2009, and is summarized in the tablebelow:

 

| ** **                                                                                                        | ** ** | **Three months ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                        | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
| Base management fee (1)                                                                                           |       | $                          | 721        |   | $ | 434 |   |
| Credit for fees received by Adviser from the  portfolio companies                                                 |       | —                     |       | (5 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2.0% fee on senior syndicated loans to 0.5% per annum (2) |       | (7                         | )          | (105 | ) |
| Net base management fee                                                                                           |       | $                          | 714        |   | $ | 324 |   |

 

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(1)          Base management fee is net of loanservicing fees per the terms of the Advisory Agreement.

(2)          The board of our Adviser voluntarily andirrevocably waived, for the three months ended December 31, 2009 and 2008,the annual 2.0% base management fee to 0.5% for senior syndicated loanparticipations.  Fees waived cannot berecouped by the Adviser in the future.

 

Incentive feedecreased for the three months ended December 31, 2009 as compared to theprior year period.  The board of our Adviservoluntarily, irrevocably and unconditionally waived a portion of the incentivefee for the three months ended December 31, 2009 and the entire incentivefee for the three months ended December 31, 2008.  The incentive fee and associated credits aresummarized in the table below:

 

| ** **                                                                             | ** ** | **Three months ended**     | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                             | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
| Incentive fee                                                                          |       | $                          | 375        |   | $ | 1,176 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors |       | (22                        | )          | (1,176 | ) |
| Net incentive fee                                                                      |       | $                          | 353        |   | $ | — |   |

 

Administration feedecreased for the three months ended December 31, 2009 as compared to theprior year period, due to a decrease of administration staff and relatedexpenses, as well as a decrease in our total assets in comparison to the totalassets of all companies managed by our Adviser under similar agreements.  The calculation of the administrative fee isdescribed in detail above under *“InvestmentAdvisory and Management Agreement”* in Note 4 of the notes to theconsolidated financial statements in our Annual Report on Form 10-K asfiled with the SEC on November 23, 2009.

 

Other operatingexpenses (including professional fees, deferred financing fees, stockholderrelated costs, director’s fees, insurance and other direct expenses) increasedfor the three months ended December 31, 2009 as compared to the prior yearperiod, due primarily to legal fees incurred in connection with troubled loansduring the three months ended December 31, 2009.

 

**NetRealized Loss on Investments**

 

Net realized losson investments for the three months ended December 31, 2009 was $920,which consisted of losses of $513 and $407 from the Kinetek and Wescosyndicated loan sales, respectively.  Netrealized loss for the three months ended December 31, 2008 was $1,731,which consisted of a $1,758 loss from the sale of the Greatwide syndicatedloan, offset by a $27 gain from the Country Road payoff.

 

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**NetUnrealized Appreciation (Depreciation) on Investments**

 

Net unrealizedappreciation (depreciation) on investments is the net change in the fair valueof our investment portfolio during the reporting period, including the reversalof previously recorded unrealized appreciation or depreciation when gains andlosses are realized.  The net unrealizedappreciation on investments for the three months ended December 31, 2009consisted of the following:

 
| ·    Control  investments                                                                |   | $     | (1,000 | )      |
|--------------------------------------------------------------------------------------------------------------|--------|-------|--------|--------|
| ·    Non-Control/Non-Affiliate  investments                                              |   | 2,193 |   |
| ·    Reversal of  previously recorded unrealized depreciation upon realization of losses |   | 1,406 |   |
| Total                                                                                                        |   | $     | 2,599  |   |

 

Although ourinvestment portfolio appreciated during the three months ended December 31,2009, our entire portfolio was fair valued at 88% of cost as of December 31,2009.  The cumulative unrealizeddepreciation of our investments does not have an impact on our current abilityto pay distributions to stockholders; however, it may be an indication offuture realized losses, which could ultimately reduce our income available fordistribution.

 

**NetUnrealized Depreciation on Borrowings under Line of Credit**

 

Unrealizeddepreciation on borrowings under line of credit is the net change in the fairvalue of our line of credit borrowings during the year, including the reversalof previously recorded unrealized appreciation or depreciation when gains andlosses are realized.  We elected to applyASC 825, “Financial Instruments,” which requires that we apply a fair value methodologyto the KEF Facility.  We estimated thefair value of the KEF Facility using estimates of value provided by anindependent third party and our own assumptions in the absence of observablemarket data, including estimated remaining life, current market yield andinterest rate spreads of similar securities as of the measurement date.  The KEF Facility was fair valued at $73,531as of December 31, 2009, and unrealized depreciation of $219 was recordedfor the three months ended December 31, 2009.

 

**Net Increase (Decrease) in Net Assets Resulting fromOperations**

 

For the three months ended December 31, 2009, we realized anet increase in net assets resulting from operations of $6,326 as a result ofthe factors discussed above.  For thethree months ended December 31, 2008, we realized a net decrease in netassets resulting from operations of $9,103. Our netincrease (decrease) in net assets resulting from operations per basic anddiluted weighted average common share for the three months ended December 31,2009 and December 31, 2008 were $0.30 and ($0.43), respectively.

 

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**LIQUIDITY AND CAPITAL RESOURCES (dollar amounts in thousands,unless otherwise indicated)**

 

**OperatingActivities**

 

At December 31,2009, we had investments in debt securities of, or loans to, 46 privatecompanies with a cost basis totaling approximately $347,464.  During the three months ended December 31,2009 and December 31, 2008, the following investment activity occurred:

 

| **Quarter********Ended** | ** ** | **New********Investments (1)** | ** ** | **Principal  Repayments (2)** | ** ** | **Proceeds from  Sales/Exits (3)** | ** ** | **Net Loss on  Disposal** | ** ** |
|--------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------------------------------|------------|---------------------------|------------|
| December 31, 2009   |       | $                              | 2,171      |                          | $          | 15,404                             |       | $                         | 2,782      |   | $ | (920 | ) |
|                     |       |                           |       |                          |       |                               |       |                      |       |
| December 31, 2008   |       | $                              | 8,702      |                          | $          | 14,927                             |       | $                         | 2,212      |   | $ | (1,731 | ) |

 

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**(1)  NewInvestments:**

 

| ** **             | ** ** | **New Investments** | ** ** | **Disbursements to  Existing Portfolio** | ** ** | **Total**     | ** ** |
|------------------------|------------|---------------------|------------|------------------------------------------|------------|---------------|------------|
| **Quarter Ended** | ** ** | **Companies**       | ** ** | **Investments**                          | ** ** | **Companies** | ** ** | **Disbursements** | ** ** |
| December 31, 2009 |       | 1                   | (a)        | $                                        | 180        | ** **    | $          | 1,991 |   | $ | 2,171 | ** ** |
|                   |       |                | ** ** | ** **                               | ** ** | ** **    | ** ** | ** ** | ** ** |
| December 31, 2008 |       | —              |       | $                                        | —     |          | $          | 8,702 |   | $ | 8,702 |   |

 

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(a)          Northstar Broadband

 

**(2)****        ****Principal Repayments:**

 

| **Quarter Ended**      | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Unscheduled  Principal  Repayments (*)** | ** ** | **Scheduled  Principal  Repayments** | ** ** | **Total Principal  Repayments** | ** ** |
|------------------------|------------|----------------------------------------|------------|--------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| December 31, 2009 |       | 1                                      | (a)        | $                                          | 13,054     |                                 | $          | 2,350                           |       | $ | 15,404 |   |
|                   |       |                                   |       |                                       |       |                                 |       |                            |       |
| December 31, 2008 |       | 2                                      | (b)        | $                                          | 6,966      |                                 | $          | 7,961                           |       | $ | 14,927 |   |

 

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(*) Includesprincipal payments due to excess cash flows, covenant violations, exits,refinancings, etc.

(a)          Fullpayoff from Tulsa Welding and partial payoff from BAS Broadcasting senior termdebt (last out tranche).

(b)         Fullpayoff from CommunityMedia and Country Road.

 

**(3)****        ****Proceeds from Sales/Exits:**

 

| **Quarter Ended**      | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Proceeds  Received** | ** ** | **Position  (Principal)  Exited** | ** ** | **Unamortized  Loan Costs (*)** | ** ** | **Net Loss on  Exit** | ** ** |
|------------------------|------------|----------------------------------------|------------|------------------------|------------|-----------------------------------|------------|---------------------------------|------------|-----------------------|------------|
| December 31, 2009 |       | 2                                      | (a)        | $                      | 2,782      |                              | $          | (3,685                          | )          | (17                   | )          | $ | (920 | ) |
|                   |       |                                   |       |                   |       |                              |       |                            |       |                  |       |
| December 31, 2008 |       | —                                 | (b)        | $                      | 2,212      |                              | $          | (3,950                          | )          | 7                     |       | $ | (1,731 | ) |

 

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(*)         Includesbalance of premiums, discounts and acquisition cost at time of exit.

(a)          Completesale of Kinetek senior term debt and Wesco Holdings senior subordinated termdebt.

(b)         Partial sale of Greatwide Logisticssyndicated loan (senior term debt).

 

The followingtable summarizes the contractual principal repayments and maturity of ourinvestment portfolio by fiscal year, assuming no voluntary prepayments:

 

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| ** **                                              | ** **                                                                           | ** ** | **Amount** | ** ** |
|---------------------------------------------------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the remaining nine months ending September 30: | 2010                                                                                 |       | $          | 36,599     |   |
| For the fiscal  year ending September 30:          | 2011                                                                                 |       | 92,485     |       |
|                                                    | 2012                                                                                 |       | 72,816     |       |
|                                                    | 2013                                                                                 |       | 121,017    |       |
|                                                    | 2014                                                                                 |       | 11,773     |       |
|                                                    | 2015                                                                                 |       | 6,851      |       |
| ** **                                              | **Total Contractual Repayments**                                                     |       | 341,541    |       |
|                                                    | Investments in Equity Securities                                                     |       | 5,478      |       |
|                                                    | Unamortized premiums, discounts and investment  acquisition costs on debt securities |       | 445        |       |
| ** **                                              | **Total**                                                                            |       | $          | 347,464    |   |

 

Net cash providedby operating activities for the three months ended December 31, 2009,consisting primarily of the items described in *“—Resultsof Operations”* and the investment activity described above, was $15,069as compared to net cash provided by operating activities of $12,701 for thethree months ended December 31, 2008.

 

**FinancingActivities**

 

Net cash used infinancing activities for the three months ended December 31, 2009 was$13,971 and mainly consisted of net payments on the KEF Facility of $9,600 anddistributions to stockholders of $4,428. Net cash used in financing activities for the three months ended December 31,2008 was $13,438 and primarily consisted of distributions to stockholders of$8,856 and net repayments our line of credit of $4,560.

 

**Distributions**

 

In order toqualify as a RIC and to avoid corporate level tax on the income we distributeto our stockholders, we are required, under Subchapter M of the Code, todistribute at least 90% of our ordinary income and short-term capital gains toour stockholders on an annual basis. Further, our KEF Facility requires us topay distributions only from estimated net investment income.  Inaccordance with these requirements, we declared and paid monthly cashdistributions of $0.07 per common share for October, November and December 2009.  In January 2010, our Board of Directorsdeclared a monthly distribution of $0.07 per common share for each of January, February andMarch 2010.

 

*Section 19(a) Disclosure*

 

OurBoard of Directors estimates the source of the distributions at the time oftheir declaration as required by Section 19(a) of the 1940 Act.  On a monthly basis, if required under Section 19(a),we post a Section 19(a) notice through the Depository Trust Company’sLegal Notice System (“LENS”) and also send to our registered stockholders awritten Section 19(a) notice along with the payment of distributionsfor any payment which includes a distribution estimated to be paid from anyother source other than net investment income. The estimates of the source of the distribution are interim estimatesbased on GAAP that are subject to revision, and the exact character of thedistributions for tax purposes cannot be determined until our books and recordsare finalized for the calendar year. Following the calendar year end, after we have determined definitiveinformation, if we have made distributions of taxable income (or return ofcapital), we will deliver a Form 1099-DIV to our stockholders specifyingsuch amount and the tax characterization of such amount.  Therefore, these estimates are made solely inorder to comply with the requirements of Section 19(a) of the 1940Act and should not be relied upon for tax reporting or any other purposes andcould differ significantly from the actual character of distributions for taxpurposes.

 

Thefollowing GAAP estimates were made by our Board of Directors during the quarterended December 31, 2009:

 
| **Month Ended**        | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distribution** | ** ** |
|------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|
| October 31, 2009  |       | $                   | 0.080      |                  | $          | (0.010                 | )          | $ | 0.070 |   |
| November 30, 2009 |       | 0.079               |       | (0.009                | )          | 0.070                  |       |
| December 31, 2009 |       | 0.078               |       | (0.008                | )          | 0.070                  |       |
|                        |            |                     |            |                       |            |                        |            |  |  |  |

 

Becauseour Board of Directors declares distributions at the beginning of a quarter, itis difficult to estimate how much of our monthly distributions, based on GAAP,will come from ordinary income, capital gains and returns of capital.  Subsequent to the quarter ended December 31,2009, the following corrections were made to the above listed estimates forthat quarter:

 

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| **Month Ended**        | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distribution** | ** ** |
|------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|
| October 31, 2009  |       | $                   | 0.099      |                  | $          | (0.029                 | )          | $ | 0.070 |   |
| November 30, 2009 |       | 0.082               |       | (0.012                | )          | 0.070                  |       |
| December 31, 2009 |       | 0.029               |       | 0.041                 |       | 0.070                  |       |
|                        |            |                     |            |                       |            |                        |            |  |  |  |

 

Fordistributions declared subsequent to quarter end, the following estimates,based on GAAP, have been made pursuant to Section 19(a) of the 1940Act:

 
| **Month Ended**        | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distribution** | ** ** |
|------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|
| January 31, 2010  |       | $                   | 0.071      |                  | $          | (0.001                 | )          | $ | 0.070 |   |
| February 28, 2010 |       | 0.088               |       | (0.018                | )          | 0.070                  |       |
| March 31, 2010    |       | 0.057               |       | 0.013                 |       | 0.070                  |       |
|                        |            |                     |            |                       |            |                        |            |  |  |  |

 

**Issuanceof Equity**

 

On October 20,2009, we filed a registration statement on Form N-2 with the SEC, whichwas declared effective on January 28, 2010.  The registration statement permits us toissue, through one or more transactions, up to an aggregate of $300,000 insecurities, consisting of common stock, senior common stock, preferred stock,subscription rights, debt securities and warrants to purchase common stock, ora combination of these securities.

 

We anticipateissuing equity securities to obtain additional capital in the future.  However, we cannot determine the terms of anyfuture equity issuances or whether we will be able to issue equity on termsfavorable to us, or at all. Additionally, when our common stock is trading below NAV, we will haveregulatory constraints under the 1940 Act on our ability to obtain additionalcapital in this manner.  Generally, the1940 Act provides that we may not issue and sell our common stock at a pricebelow our NAV per share, other than to our then existing stockholders pursuantto a rights offering, without first obtaining approval from our stockholdersand our independent directors.  As of December 31,2009, our NAV per share was $11.92 and our closing market price was $7.69 pershare.  To the extent that our commonstock continues to trade at a market price below our NAV per share, we willgenerally be precluded from raising equity capital through public offerings ofour common stock, other than pursuant to stockholder approval or a rightsoffering.  The asset coverage requirementof a business development company under the 1940 Act effectively limits ourratio of debt to equity to 1:1.  To theextent that we are unable to raise capital through the issuance of equity, ourability to raise capital through the issuance of debt may also be inhibited tothe extent of our regulatory debt to equity ratio limits.

 

At our AnnualMeeting of Stockholders held on February 19, 2009, our stockholdersapproved a proposal that authorizes us to sell shares of our common stock at aprice below our then current NAV per share for a period of one year, providedthat our Board of Directors makes certain determinations prior to any suchsale.  At the upcoming Annual Meeting ofStockholders scheduled for February 18, 2010, our stockholders will beasked to vote in favor of renewing this proposal for another year.

 

**RevolvingCredit Facility**

 

On May 15,2009, we entered into the KEF Facility, which currently provides for $102,000revolving line of credit.  .  Advances under the KEF Facility willgenerally bear interest at the 30-day LIBOR or the commercial paper rate(subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of0.75% per annum on undrawn amounts.  Asof December 31, 2009, there was a cost basis of approximately $73,400 ofborrowings outstanding under the KEF Facility at an average interest rate of7.30%, and the remaining borrowing capacity under the KEF Facility was$28,600.  Available borrowings aresubject to various constraints imposed under the KEF Facility, based on theaggregate loan balance pledged by Business Loan. Interest is payable monthlyduring the term of the KEF Facility.  TheKEF Facility matures on May 14, 2010 and, if the facility is not renewedor extended by this date, all principal and interest will be due and payablewithin one year of maturity.  In addition,after May 14, 2010, if the KEF Facility is not renewed, all principalcollections from our loans are required to be used to pay outstanding principalon the KEF Facility.

 

Duringthe three months ended December 31, 2009, we reduced the size of the KEFFacility by $25,000, from $127,000 to $102,000.  Without the addition ofother committed lenders, the KEF Facility provides a total commitment of$102,000 from January 1, 2010 to May 11, 2010 and $77,000 thereafter.

 

The KEF Facility contains covenants that require Business Loan tomaintain its status as a separate entity, prohibit certain significantcorporate transactions (such as mergers, consolidations, liquidations ordissolutions), and restrict material changes to our credit and collection policies.  The facility also limits payments ofdistributions. Further, the KEF Facility requires us to pay distributions onlyfrom estimated net investment income.  Asa result of that change from our prior credit facility, we reduced ourdistribution from

 

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$0.14 per shareper month to $0.07 per share per month. As of December 31, 2009, BusinessLoan was in compliance with all of the facility covenants.

 

We applied ASC 825, “Financial Instruments,” specificallyfor the KEF Facility, which was consistent with our application of ASC 820 toour investments.  ASC 825 requires that we apply a fair value methodology to theKEF Facility. We estimated the fair value of the KEF Facility using estimatesof value provided by an independent third party and our own assumptions in theabsence of observable market data, including estimated remaining life, currentmarket yield and interest rate spreads of similar securities as of themeasurement date.  We also considered ourown credit risk.  The following tablepresents the KEF Facility carried at fair value as of December 31, 2009,by caption on the accompanying consolidated statements of assets andliabilities for each of the three levels of hierarchy established by ASC820-10:

** **
| ** **                      | ** ** | **As of December 31, 2009** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                                | —     |   | $ | — |   | $ | 73,531 |   | $ | 73,531 |   |
| Total                           |       | $                                | —     |   | $ | — |   | $ | 73,531 |   | $ | 73,531 |   |

 
| ** **                      | ** ** | **As of September 30, 2009** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |
| Total                           |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |

 

*Changesin Level 3 Fair Value Measurements*

 

The followingtable provides a roll-forward in the changes in fair value during thethree-month period from September 30, 2009 to December 31, 2009, forthe KEF Facility for which we determine fair value using unobservable (Level 3)factors. When a determination is made to classify a financial instrument withinLevel 3 of the valuation hierarchy, the determination is based upon thesignificance of the unobservable factors to the overall fair value measurement.However, Level 3 financial instruments typically include, in addition to theunobservable or Level 3 components, observable components (that is, componentsthat are actively quoted and can be validated by external sources).Accordingly, the losses in the table below include changes in fair value due inpart to observable factors that are part of the valuation methodology.

 

**Fairvalue measurements using unobservable data inputs (Level 3)**

 
| ** **                                      | ** ** | **Borrowings  under line  of credit** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|
| **Three months ended  December 31, 2009:** |       |                                  |       |
| Fair value at September 30, 2009           |       | $                                     | 83,350     |   |
| Unrealized depreciation (a)                     |       | (219                                  | )          |
| Net borrowings (b)                              |       | (9,600                                | )          |
| Transfers in (out) of Level 3                   |       | —                                |       |
| Fair value as of December 31, 2009         |       | $                                     | 73,531     |   |

 

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(a)          Included in unrealized depreciation onborrowings under line of credit on the accompanying condensed consolidatedstatements of operations for the three months ended December 31, 2009.

(b)         Includes borrowings and principalrepayments on the line of credit.

 

**ContractualObligations**

 

As of December 31,2009, we were not party to any signed term sheets for potential investments.

 

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**Off-BalanceSheet Arrangements**

 

We did not haveany off-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofRegulation S-K as of December 31, 2009.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported consolidated amounts ofassets and liabilities, and disclosure of contingent assets and liabilities atthe date of the financial statements, and revenues and expenses during theperiod reported. Actual results could differ materially from those estimates.  We have identified our investment valuationprocess, which was modified during the three months ended September 30,2009, as our most critical account policy.

 

***Investment Valuation***

 

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

 

*GeneralValuation Policy:*  We value our investments in accordance withthe requirements of the 1940 Act.  Asdiscussed more fully below, we value securities for which market quotations arereadily available and reliable at their market value.  We value all other securities and assets atfair value as determined in good faith by our Board of Directors.

 

We adoptedguidance for fair value measurements on October 1, 2008. In part, thisguidance defines fair value, establishes a framework for measuring fair value,and expands disclosures about assets and liabilities measured at fair value.The guidance provides a consistent definition of fair value that focuses onexit price in the principal, or most advantageous, market and prioritizes,within a measurement of fair value, the use of market-based inputs overentity-specific inputs. The guidance also establishes the following three-levelhierarchy for fair value measurements based upon the transparency of inputs tothe valuation of an asset or liability as of the measurement date.

 

·                  *Level 1*—inputs to the valuation methodology arequoted prices (unadjusted) for identical assets or liabilities in activemarkets;

 

·                  *Level 2*—inputs to the valuation methodologyinclude quoted prices for similar assets and liabilities in active markets, andinputs that are observable for the asset or liability, either directly orindirectly, for substantially the full term of the financial instrument. Level2 inputs are in those markets for which there are few transactions, the pricesare not current, little public information exists or instances where pricesvary substantially over time or among brokered market makers; and

 

·                  *Level 3*—inputs to the valuation methodology areunobservable and significant to the fair value measurement. Unobservable inputsare those inputs that reflect our own assumptions that market participantswould use to price the asset or liability based upon the best availableinformation.

 

See Note 3, *“Investments”* in the accompanying notes to the condensedconsolidated financial statements for additional information regarding fairvalue measurements.

 

We use generallyaccepted valuation techniques to value our portfolio unless we have specificinformation about the value of an investment to determine otherwise. From timeto time we may accept an appraisal of a business in which we hold securities.These appraisals are expensive and occur infrequently but provide a third-partyvaluation opinion that may differ in results, techniques and scopes used tovalue our investments.  When thesespecific third-party appraisals are engaged or accepted, we would use estimatesof value provided by such appraisals and our own assumptions includingestimated remaining life, current market yield and interest rate spreads ofsimilar securities as of the measurement date to value the investment we havein that business.

 

In determining thevalue of our investments, our Adviser has established an investment valuationpolicy (the “Policy”).  The Policy hasbeen approved by our Board of Directors, and each quarter our Board ofDirectors reviews whether our Adviser has applied the Policy consistently andvotes whether or not to accept the recommended valuation of our investmentportfolio.

 

The Policy, whichis summarized below, applies to the following categories of securities:

 

·                  Publicly-traded securities;

·                  Securities for which a limited market exists; and

·                  Securities for which no market exists.

 

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*ValuationMethods:*

 

**Publicly-tradedsecurities:** Wedetermine the value of publicly-traded securities based on the closing pricefor the security on the exchange or securities market on which it is listed andprimarily traded on the valuation date. To the extent that we own restrictedsecurities that are not freely tradable, but for which a public marketotherwise exists, we will use the market value of that security adjusted forany decrease in value resulting from the restrictive feature.

 

**Securitiesfor which a limited market exists:**We value securities that are not traded on anestablished secondary securities market, but for which a limited market for thesecurity exists, such as certain participations in, or assignments of,syndicated loans, at the quoted bid price. In valuing these assets, we assess trading activity in an asset class,evaluate variances in prices and other market insights to determine if anyavailable quote prices are reliable.  Ifwe conclude that quotes based on active markets or trading activity may berelied upon, firm bid prices are requested; however, if a firm bid price isunavailable, we base the value of the security upon the indicative bid priceoffered by the respective originating syndication agent’s trading desk, orsecondary desk, on or near the valuation date. To the extent that we use the indicative bid price as a basis forvaluing the security, our Adviser may take further steps to consider additionalinformation to validate that price in accordance with the Policy.

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, we will value our syndicated loans using estimated net presentvalues of the future cash flows or discounted cash flows. The use of a DCFmethodology follows that prescribed by ASC 820, which provides guidance on theuse of a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in ASC 820 is the use of valuinginvestments based on DCF.  For thepurposes of using DCF to provide fair value estimates, we consider multipleinputs such as a risk-adjusted discount rate that incorporates adjustments thatmarket participants would make both for nonperformance and liquidityrisks.  As such, we develop a modifieddiscount rate approach that incorporates risk premiums including, among others,increased probability of default, or higher loss given default, or increasedliquidity risk.  The DCF valuationsapplied to the syndicated loans provide an estimate of what we believe a marketparticipant would pay to purchase a syndicated loan in an active market, therebyestablishing a fair value.  We willcontinue to apply the DCF methodology in illiquid markets until quoted pricesare available or are deemed reliable based on trading activity.

 

As of December 31,2009, we assessed trading activity in syndicated loan assets and determinedthat there continued to be market liquidity and a functioning secondary marketfor these assets.  Thus, firm bid pricesor indicative bids were used to fair value our remaining syndicated loans at December 31,2009. However, for the syndicated loan sale completed after December 31,2009, we used the sales price to value such syndicated loan.

 

**Securitiesfor which no market exists:** The valuation methodology for securities for which nomarket exists falls into three categories: (1) portfolio investmentscomprised solely of debt securities; (2) portfolio investments incontrolled companies comprised of a bundle of securities, which can includedebt and equity securities; and (3) portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities.

 

(1)          **Portfolio investmentscomprised solely of debt securities:** Debt securities that are not publicly traded on anestablished securities market, or for which a limited market does not exist (“Non-PublicDebt Securities”), and that are issued by portfolio companies where we have noequity or equity-like securities, are fair valued in accordance with the termsof the policy, which utilizes opinions of value submitted to us by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”). We may also submit PIKinterest to SPSE for their evaluation when it is determined that PIK interestis likely to be received.

 

In the case of Non-Public Debt Securities, we have engaged SPSE tosubmit opinions of value for our debt securities that are issued by portfoliocompanies in which we own no equity, or equity-like securities.  SPSE’s opinions of value are based on thevaluations prepared by our portfolio management team as described below.  We request that SPSE also evaluate and assignvalues to success fees (conditional interest included in some loan securities)when we determine that there is reasonable probability of receiving a successfee on a given loan. SPSE will only evaluate the debt portion of ourinvestments for which we specifically request evaluation, and may decline tomake requested evaluations for any reason at its sole discretion. Uponcompleting our collection of data with respect to the investments (which mayinclude the information described below under “—Credit Information,” the riskratings of the loans described below under “—Loan Grading and Risk Rating” andthe factors described hereunder), this valuation data is forwarded to SPSE forreview and analysis. SPSE makes its independent assessment of the data that wehave assembled and assesses its independent data to form an opinion as to whatthey consider to be the market values for the securities. With regard to itswork, SPSE has issued the following paragraph:

 

SPSE provides evaluated price opinions which are reflective of whatSPSE believes the bid side of the market would be for each loan after carefulreview and analysis of descriptive, market and credit information. Each pricereflects SPSE’s best judgment based upon careful examination of a variety ofmarket factors. Because of fluctuation in the market and in other 

 

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factors beyond its control, SPSE cannot guarantee these evaluations.The evaluations reflect the market prices, or estimates thereof, on the datespecified. The prices are based on comparable market prices for similarsecurities. Market information has been obtained from reputable secondarymarket sources. Although these sources are considered reliable, SPSE cannotguarantee their accuracy.

 

SPSE opinions of value of our debt securities that are issued byportfolio companies where we have no equity or equity-like securities aresubmitted to our Board of Directors along with our Adviser’s supplementalassessment and recommendation regarding valuation of each of these investments.Our Adviser generally accepts the opinion of value given by SPSE, however, incertain limited circumstances, such as when our Adviser may learn newinformation regarding an investment between the time of submission to SPSE andthe date of our Board of Directors’ assessment our Adviser’s conclusions as tovalue may differ from the opinion of value delivered by SPSE. Our Board ofDirectors then reviews whether our Adviser has followed its establishedprocedures for determinations of fair value, and votes to accept or reject therecommended valuation of our investment portfolio. Our Adviser and our managementrecommended, and our Board of Directors voted to accept, the opinions of valuedelivered by SPSE on the loans in our portfolio as denoted on the Schedule ofInvestments included in our accompanying condensed consolidated financialstatements.

 

Because there is a delay between when we close an investment and whenthe investment can be evaluated by SPSE, new loans are not valued immediatelyby SPSE; rather, management makes its own determination about the value ofthese investments in accordance with our valuation policy using the methodsdescribed herein.

 

(2)          **Portfolio investments incontrolled companies comprised of a bundle of investments, which can includedebt and equity securities:** The fair value of these investments is determinedbased on the total enterprise value of the portfolio company, or issuer,utilizing a liquidity waterfall approach. For Non-Public Debt Securities and equity or equity-like securities(e.g. preferred equity, equity, or other equity-like securities) that arepurchased together as part of a package, where we have control or could gaincontrol through an option or warrant security, both the debt and equitysecurities of the portfolio investment would exit in the mergers andacquisitions market as the principal market, generally through a sale orrecapitalization of the portfolio company. In accordance with ASC 820-10, weapply the in-use premise of value which assumes the debt and equity securitiesare sold together. Under this liquidity waterfall approach, we continue to usethe enterprise value methodology utilizing a liquidity waterfall approach todetermine the fair value of these investments under ASC 820-10 if we have theability to initiate a sale of a portfolio company as of the measurement date.Under this approach, we first calculate the total enterprise value of theissuer by incorporating some or all of the following factors:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  discounted cash flow or other pertinent factors.

 

In gathering the sales to third parties of similar securities, we mayreference industry statistics and use outside experts. Once we have estimatedthe total enterprise value of the issuer, we subtract the value of all the debtsecurities of the issuer; which are valued at the contractual principalbalance. Fair values of these debt securities are discounted for any shortfallof total enterprise value over the total debt outstanding for the issuer. Oncethe values for all outstanding senior securities (which include the debt securities)have been subtracted from the total enterprise value of the issuer, theremaining amount, if any, is used to determine the value of the issuer’s equityor equity-like securities.  If, in ourAdviser’s judgment, the liquidity waterfall approach does not accuratelyreflect the value of the debt component, our Adviser may recommend that we usea valuation by SPSE or, if that is unavailable, a DCF valuation technique.

 

(3)          **Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities:**We value Non-Public Debt Securities that are purchasedtogether with equity and equity-like securities from the same portfoliocompany, or issuer, for which we do not control or cannot gain control as of themeasurement date, using a hypothetical secondary market as our principalmarket. In accordance with ASC 820-10, we determine the fair value of thesedebt securities of non-control investments assuming the sale of an individualdebt security using the in-exchange premise of value. As such, we estimate thefair value of the debt component using estimates of value provided by SPSE andour own assumptions in the absence of observable market data, includingsynthetic credit ratings, estimated remaining life, current market yield andinterest rate spreads of similar securities as of the measurement date. Forequity or equity-like securities of investments for which we do not control orcannot gain control as of the measurement date, we estimate the fair value ofthe equity using the in-exchange premise of value based on factors such as theoverall value of the issuer, the relative fair value of other units of accountincluding debt, or other relative value approaches. Consideration also is givento capital structure and other contractual obligations that may impact the fairvalue of the equity. Further, we may utilize comparable values of similarcompanies, recent 

 

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investments and indices with similar structures and riskcharacteristics or our own assumptions in the absence of other observablemarket data and may also employ DCF valuation techniques.

 

Due to the uncertainty inherent in the valuation process, suchestimates of fair value may differ significantly from the values that wouldhave been obtained had a ready market for the securities existed, and thedifferences could be material. Additionally, changes in the market environmentand other events that may occur over the life of the investments may cause thegains or losses ultimately realized on these investments to be different thanthe valuations currently assigned. There is no single standard for determiningfair value in good faith, as fair value depends upon circumstances of eachindividual case. In general, fair value is the amount that we might reasonablyexpect to receive upon the current sale of the security in an arms-lengthtransaction in the security’s principal market.

 

*ValuationConsiderations: *From time to time, depending on certaincircumstances, the Adviser may use the following valuation considerations,including but not limited to:

 

·                  the nature andrealizable value of the collateral;

·                  the portfolio company’searnings and cash flows and its ability to make payments on its obligations;

·                  the markets in whichthe portfolio company does business;

·                  the comparison topublicly traded companies; and

·                  DCF and other relevantfactors.

 

Because such valuations, particularly valuations of private securities andprivate companies, are not susceptible to precise determination, may fluctuateover short periods of time, and may be based on estimates, our determinationsof fair value may differ from the values that might have actually resulted hada readily available market for these securities been available.

 

*CreditInformation:*  Our Adviser monitors a wide variety of keycredit statistics that provide information regarding our portfolio companies tohelp us assess credit quality and portfolio performance. We and our Adviserparticipate in the periodic board meetings of our portfolio companies in whichwe hold Control and Affiliate investments and also require them to provideannual audited and monthly unaudited financial statements. Using thesestatements or comparable information and board discussions, our Advisercalculates and evaluates the credit statistics.

 

*LoanGrading and Risk Rating:*  As part of our valuationprocedures above, we risk rate all of our investments in debt securities. Forsyndicated loans that have been rated by an NRSRO (as defined in Rule 2a-7under the 1940 Act), we use the NRSRO’s risk rating for such security. For allother debt securities, we use a proprietary risk rating system. Our risk ratingsystem uses a scale of 0 to 10, with 10 being the lowest probability ofdefault. This system is used to estimate the probability of default on debtsecurities and the probability of loss if there is a default. These types ofsystems are referred to as risk rating systems and are used by banks and ratingagencies. The risk rating system covers both qualitative and quantitativeaspects of the business and the securities we hold.

 

For the debtsecurities for which we do not use a third-party NRSRO risk rating, we seek tohave our risk rating system mirror the risk rating systems of major risk ratingorganizations, such as those provided by an NRSRO. While we seek to mirror theNRSRO systems, we cannot provide any assurance that our risk rating system willprovide the same risk rating as an NRSRO for these securities. 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 our system rates debt securities of companies that areunrated by any NRSRO, there can be no assurance that the correlation to theNRSRO set out below is accurate. We believe our risk rating would besignificantly higher than a typical NRSRO risk rating because the risk ratingof the typical NRSRO is designed for larger businesses. However, our riskrating has been designed to risk rate the securities of smaller businesses thatare not rated by a typical NRSRO. Therefore, when we use our risk rating onlarger business securities, the risk rating is higher than a typical NRSROrating. The primary difference between our risk rating and the rating of atypical NRSRO is that our risk rating uses more quantitative determinants andincludes qualitative determinants that we believe are not used in the NRSROrating. It is our understanding that most debt securities of medium-sizedcompanies do not exceed the grade of BBB on an NRSRO scale, so there would beno debt securities in the middle market that would meet the definition of AAA,AA or A. Therefore, our scale begins with the designation 10 as the best riskrating which may be equivalent to a BBB from an NRSRO, however, no assurancecan be given that a 10 on our scale is equal to a BBB on an NRSRO scale.

 

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| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone  Capital’s Description(a)**                                                           | ** ** |
|----------------------------|------------|------------------|------------|-------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of  Default (PD) during the next ten years is 4% and the Expected Loss (EL) is 1%  or less |       |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5% and the  EL is 1% to 2%                                                                       |       |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10% and  the EL is 2% to 3%                                                                      |       |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16% and  the EL is 3% to 4%                                                                      |       |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8% and  the EL is 4% to 5%                                                                    |       |
| **6**                      |       | B1               |       | B+                |       | PD is 22% 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% 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 setforth are for a ten year term debt security. If a debt security is less thanten years, then the probability of default is adjusted to a lower percentagefor the shorter period, which may move the security higher on our risk ratingscale.*

 

The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default. Our policy is to stop accruing interest on an investmentif we determine that interest is no longer collectible. At each of December 31,2009 and September 30, 2009, one Non-Control/Non-Affiliate investment andfour Control investments were on non-accrual. Additionally, we do not risk rate our equity securities.

 

The followingtable lists the risk ratings for all non-syndicated loans in our portfolio at December 31,2009 and September 30, 2009, representing approximately 97% and 96%,respectively, of all loans in our portfolio at the end of each period:

 
| **Rating**       | ** ** | **Dec. 31, 2009** | ** ** | **Sept. 30, 2009** | ** ** |
|------------------|------------|------------------------|------------|--------------------|------------|
| Average          | ** ** | **7.2**                | ** ** | **7.1**            | ** ** |
| Weighted Average | ** ** | **7.1**                | ** ** | **7.2**            | ** ** |
| Highest          | ** ** | **9.0**                | ** ** | **9.0**            | ** ** |
| Lowest           | ** ** | **5.0**                | ** ** | **3.0**            | ** ** |

 

The followingtable lists the risk ratings for all syndicated loans in our portfolio that werenot rated by an NRSRO at December 31, 2009 and September 30, 2009,representing approximately 2% of all loans in our portfolio at the end of eachperiod:

 
| **Rating**       | ** ** | **Dec. 31, 2009** | ** ** | **Sept. 30, 2009** | ** ** |
|------------------|------------|------------------------|------------|--------------------|------------|
| Average          | ** ** | **8.0**                | ** ** | **7.0**            | ** ** |
| Weighted Average | ** ** | **8.0**                | ** ** | **7.0**            | ** ** |
| Highest          | ** ** | **8.0**                | ** ** | **7.0**            | ** ** |
| Lowest           | ** ** | **8.0**                | ** ** | **7.0**            | ** ** |

 

For syndicatedloans that are currently rated by an NRSRO, we risk rate such loans inaccordance with the risk rating systems of major risk rating organizations,such as those provided by an NRSRO. The following table lists the risk ratingsfor all syndicated loans in our portfolio that were rated by an NRSRO at December 31,2009 and September 30, 2009, representing approximately 1% and 2%,respectively, of all loans in our portfolio at the end of each period:

 
| **Rating**       | ** ** | **Dec. 31, 2009** | ** ** | **Sept.30, 2009** | ** ** |
|------------------|------------|------------------------|------------|-------------------|------------|
| Average          |       | CCC+/Caa1              |       | CCC+/Caa1         |       |
| Weighted Average |       | B-/B3                  |       | CCC+/Caa1         |       |
| Highest          |       | B/B2                   |       | B-/B3             |       |
| Lowest           |       | D/Ca                   |       | D/C               |       |

 

***Tax Status***

 

We intend tocontinue to qualify for treatment as a RIC under Subtitle A, Chapter 1 ofSubchapter M of the Code. As a RIC, we are not subject to federal income tax onthe portion of our taxable income and gains distributed to stockholders. Toqualify as a RIC, we must meet certain source-of-income, asset diversification,and annual distribution requirements.  Underthe annual distribution 

 

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requirement, weare required to distribute to stockholders at least 90% of our investmentcompany taxable income, as defined by the Code. We have a policy to pay out as a distribution up to 100% of that amount.

 

In an effort toavoid certain excise taxes imposed on RICs, we currently intend to distributeduring each calendar year, an amount at least equal to the sum of (1) 98%of our ordinary income for the calendar year, (2) 98% of our capital gainsin excess of capital losses for the one-year period ending on October 31of the calendar year and (3) any ordinary income and net capital gains forpreceding years that were not distributed during such years.

 

***Revenue Recognition***

 

*Interest Income Recognition*

 

Interest income,adjusted for amortization of premiums and acquisition costs and for theaccretion of discounts, is recorded on the accrual basis to the extent thatsuch amounts are expected to be collected. Generally, when a loan becomes 90 days or more past due or if ourqualitative assessment indicates that the debtor is unable to service its debtor other obligations, we will place the loan on non-accrual status and ceaserecognizing interest income on that loan until the borrower has demonstratedthe ability and intent to pay contractual amounts due.  However, we remain contractually entitled tothis interest.  At December 31,2009, two Non-Control/Non-Affiliate investments and four Control investmentswere on non-accrual with an aggregate cost basis of approximately $13,001 or 3.7%of the cost basis of all investments in our portfolio.  At September 30, 2009, one Non-Control/Non-Affiliateinvestment and four Control investments were on non-accrual with an aggregatecost basis of approximately $10,022 or 2.8% of the cost basis of allinvestments in our portfolio. Conditional interest, or a success fee, is recorded when earned or uponfull repayment of a loan investment.

 

*Paid in Kind Interest*

 

Twoloans in our portfolio contain PIK provisions. The PIK interest, computed atthe contractual rate specified in each loan agreement, is added to theprincipal balance of the loan and recorded as interest income. To maintain ourstatus as a RIC, this non-cash source of income must be paid out tostockholders in the form of distributions, even though we have not yetcollected the cash.   For the threemonths ended December 31, 2009 and 2008, we recorded PIK income of $51 and$17, respectively.

 

*Services Provided to Portfolio Companies*

 

As a business development company under the 1940 Act, we are requiredto make available significant managerial assistance to our portfolio companies.We provide these services through our Adviser, who provides these services onour behalf through its officers who are also our officers.  Currently, neither we nor our Adviser chargesa fee for managerial assistance, however, if our Adviser does receive fees for suchmanagerial assistance, our Adviser will credit the managerial assistance feesto the base management fee due from us to our Adviser.

 

Our Adviser receives fees for the other services it provides to ourportfolio companies.  These other feesare typically non-recurring, are recognized as revenue when earned and aregenerally paid directly to our Adviser by the borrower or potential borrowerupon the closing of the investment. The services our Adviser provides to ourportfolio companies vary by investment, but generally include a broad array ofservices such as investment banking services, arranging bank and equityfinancing, structuring financing from multiple lenders and investors, reviewingexisting credit facilities, restructuring existing investments, raising equityand debt capital, turnaround management, merger and acquisition services andrecruiting new management personnel. When our Adviser receives fees for these services, 50% of certain ofthose fees are voluntarily and irrevocably credited against the base managementfee that we pay to our Adviser, whereas prior to such date fees were 100%credited.  Any services of this naturesubsequent to the closing would typically generate a separate fee at the time ofcompletion.

 

Our Adviser also receives fees for monitoring and reviewing portfoliocompany investments.  These fees arerecurring and are generally paid annually or quarterly in advance to ourAdviser throughout the life of the investment. Fees of this nature are recorded as revenue by our Adviser when earnedand are not credited against the base management fee.

 

We may receive fees for the origination and closing services we provideto portfolio companies through our Adviser. These fees are paid directly to us and are recognized as revenue uponclosing of the originated investment and are reported as fee income in theaccompanying condensed consolidated statements of operations.

 

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**RecentAccounting Pronouncements**

 

Refer to Note 2 inthe accompanying condensed consolidated financial statements for a summary ofrecently issued accounting pronouncements.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK.**

 

We are subject tofinancial market risks, including changes in interest rates.  We estimate that ultimately approximately 20%of the loans in our portfolio will be made at fixed rates and approximately 80%will be made at variable rates.  As of December 31,2009, our portfolio consisted of the following:

 
| 84  | % | variable rates  with a floor               |
|-----|---|--------------------------------------------|
| 2   | % | variable rates  with a floor and ceiling   |
| 10  | % | variable rates  without a floor or ceiling |
| 4   | % | fixed rate                                 |
| 100 | % | total                                      |

 

There have been nomaterial changes in the quantitative and qualitative market risk disclosuresfor the three months ended December 31, 2009 from that disclosed in ourAnnual Report on Form 10-K for the fiscal year ended September 30,2009, as filed with the SEC on November 23, 2009.

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

a) Evaluation ofDisclosure Controls and Procedures

 

As of December 31,2009, we, including our Chief Executive Officer and Chief Financial Officer,evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)).  Based on that evaluation,our management, including the Chief Executive Officer and Chief FinancialOfficer, concluded that our disclosure controls and procedures were effectivein timely alerting management, including the Chief Executive Officer and ChiefFinancial Officer, of material information about us required to be included inperiodic Securities and Exchange Commission filings.  However, in evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

b) Changes inInternal Control over Financial Reporting

 

There have been nochanges in our internal control over financial reporting that occurred duringthe quarter ended December 31, 2009, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II—OTHERINFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

Neitherwe nor any of our subsidiaries are currently subject to any material legalproceeding, nor, to our knowledge, is any material legal proceeding threatenedagainst us or any of our subsidiaries.

 

**ITEM 1A. RISK FACTORS.**

 

Our business issubject to certain risks and events that, if they occur, could adversely affectour financial condition and results of operations and the trading price of ourcommon stock.  For a discussion of theserisks, please refer to the “Risk Factors” section of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2009, filed by us with the SEC on November 23,2009.

 

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

 

Notapplicable.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES.**

 

Notapplicable.

 

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

 

Notapplicable

 

**ITEM 5. OTHER INFORMATION.**

 

Notapplicable

 

**ITEM 6.  EXHIBITS**

 

Seethe exhibit index.

 

**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** ** | **GLADSTONE  CAPITAL CORPORATION** |
|------------|------------------------------------|
|       |                               |
|       | By:                                | /s/ GRESFORD  GRAY |
|       | Gresford Gray                      |
|       | Chief Financial  Officer           |

 

Date:February 1, 2010

 

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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.                                                                   |
|        |       |                                                                                                                                                                                                                                                                |
| 3.3         |       | Amendment to  By-laws, incorporated by reference to Exhibit 3.3 to the Company’s Quarterly  Report on Form 10-Q for the quarter ended December 31, 2003 (File  No. 814-00237), filed February 17, 2004.                               |
|        |       |                                                                                                                                                                                                                                                                |
| 3.4         |       | Second amendment  to By-laws, incorporated by reference to Exhibit 99.1 to the Company’s  Current Report on Form 8-K (File No. 814-00237), filed  July 10, 2007.                                                                           |
|        |       |                                                                                                                                                                                                                                                                |
| 11          |       | Computation of  Per Share Earnings (included in the notes to the unaudited condensed  consolidated financial statements contained in this report).                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                |
| 31.1        |       | Certification of  Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                |
| 31.2        |       | Certification of  Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                |
| 32.1        |       | Certification of  Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                |
| 32.2        |       | Certification of  Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                               |

 

Allother exhibits for which provision is made in the applicable regulations of theSecurities and Exchange Commission are not required under the relatedinstruction or are inapplicable and therefore have been omitted.

 

48

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